Investment Insights

 — Steve Orr 

One or two

Look, Virginia, markets can go down! Depending on the index, stocks slid 1 or 2 percent last week. For the S&P 500, it was the first down week in four, and only the third negative week since the October lows. This Bull run has pushed nearly every index 20% higher since October. Is this Bull cycle over? Hardly. But history and our chart indicators are suggesting that a rest stop is needed.

Valuation and sentiment measures remain elevated but can stay that way longer than finance professors believe is rational. The trend remains strong, with market levels sitting above exponential and simple moving averages. In the very short term, April is usually a strong month for stock returns, as traders play for good first quarter earnings reports. Election years are more of a mixed bag, with corrections starting later in the month that last into May.

What about the foundations for this Bull to date? Is it built on just memes or market patterns than have repeated in history? It has been more than 100 days since a 2% pullback for the S&P 500, a rare occurrence. Looking back further, the mega-cap index was up more than 30% in the year ending March 31. That is the best 12-month gain since October 2021. According to Bespoke Research, the S&P 500’s median performance one, three, six and 12 months after rising 30% in a year was better than the average for all periods. Another mark in the Bull’s favor is that over the past two years, returns are still below average. So, the Bull has some ground to make up versus history. We are sticking with a mild near-term correction and full-year gains for stocks. 

Happy times

Earnings are the mother’s milk of stock prices, and companies begin turning in their first quarter report cards this week. Delta and Costco lead off mid-week, with the big banks following on Friday and next Monday. The fourth quarter of 2022 and first two quarters of 2023 saw the S&P index post negative earnings year-over-year. That period coincided with rising interest rates, the housing recession and slowing manufacturing.

Quarterly earnings turned positive in the second half of 2023 and should post around a 5% year-over-year gain for the first quarter of this year. Three straight quarters of positive earnings will cheer traders and investors alike. Artificial intelligence-related stocks have grabbed headlines for, well, many months. Recent chart action shows us the rally and earnings improvement may be moving away from AI and into more tangible earnings like raw materials and energy production. Analysts have set the bar for earnings growth fairly low. About three-quarters of the time since 2009 when analysts do not give companies much of a chance, the S&P 500 index surprises to the upside.

The next six weeks of announcements should give us some idea of what business leaders are expecting for the rest of the year. The volume of reports will peak the last Thursday and Friday of April. Walmart and Target report mid-May; they mark the “unofficial” end of earnings season.

Lasting?

The non-farm payrolls report is another index in a Bull market. March’s net-new jobs of 303,000 was quite the surprise. The unemployment rate of 3.8% in the companion Household Survey also was good news. Digging into the BLS reports, we wonder how long these good reports will continue. The unemployment rate has stayed below 4% for 26 months. We are not sure, but that may be some sort of record. Over the past three months, construction has added 91,000 jobs. We realize that is a national estimate, but we think most of those workers are onsite in Austin and Dallas apartment projects. Since October 2019, the number of full-time native-born workers has dropped by 1.4 million. Conversely, over the same time period, non-native full-time employment has jumped by 3 million. Most of the recent growth is in healthcare, government and part-time. The Household survey reports that overall, the workforce is 2 million smaller than June a year ago. Between retirements and new entrants, the shrinking pie has held the unemployment rate between 3.5% and 3.9%.  

A shrinking workforce has long-term negative effects for inflation. Fewer full-time workers with the correct skills means supply constraints push wages higher. Recall two years ago the Fed was very worried about wage inflation as a key driver in consumer prices. The Fed’s job is not done as we think Wednesday’s consumer price index for March will show prices rising at a 3.5% year-over-year rate.

And that is before the recent move higher in gasoline prices. The usual spring jump in gasoline prices will also be higher this year. The annual required change to more expensive summer blends will be amplified by fewer cargoes of crude reaching refineries here and in Europe, thanks to geopolitical tensions and Ukraine successfully taking out a Russian pipeline last week.

The economy continues to rumble along in second gear: not too hot, not too cold. The administration’s infrastructure and CHIPS Act spending is helping heavy construction. Manufacturing surveys show some industries and new orders starting to bottom and possibly turn higher. We continue to believe the “recession” has been a slow rolling event through several sectors of the economy over the past two years. The spending by the administration and Congress should keep the economy away from recession this year.