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It Looks Like a Soft Landing for Now

May 20, 2024

After a 5.5% decline from the peak in the S&P 500, markets got exactly what they wanted come the turn of the month.  The rhetoric began to turn following the latest FOMC meeting on May 1st when the Federal Reserve Chair, Jerome Powell took a more dovish tone (tendency to lean towards policies that favor economic growth as opposed to policies aimed toward combating inflation).  The first instance of this was in their official statement where they made the decision to reduce their QT (Quantitative Tightening) on their treasury portfolio from $60 billion a month to $25 billion, five billion dollars below consensus.  That was welcomed news for the fixed income market that has been concerned about the increase in treasury supply this year.  Then throughout the speech he pushed back against the chance of a rate increase, which is something the market was worried about after recent hotter than expected inflation prints.  Powell acknowledged that although there was no progress on the inflation fight in the first quarter, he sees the deceleration continuing as the year progresses.  Powell stated he sees owners’ equivalent rent coming down throughout the year as well as the labor market coming into better balance, both of which would be tailwinds for the inflation picture.  The term stagflation was starting to be talked about more following the release of first quarter GDP which came in lower than expected, while the inflation components such as ECI (Employer Cost Index) came in hotter than expected.  When asked about this Powell responded in a somewhat comical way saying that he doesn’t see the stag or the flation. I agree with his opinion on the matter considering the detractors from GDP were mostly in trade and inventories.  His speech set the stage for a slew of economic data throughout the month that fit right into the soft-landing narrative.  We received the non-farm payrolls report which showed a slowdown in the labor market.  The headline figure came in at 175 thousand, which was below both forecasts and last month’ reading, while the unemployment rate ticked up to 3.9%.  What I believe got the market most excited was the deceleration in wage growth which came in lower than consensus at an annualized reading of 3.9% which marks the slowest pace since May 2021.  This shows an overall strong labor market, that is getting into better balance, and is less likely to add upside pressure to the inflation picture.  Other metrics also pointed to a decelerating growth picture with ISM Manufacturing, ISM Services, and retail sales all coming in below consensus.  Although these figures have all come down, GDP estimates for Q2 are still showing above trend growth. As of this week, the Atlanta Fed GDP tracker now is estimating growth in the second quarter to be 3.6%.  Although this figure is likely to come down, it does show an overall decent growth environment.   And now for the main event, the CPI (Consumer Price Index) came in a tenth better than expected for the month, decelerating to an annualized pace of 3.4%, while core which excludes food and energy declined to a 3.6% pace.  The report sent the major equity indices soaring to all-time highs in the session.  Why the market had such a positive response to a minor improvement in the inflation reading is likely to do with a trend change of the upside readings in the prior months.

 

 So the big question is where do stocks go from here?  I believe that momentum in the market is pointing to further upside, but after an accelerated move over the past month, price action is likely to be more muted from here.  Earning season is nearing the end for the current quarter which overall shaped out pretty well with S&P 500 EPS growth coming in at roughly 5.7% for the quarter.  The last big name to report will be Nvidia next week, which could cause some volatility in the market.  Beyond that the next potential market mover could be the Fed’s preferred measure of inflation, the PCE deflator which will be released on May 31st.  Expectations are for core to remain relatively stagnant at 2.8% for the third straight month.   After the latest market runup valuations are looking stretched trading around 21.8X 2024 earnings, so the probability of a summer pullback ahead of the election has increased.  Since valuations alone tend to be poor short-term timing mechanisms for market pullbacks, I will be looking at the technicals when deciding when to pair back risk.  The S&P is just getting to overbought levels on the daily charts, but based on the weekly charts the index still has room for an increase in momentum.  Overall, if we do get a pullback in the summer months, I think we could potentially be set up for a strong fourth quarter rally.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.  Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.