“Often a sign of expertise is noticing what doesn’t happen.” – Malcolm Gladwell
April was a mixed month for investors. US large cap stock indices posted up impressive gains while the small-cap and mid-cap indexes we follow fell. At the same time, the MSCI World and MSCI EAFE indexes were positive, but the MSCI Emerging Markets index lagged behind. Away from the equity markets the Bloomberg Aggregate Bond index continued its upward slope as commodities and the dollar remained weak.
All data as of 04/28/2023, Source: Wells Fargo Investment Institute. An index is not managed and not available for direct investment. Past performance is not a guarantee of future results. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.
After reaching a bear market low around 3500 in October 2022, the S&P 500 has managed to recover more than 40% of the losses off the January 2022 all-time highs over the last six months. Such a strong move might make one believe all is well and the worst is behind us. We really hope that is true.
Of course, hope is not a strategy.
Instead of hoping things work out just fine, we want to take a look at where the stock market is at this point in time, what the big issues facing the markets are, before finally coming up with a game plan for moving forward.
Let’s dig in …
Where are we now?
When people talk about the stock market the conversation tends to assume that the “market” is a monolithic entity:
- “The stock market was up today because of X, Y and Z.”
- “The stock market reacted to the news that (insert news event here) when it …”
In reality the “stock market” is a market of stocks. The S&P500, for example, is a cap-weighted index comprised of 500 stocks. It’s performance –up, down or sideways – is just aggregating how the individual components perform. Because it is a cap-weighted index, the companies that are more valuable have more of an influence on what happens to the performance of the index. If the largest stock in the index moves 10% higher in price it will have a much greater effect on the index’s performance than if the 200th or 500th largest company moves 20% higher.
It is by no means a perfect vessel for judging how equity investments are doing, but it’s the best that we have.
If you tune into the financial news rhetoric these days you would think that the stock market is in trouble. There is a lot of talk of an impending recession, weakening corporate earnings, and, of course, a possible default on the national debt. The year-to-date returns tell a different story with the S&P500 up more than 8% through the end of April.
The weekly chart of the S&P500 (Chart #1) also looks positive. The index is above the downtrend line and has been producing a series of higher highs and higher lows. From a technical perspective, we believe, the index is currently in a good place with a positive outlook going forward.
Chart #1: www.stockcharts.com Data 11/25/19 – 05/01/23 as of 05/01/23. An index is not managed and not available for direct investment. Past performance is not a guarantee of future results.
Fundamentally, 1st quarter earnings season has been better than expected. According to Refinitiv data, analysts now expect earnings for the S&P 500 in aggregate to have declined 4.8% in the first quarter of 2023 from the year-ago period. However, this is an improvement from the estimated decline of 6.7% at the end of the first quarter (March 31). The index is also reporting higher revenues for the first quarter today relative to the end of last week and relative to the end of the quarter.
As of Friday, 85% of S&P 500 companies have reported first-quarter earnings. Of these companies, 79% have reported actual EPS above estimates, which is above the 10-year average of 73%. Positive earnings surprises reported by companies in multiple sectors (led by the Information Technology, Consumer Discretionary, Energy, Industrials, and Communication Services sectors) have been the largest contributors to the decrease in the overall earnings decline for the index since March.
What are the big issues of concern for the stock market?
Even as the S&P500 has had a strong start to the year, we feel a real uneasiness hanging over the markets. Finding reasons to be pessimistic about the stock market is not a hard thing to do these days.
All years have mysteries, but this year feels special. Here are our top five concerns:
Regional banks under stress: Since the March collapse of Silicon Valley Bank the entire banking sector has been under immense pressure. As of May 4th, there have been three large, regional banks that have been taken into receivership by Federal regulators. Other banks continue to be under. The good news is that regulators have been able to deal with the issues without much stress on the overall market.
Weakening Economy: There has been a lot of talk about a weakening economy but a recession has yet to appear. Expectations for 2023 2nd quarter GDP and full year 2023 GDP are trending of late. According to the Atlanta Federal Reserve’s GDPNow estimate, as of May 8, 2023, the real GDP growth (seasonally adjusted annual rate) in the second quarter of 2023 is 2.7%. This is better than the growth rate of 2.6% in the fourth quarter of 2022 and the 1.1% growth rate posted in the first quarter of 2023.
Interest rate stabilization: On May 3rd the Governors of the Federal Reserve Bank (The Fed) increased interest rates another ¼ of a percent (25bps). The big change was the following from the committee statement:
“In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”
In Fed-speak, this can be interpreted to mean as a pause in rate hikes is coming but The Fed cannot say this out loud because the Committee will continue to be “data dependent,” so the Fed could change their mind on the pause.
