Goldilocks and a Few Bears
• The Fed will increase rates one more time in July by 25 basis points, the 11th hike since March 2022. The question remains: Is this the final hike, a pause, or a matter to be continued in September?
• The current Consumer Price Index reading of 3% represents a 6.1% decline from last year and is its largest drop since 2009.
• Although job growth has slowed since the post-pandemic recovery, businesses still added +200,000 jobs monthly for the past 30 months.
• As of this writing, 87% of the S&P stocks are over their 50-day moving average while 81% have passed their 100-day moving average and 73% are above their 200-day moving average.
A Month Later
Following up on last month’s Market Perspectives, “A Stealth Goldilocks Market,” the markets continue to surprise despite the aging recession countdown. Earlier this year, investors were convinced that a hard landing was inevitable. A few months later the mood changed, and the worst-case scenario faded quickly. Now, changing investor moods have also translated into market momentum. Since the beginning of June, both the Nasdaq and S&P 500 are up roughly 1% a week, while the Russell 2000 (small cap) has averaged about 1.5% weekly for the past seven weeks.
Although the Fed has dramatically raised rates this year, that has really had little impact on the consumer. Significant accumulated pandemic-era savings, low-interest rates financing consumption trends, and rising markets have all led to the current economic crossroads.
Despite the impact of Fed rate hikes on rate-sensitive sectors of the economy—housing markets, manufacturing and bank loans—consumers are looking beyond today’s rates and feeling a bit more optimistic. As just one example, the latest July Conference Board’s Consumer Conference Index shows consumer optimism levels hitting a new two-year high. Slowing inflation growth trends in June have helped dispel any near-term recession odds.
Market watchers are also dismissing another indicator, the much-heralded yield curve inversion (shorter-term yields higher than longer maturity yields), as a near-perfect recession predictor. To date, the curves have been inverted for about a year, but no recession has arrived, despite endless conversations that one is imminent. Also notable is the Leading Economic Indicators survey, which has been declining for 15 months—the longest streak of consecutive decreases since the 2007-2008 runup to the Great Recession. Again, predictions have fallen short of gauging the timing of a recession (possibly the first half of last year?), but June’s data now suggests economic activity will continue to decelerate in the months ahead, coupled with the Conference Board’s prediction that the U.S. economy is likely to be in recession from Q3, 2023 to Q1, 2024.
While the deterioration of LEI data and inverted yield curves remain at the forefront of market risks, upcoming GDP estimates appear to be pushing the risk, or the timing, later into next year. This month’s Wall Street Journal polling of economists lowered the probability of a recession over the next 12 months to 54% from 61% in the prior two surveys. That drop was the largest since August 2020. Even though economists still expect GDP to contract, it would likely be 0.1% in the fourth quarter of 2023. Meanwhile, the Atlanta Fed is a bit more optimistic, at least earlier this year, based on their GDPNow model with a prediction for this past Q2 of an annualized 1.7%.
To the investor, this still seems to be a Goldilocks market. The attitude is that the “hard landing” scenario has been taken off the table; inflation growth will continue to fall, albeit more slowly, and the rate hikes will soon lead to rate cuts. A number of fan favorite stocks (Microsoft, Amazon, Nvidia, Google, etc.) are priced to perfection, and investor surveys such as the American Association of Individual Investors (AAII) show the highest percentage of bulls (51%) in almost two years and the lowest level of bearish investors in two years at 21%.
A Goldilocks Outlook
Full Employment Levels (close enough)
Job growth has slowed considerably since the post-pandemic recovery period, but that has not kept businesses from adding more than 200,000 jobs a month for the past 30 months; this growth is despite rising inflation levels, interest rate hikes, a few industry rollbacks and worries over the impending recession.
Although new job openings have dropped from earlier in the year—now sitting at 9.8 million jobs available—a comfortable margin of 1.8 openings still exists for those unemployed and looking. Initial claims are also up a bit despite continuing claims sitting at their lowest level since mid-February, as the nation’s unemployment rate appears to have settled in a range of around 3.6%.
Whether or not these levels are sustainable over the next 12 months is an open-ended question, but the June employment report from the Bureau of Labor Statistics (BLS) points to a still somewhat stabilized labor market. Approximately 209,000 jobs were added last month with state government adding 27,000 new positions and federal jobs up by 32,000. Healthcare increased by 41,000 positions, construction was up 23,000, and professional and business services added 21,000 new employees. Last was leisure and hospitality, adding 21,000 service jobs (but still 369,000 below February 2020 levels, as evidenced by the “help wanted” signs at your favorite restaurant/store). A few notable losses included brick-and-mortar retailers, down by 11,000 jobs, and transportation and warehousing with a loss of 7,000 jobs.
Digging a bit deeper, on a statewide basis, BLS data also noted that currently, 25 states are at or within 0.1% of their record low unemployment levels. The highest jobless level is in Nevada at 5.4%, and California is a distant second at 4.6%.
We see no real recession concerns reflected in the labor markets—yet.
Inflation Management Appears to be Working…Timing is Key
The inflation report for June was weaker than expected in both headline and core readings. In fact, the most recent 3% CPI level (Consumer Price Index) represents a 6.1% decline from its 12-month high last year; it also represents its largest drop since July 2009.
The more Fed-sensitive indicator, Core Inflation (excludes fuel and food) is still rather sticky, however, and highlights a more stubborn level of 4.8% annualized inflation growth. Look a bit further out, however, and the trend still tracks downward with the 12 months posting the smallest year-over-year gain since October 2021 and following the 5.3% increase in May. Also noteworthy was a drop in the Producers Price Index (PPI). After falling for 12 consecutive months, annualized PPI growth now sits at 0.1%, representing its lowest level of inflation growth since August 2020.
