Both stock and bond markets seem to be taking today’s many conflicting financial and political cross currents in stride, with equities holding on to decent gains so far in 2023 and bond markets mostly behaving well despite the brewing debt ceiling debate, the Federal Reserve’s recent interest rate hikes and challenges in our regional banking system.
Inflation Continues to Recede
While the Fed did raise the fed funds target rate another 25 basis points earlier this month to a range of 5.0% to 5.25%, the broad consensus among market participants is that this was probably the last hike for this interest rate cycle. There are many indications that inflation is receding and that the Fed’s actions are dampening consumer demand as well as prices in many parts of the economy. The Consumer Price Index (CPI) has declined for ten consecutive months with the latest reading (April) being 4.9%. We expect the Fed is now in wait-and-see mode, where it is looking for further decreases in the CPI in the coming months while keeping rates where they are. Among the more challenging vectors of the inflation problem are rents and wages. While rents are set to decline in the coming months, unemployment remains low and thus wage growth is still relatively strong.
Debt Ceiling Standoff
The biggest wild card for markets in the near term is Congress’s lifting (or not) of the U.S. debt ceiling. Since 1960, Congress has raised the debt ceiling seventy-eight times, and almost always without a fuss. It is important to remember the debt ceiling is not, strictly speaking, about government spending. It is about actually paying the bills for spending that Congress itself has already voted on and authorized. If Congress does not act to lift the debt ceiling by around June 1st, Treasury Secretary Janet Yellen has said the U.S. is in danger of defaulting on its financial obligations, which could include withholding Social Security checks and/or not paying interest on government bonds. If default were to happen, it would undoubtedly be very bad for both stocks and bonds, our financial system, and our national credibility. Borrowing costs would rise across the board, jobs would be lost and the economy could tip quickly into recession. In 2011, U.S. stocks declined about 17% peak-to-trough during the summer debt ceiling showdown between President Obama and the GOP-led Congress. In the end, an agreement was reached, but U.S. suffered its first ever debt downgrade by ratings agency Standard and Poor’s. How this current showdown plays out over the next few weeks is anyone’s guess, but the markets, at least at this writing, do not seem to be very worried.
First Quarter Corporate Earnings
Around 90% of companies have reported their first quarter earnings and the results have been pretty good. About 78% have met or exceeded their own earnings projections, which is slightly higher than the 73% average. We attribute this performance, however, mostly to companies adopting very conservative projections at the beginning of the year. Overall, with the job market holding up well in the face of higher interest rates, companies have been doing a little better than expected. The S&P 500 Index now trades at about eighteen times its forward earnings estimate, making the stock market still a little pricey, in historical terms. If the Fed can engineer further declines in inflation to meet its 2% inflation target, we would expect the tone in markets to improve going into next year.
As always, we are closely monitoring developments in the markets and are available to talk. Please let us know if there is anything you would like to discuss about the markets or your portfolio.
*Image: alberto clemares expósito from Getty images via Canva.com