Markets have turned positive since our last report, as a resolution on the debt ceiling, improving inflation numbers, and a pause on interest rate hikes have buoyed sentiment and returns. An “AI Boom” has also helped drive a significant rally in large cap tech stocks, with the S&P 500 now officially over +20% from its low, a common definition for the beginning of a new bull market. However, while this bounce has certainly been welcome, the rally has been concentrated in just a few stocks and the broader market is barely higher for the year. This places greater pressure on an earnings recovery to maintain these lofty levels.
The greatest cloud to clear in the last month was the debt ceiling showdown, which not only weighed on the stock market but also caused distortions in the US Treasury and debt markets. As the clock ticked closer to the deadline, economists were attempting to predict the fallout of the unthinkable, a default of the US government. Markets, however, started to sniff out a deal in the days before, and fortunately a resolution was reached without the volatility seen in prior standoffs. Ultimately, the thin majorities in Congress and presence of a larger number of moderates forced a deal to happen, which markets gladly welcomed.
In terms of economic data, we saw a variety of reports which continue to paint a picture of an economy that is slowing but still resilient. The May jobs report showed over 300,000 jobs created, while retail sales show a consumer continuing to spend even as they pare back and rely more on credit. The jobs market appears to be in that “goldilocks” zone of healthy job creation but at rate which is creating less wage pressure in the economy.
Critically for the market, the headline CPI figure dropped to 4.0% in May, which is showing progress in the Fed’s fight against inflation. The inflation rate has been helped lower by declining oil and food prices that have come back to Earth after surging last year. These improvements have given the Federal Reserve some breathing room to pause its interest rate hikes while they wait and see what happens. However, despite these improvements, core inflation rates, which strip out these volatile food and energy prices, are still above target, as areas like housing, car prices, and services remain elevated. For this reason, the Fed is leaving the window open for more increases if needed.
In sum, markets are feeling optimistic of late and understandably so. However, the rally has not been felt equally across the market, with 10 stocks accounting for 90% of the S&P 500’s gain year to date. The other 490 stocks are collectively up only around 2%, which reflects the fact that earnings are still very much under pressure despite the recent uptick in sentiment. In fact, earnings are down 3% year over year even as the market is up double digits. So something has to give, and the pressure will be on earnings in the coming quarters to improve their outlook.
We also need to see more breadth in the rally. In other words, a lot more stocks need to take out their 52-week highs than just a few big ones in the tech sector. Looking at the historical data suggests this rally could have real legs to it, based on prior times inflation has dropped and the Fed paused its interest rate hikes. But it’s no guarantee and Wall Street analysts are quite split right now as to whether we’ve really exited this bear market or not.
You can be assured we are continually monitoring these developments and remain on the lookout for opportunities in portfolios. We have made some shifts in our bond strategy this year to not only reduce risks ahead of the debt standoff, but also take advantage of higher interest rates, which we believe may be peaking. On the equity side, we’ve been making tactical shifts to trim outperformers which we think will be more tempered going forward, while adding in names we think are attractively priced and offer strong long-term potential. We’ve also got several stocks researched and “on deck” for the next window of opportunity.