And as noted by the Bespoke Research team, another interesting trend is a new high in the spread (or difference) between the CPI and PPI inflation growth levels. Looking back seven decades through all previous spread highs, these instances generally have occurred later in a recession or in the early months of an economic expansion. Bespoke data also noted that on average, 12 months following the seven historical occurrences where such a wide gap in the CPI-PPI spread exists, returns averaged a positive 19.32%.
Two other observations around June’s inflation data: first, declining inflation levels appear to have further bolstered investor hopes that the Federal Reserve is near the end of its rate hiking cycle. And most of the shortages and price spirals induced by consumer demand spikes fueled by Covid stay-at-home shopping and supply chain backlogs are quickly fading in the rearview mirror.
Housing Foundations Still Solid
Against conventional wisdom, homebuilding industry stocks have managed to hit recent market highs as a few builders are reporting better-than-expected backlogs, homes closed and earnings surprises. As an example, one homebuilder Lennar recently reported quarterly earnings with net profits of $872 million, having closed on 17,074 completed homes, a sales backlog of 20,214 homes, and net margins of nearly 16%. Though somewhat atypical with worries of a hard landing recession around the corner, Lennar’s stock was also up 41% through this year. The question, of course, is, are such trends sustainable with mortgage rates still hovering around 6.7%?
Although housing prices have remained elevated and affordability for the average homeowner has continued to slip, existing housing shortages and buyer demand has supported current price levels. According to the National Association of Realtors, today’s existing home inventory of 1.08 million homes is at the lowest monthly level (May’s most recent data) since 1999, lower by 13.6% from last year. Based on July’s data from Redfin, only about 1% of existing U.S. homes have changed hands during the first six months of 2023, the lowest turnover rate in at least a decade. This data is a reminder of the number of homeowners “trapped” by their low mortgage rate loans in their current home.
As a result, shortages of existing homes have pushed new buyers toward new home construction, which in May accounted for 30% of single-family home purchases (normally 10-20%). This trend doesn’t seem to be subsiding, and until rates fall, fewer homeowners will be enticed to put up “For Sale” signs. As expected, new housing permits, starts and completions have also been trending upward since the beginning of the year; permits are up 23%, starts and completions are both up approximately 6%, and new home mortgage applications for June are up 26% versus last year. Although pricing issues remain, new construction should help alleviate or stabilize home prices. In the meantime, the building industry is counting on rates beginning to reverse early next year.
Running With the Bulls
On October 12 last year, the S&P fell to a bear market low, down more than 20% from the prior January highs. Nine months later, the S&P was up 27%, following a precedent in terms of market recovery timing. Bespoke Research reports that since WWII, once we’ve recovered and moved nine months past a bear market low, the S&P has been higher a year later by an average of 14.68%. Though not a perfect score, the trend has held 12 out of 13 times.
There is no question, however, that current market valuations are high on a relative basis, but not all stocks nor sectors have moved in lockstep with this year’s rally. Year-to-date, mega-cap company stocks have driven the markets (think Apple, Microsoft, Nvidia, Amazon, Meta, Telsa and Alphabet).
A deeper dive into the S&P sectors also provides a bit more detail about the bifurcated valuations. Currently, the larger sectors comprising the S&P are communications (XLC) with an 8.2% weight, consumer discretionary (XLY) at 10.5% weight, financials (XLF) with 12.8%, health care (XLV) at 13.4% and technology at 28% weighting. Not surprisingly, the highest-performing sector was technology (XLK), with a return of 42% on a year-to-date basis. Technology is also the most expensive sector, trading at approximately 35 times last year’s earnings. The other top two performers driving the market were communications, with a 37.2% return and consumer discretionary, with a 33% return. The financial sector was an outlier, however, returning about 4% since January 1.
Again, not all stocks, sectors or markets have rallied up to these levels, however. Significant moves within the S&P 500 (and Nasdaq) were primarily fueled by the three momentum sectors noted, comprising nearly 47% of the S&P. A case in point: Although the more recognized S&P 500 is up 18% through July 21, the equal weight S&P (RSP) is at a more “reasonable” 9%. Considering reasonable valuations, quite a few examples exist of interesting sectors that have bypassed the market momentum, such as energy, down 1.7% for the year; financials, up 4%; staples, up 2.6%; and healthcare, at a positive 1%.
Other interesting opportunities include small-cap stocks, up 11.5% year to date but still just shy of rallying above the bear market hurdle that its larger-cap peers have achieved. Another positive is that the small-cap index (Russell 2000) had recovered the ground lost in March when investors smelled trouble in a number of smaller regional banks and hit the panic button. We think this may be a sign that the markets have moved past the earlier “bank run” concerns.
One last encouraging sign in terms of market participation is the number of S&P stocks that are now moving above significant technical hurdles. As of this writing, 87% of the S&P stocks are over their 50-day moving average, while 81% have passed their 100-day, and 73% are above their 200-day moving average. Together, these signs are all stabilizing signals that market watchers constantly monitor.
What should we expect for earnings this quarter and next? We are again still early into earnings calls. As we have witnessed in the past, however, company earnings have tended to beat expectations over the past few years, and analysts are now beginning to raise company earnings expectations for the second half of 2023 through next year.
Not Investment Advice or an Offer -This information is intended to assist investors. The information does not constitute investment advice or an offer to invest or to provide management services. It is not our intention to state, indicate, or imply in any manner that current or past results are indicative of future results or expectations. As with all investments, there are associated risks and you could lose money investing. Argent Financial Group is the parent company of Argent Trust, Heritage Trust and AmeriTrust.