Persistent Inflation: Analysts have different views on what will happen. Some think that inflation pressures will remain high and that the Federal Reserve will continue to raise interest rates to combat inflation. Others think that inflation will ease as the economy slows down and that the Fed will pause its rate hikes or even cut rates if a recession occurs. According to the U.S. Bureau of Labor Statistics, the Consumer Price Index (CPI) increased by 5.0% in March 2023 from a year ago, with food and energy prices rising by 8.5% and -6.4%, respectively. The Fed’s preferred inflation measure, the Personal Consumption Expenditures (PCE) price index, increased by 4.2% in March 2023 from a year ago, while the core PCE price index increased by 4.6%. The Fed’s target for inflation is 2%.
The Debt Ceiling: While the previously mentioned issues are likely to play out over a sustained period of time, we know that the debt ceiling has the potential to have much more immediate effects on stock market volatility. U.S. Treasury Secretary Janet Yellen has warned that the government could run out of cash and default on its debt as early as June 1, 2023, unless Congress raises or suspends the debt ceiling.
According to some analysts, approaching the debt ceiling could cause disruptions in financial markets, declines in equity prices, loss of consumer and business confidence, and contraction in access to private credit. A breach of the debt ceiling could cause severe damage to the economy and trigger a recession. Some analysts also suggest that it might take a stock market meltdown or signs of a looming recession to resolve the debt ceiling impasse.
Famed investor Benjamin Graham, the author of “Security Analysis,” wrote that “the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.”
The quote suggests that in the short run, the stock market is influenced by the opinions and emotions of investors, who may buy or sell stocks for various reasons that are not related to their intrinsic value. The stock market may also react to news, rumors, fads, or other factors that create temporary imbalances between supply and demand. However, in the long run, the stock market reflects the true value of businesses, based on their earnings, assets, growth potential, and competitive advantages.
We believe the most immediate issue facing the markets is the Federal Government running up against the debt ceiling limits. Without a clear solution by June 1, we believe the risk of temporary financial market disruption becomes more likely. And that’s the key – assuming a quick resolution either prior to or just after the June 1 deadline, such a disruption would likely be temporary.
Taking a step back, we take notice of what hasn’t happened. A few regional banks have imploded, but the banking system quickly absorbed the losses. The rapid increase in interest rates over the past 12+ months haven’t hurt the jobs market. Nor has it set off an economic recession. First quarter corporate earnings, coming in better than expectations, we feel adds credence to this point of view. The financial system appears to be strong. We believe the economy is in a much better place than the recessionary rhetoric.
Our theme for 2023 has been a year of ups and downs – a year of voting not weighing – for the stock market indexes. Current circumstances have not changed our beliefs. In our opinion, a resolution to the current impasse is not simple or obvious but will get done. Once resolved, we expect the markets will move forward.
Now is not the time to panic or take a big risk. In truth, we don’t believe there is a good time to panic or take a big risk with your investments. We believe all investors should have an investment plan based on sound principals and not deviate because of possible short-term issues that may or may not have a temporary effect on valuations.
For More Information About our Complimentary Portfolio Review Service, Contact Our Team Of Financial Advisors Today!
- First-quarter S&P 500 Earnings Seen Down 4.8%-Refinitiv (reuters.com)
- S&P 500 Earnings Season Update: April 28, 2023, John Butters (factset.com)
- GDPNow – Federal Reserve Bank of Atlanta (atlantafed.org)
- Federal Reserve Board – Federal Reserve issues FOMC statement
- Economic Forecast for the US Economy (conference-board.org)
- CPI Home : U.S. Bureau of Labor Statistics (bls.gov)
- Economic Forecast for the US Economy (conference-board.org)
- The Potential Economic Impacts of Various Debt Ceiling Scenarios | CEA | The White House May 3, 2023
- Why it might take ‘a stock-market meltdown’ to resolve the debt-ceiling standoff | Morningstar, May 6, 2023
- In the Short-Run, the Market Is a Voting Machine, But in the Long-Run, the Market Is a Weighing Machine – Quote Investigator®, Jan 9, 2020 (quoteinvestigator.com)
On behalf of Magellan Financial we would like to thank you for taking the time out of your busy day to take in our thoughts and opinions. If you found this helpful, please forward it on to others. If you have any questions on the materials presented, would like to be added to our email list, or would like our help with your investments, we can be contacted at 610-437-5650 or via email.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
The CRB (Commodity Research Bureau) Index measures the overall direction of commodity sectors. The CRB was designed to isolate and reveal the directional movement of prices in overall commodities trades.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents.
U.S. Dollar Index (USDX) measures the value of the U.S. dollar relative to majority of its most significant trading partners. The index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies.
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.
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Robert I Cahill, Managing Partner Rob.Cahill@wfafinet.
Jonathan D. Soden, Partner Jon.Soden@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Associate Financial Advisor Jay.Knight@wfafinet.com