Are we finally seeing the long-awaited economic slowdown?
Growth in the U.S. slowed considerably during the first three months of the year as interest rate increases and inflation took hold of an economy largely expected to decelerate even further. GDP rose at a 1.1% annualized pace in the first quarter, well below the 2.0% forecast and the 2.6% reading from Q4 2022. While consumer spending rose 3.7% and exports grew 4.8%, most of the weakness came from a decline in private inventories which declined 2.3%. While the U.S. economy appears resilient, growth is clearly slowing. PCE inflation increased 4.2% year-over-year (Y/Y) and Core PCE rose 4.9% Y/Y.
Job growth fared better than expected in April despite bank turmoil and a decelerating economy. Nonfarm payrolls increased by 253,000 for the month, beating Wall Street estimates for growth of 180,000. The unemployment rate was 3.4%, below the 3.6% estimate and tied for the lowest level since 1969. A more encompassing number that includes discouraged workers and those holding part-time jobs for economic reasons edged lower to 6.6%. Average hourly earnings, a key inflation barometer, rose 0.5% for the month. This rise exceed the market’s 0.3% estimate and represents the largest monthly gain in wages in a year. On an annualized basis, wages increased 4.4%, higher than the market’s 4.2% expectation. Although wage growth remains stubbornly high, job growth is showing signs of slowing over the last few months.
Will the decline in inflation keep the Fed on the sidelines?
April’s CPI report was widely considered to be better than expected. Headline CPI rose 0.4% month-over-month (M/M) or 4.9% Y/Y, while Core CPI increased 0.4% M/M or 5.5% Y/Y. Increases in shelter, gasoline, and used vehicles pushed the index higher but were offset somewhat by declines in prices for fuel oil, new vehicles, and food at home. With housing costs projected to decline, the Fed is focusing on “super core” inflation, which excludes food, energy, and shelter. That measure rose 0.4% for April and was up 3.7% from a year ago
Source: Bureau of Labor Statistics, CNBC
The Fed raised rates for the tenth time in a little over a year to a target range of 5.00-5.25%, the highest level since August 2007. Perhaps of greater importance was the Fed’s statement which hinted at a pause or potential end to the current rate hiking cycle. We believe the Fed should at lease pause for a few meetings to determine the economic impact of their 500 basis points of rate increases. The current tightening cycle is the fastest and largest increase in 40+ years and we have already seen the impact on regional banks and the housing market. While the Fed has lost some market credibility, we believe that the market’s predicted interest rate cuts in late 2023 seem unlikely absent a significant negative market event.
Another quarter of better-than-expected earnings!
As we predicted, Q1 earnings have come in much better than expected through 85% of the reporting season. The aggregate earnings decline in the S&P 500 has been –2.2%, well ahead of the –7.0% forecast. Even with recent USD weakness, multinationals have reported weaker EPS growth than those with a domestic focus. Five of the eleven sectors are reporting Y/Y earnings growth, led by the Consumer Discretionary and Industrials sectors. On the other hand, the other six sectors are reporting a Y/Y decline in earnings, led by the Materials and Health Care sectors. We continue to stress that U.S. companies do a strong job of managing earnings and often beat their conservative guidance. Analysts expect a decline in EPS for Q2, but growth in Q3 and Q4. For 2023, the current market estimate is 1.2% earnings growth.
Source: FactSet, as of 5/5/23
The ECB’s conundrum … flatlining growth, high inflation, & improving PMIs
The eurozone economy grew 0.1% quarter-over-quarter (Q/Q) or 1.3% Y/Y in Q1 2023, based on preliminary readings. Growth came in below expectations with particular weakness in Germany, which reported flat growth while France grew 0.2%. Irish GDP was a notable weak spot, declining by 2.7% from the previous quarter, while Portugal’s economy grew by 1.6%. The ECB is well behind the Fed in tackling high inflation. Eurozone headline inflation is 6.9% and core inflation sits at a record high of 5.7%.
Eurozone business activity accelerated to an 11-month high in April according to the latest flash PMI data. The upturn was driven by the strong rebound in demand and the surge in employment. Inflation pressures also appeared to come down based on the decline in input prices and the easing of supply constraints. One major concern is the bifurcation between activity in the service and manufacturing sectors. The manufacturing sector fell back into decline with the headline PMI reading hitting a 35-month low of 45.5. On the other hand, service sector activity hit a 12-month high of 56.2. The April composite PMI reading was 54.1. At the country level, Italy hit a 17-month high and Germany a 12-month high.
China GDP beats expectations in Q1, but PMIs highlight potential economic weakness
The Chinese economy grew at a 4.5% annualized rate in Q1 2023, well ahead of the 4.0% expectation. China’s economy expanded 3% in 2022 and the government set a target of “around 5%” in 2023. In addition, retail sales jumped 10.6% in March as online sales of physical goods picked up and industrial output rose 3.9%, slightly below the 4% forecast.
China’s manufacturing activity unexpectedly shrank in April, raising pressure on policymakers seeking to boost an economy struggling for a post-COVID lift-off amid subdued global demand and persistent property weakness. The world’s second-biggest economy grew faster than expected in the first quarter thanks to robust services consumption, but factory output has lagged amid weak global growth. Slowing prices and surging bank savings are raising doubts about demand. Despite the recent strength in consumption, China’s non-manufacturing PMI edged down to 56.4 versus 58.2 in March. Data showed retail sales growth quickening in March to near two-year highs, but that was off a low base and economists are cautious on the sustainability of such strength. Mixed data and underwhelming growth will likely keep pressure on policymakers to continue supportive fiscal and monetary stimulus in place.
2023 has been all about mega-cap tech
2023 has been all about mega-cap technology stocks that have driven U.S. equity markets higher. Within the S&P 500 Index, the top 10 holdings have contributed over 90% of the YTD return. This differs from other developed regions/countries that have seen much more balanced YTD performance. While we never want to see such narrow market leadership, the largest technology companies have consistently proven their ability to generate earnings and revenue growth during a slow growth economic environment. These businesses generally have strong secular tailwinds in place and bulletproof balance sheets that have become a flight to safety.
The correlation between equities and Treasuries has declined somewhat
The positive correlation between equities and Treasuries frustrated investors looking to diversify across asset classes in 2022. Since then, the correlation has moved lower, and recently turned negative. For investors, this means that equities and Treasuries are more likely to move in different directions, and that some traditional asset class hedges might be in play again. With rates moving significantly higher over the past year, Treasuries and other core fixed income provide diversification benefits, especially during risk-off environments.
The charts and information in this presentation are for illustrative purposes only, and are based upon sources of information that Sunpointe, LLC generally considers reliable, however we cannot guarantee, nor have we verified, the accuracy of such independent market information. The charts and information, and the sources utilized in the compilation thereof, are subjective in nature and open to interpretation. FOR USE WITH INSTITUTIONAL INVESTORS AND INVESTMENT PROFESSIONALS ONLY. NOT FOR PUBLIC DISTRIBUTION. PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.
