Soft Landing Hopes Rising
A “soft landing,” a scenario in which the Federal Reserve tames inflation through interest rate hikes but does not also push the economy into recession, has become more plausible in recent weeks as we have seen indications of a slow-growing but resilient economy alongside meaningful cooling of inflation. The Consumer Price Index (CPI), a prominent measure of inflation, hit 9.1% in June 2022. This past June, however, the CPI was up only 3% year-over-year and significantly lower than the May reading of 4%. The Fed’s inflation goal is 2%, however, so the Fed will probably hike rates another 25 basis points at its July 25-26 meeting. While the strong employment and other economic data of late is a good thing, it also gives the Fed cover to maintain (or increase) its hawkish interest rate regime. That said, investors expect the Fed to give an indication at its upcoming meeting that it is close to, or at the end of, its rate hiking campaign and is transitioning to wait-and-see mode. It is this expectation that has fostered growing bullish sentiment on Wall Street.
AI Mania Propelling Tech Stocks
The major market indexes have delivered impressive returns through the first half of the year, with the S&P 500 Index up around 17%. But it’s not that all stocks are going up—they are not. In fact, at the end of the second quarter, the vast majority of the 2023 gain in the S&P 500 could be attributed to the strong year-to-date performance of just seven giant technology companies that account for 27.9% of the whole index: Apple, Microsoft, Alphabet (Google), Amazon, Tesla, Meta (Facebook) and Nvidia. By comparison, the Dow Jones Industrial Average, which has a smaller proportion in technology, is up only 4.3% so far in 2023. Investors fascinated with the remarkable capabilities of artificial intelligence chatbot ChatGPT have scoured the market to find companies levered to the global proliferation of artificial intelligence, and they have now bid up many of these companies’ stocks to very optimistic levels. Whether or not AI will actually yield fatter corporate profits still remains to be seen.
Earnings Season Underway
Companies have begun to report their second quarter results, and analysts are expecting a dour earning season. In total, earnings are forecast to decline by about eight percent from last year’s levels, and this marks the third straight quarter of earnings declines. There are several reasons for the weakness in earnings. Revenues will only be down around 1%, but profit margins are also compressing, due in part to both higher labor costs and rising raw-input costs. Despite their deteriorating earnings, stocks don’t seem to care. Investors are acutely focused on signals from the Fed that interest rates hikes are ending. A bad quarter of earnings will soon be in the past, but the Fed releasing interest rate pressure on the economy could help propel a sharp rebound in earnings in the coming quarters.
As always, we are closely monitoring developments in the markets and are available to talk. Please contact us if there is anything you would like to discuss about your portfolio.
*Image: frantic00 from Getty images via Canva.com