U.S. equities were mostly lower this week, with the S&P 500 and the Dow posted modest declines that were approximately equal in scale to the previous week’s gains, while the NASDAQ was almost flat. Daily volatility remained moderate, and markets have traded in a relatively narrow range since early April. The S&P 500 changed by less than 1% for the fifth consecutive week. Sector performance was mixed, as energy underperformed, followed by financials, and technology was the top outperformer, followed by healthcare. Treasuries were mixed, with the curve steepening and the two-year yield moving below 4% again. On Monday, the FDIC seized First Republic Bank (FRC), an event that marked the second-largest bank failure in US history. Just one week before, the bank disclosed that customers had withdrawn $100 billion following the panic over Silicon Valley Bank's collapse in March. The seizure added to growing worries that the banking sector could be in trouble. On Wednesday, PacWest Bancorp (PACW) noted that it's currently exploring options to reinforce its finances, including the potential of a sale. The stock closed the week down 43%. A positive news came from Apple (AAPL), earnings report helped the market bounce on Friday, but it remains to be seen whether the bounce will continue next week. Health care, utilities, and consumer staples were the best-performing sectors, while energy, financials, and comm services were the worst-performing sectors.
In euro terms, the STOXX Europe 600 Index and the EURO STOXX 50 Indices ended -0.29% and -0.4%3 respectively over the last week, as recession fears and banking troubles affected investors negatively. European government bond yields declined after the European Central Bank raised interest rates by a 25 basis points, lower from previous half-point increases, to 3.25% the highest in nearly 15 years. The ECB also said it would halt its program of reinvesting money from its bond purchases by July. ECB President Christine Lagarde said during the conference that interest rates would rise to “sufficiently restrictive levels” until inflation was reduced to the 2% target. She also mentioned that “Everybody agreed that increasing rates was necessary, that we are not pausing, that is very clear,” “And we know we have more ground to cover.” The yield on benchmark 10-year German government debt fell near one-month lows.
The Federal Reserve (FMOC) unanimously raised the fed funds target rate on Wednesday by another 25 basis points to the 5% to 5.25% range. This marks the third consecutive meeting at which the Fed has hiked rates by 25 basis points. This is the 10th rate hike since March 2022, when the Fed began raising rates. The official statement from the Federal Open Market Committee changed considerably from the previous one, the language considering the pace of economic growth was toned down while reiterating that stress in the U.S. banking sector has weighed on economic activity. The largest change to the official statement was the removal of the phrase “The Committee anticipates that some additional policy firming may be appropriate”, and it was replaced with more dovish phrasing, signaling that the FED will continue to monitor economic conditions to determine if further tightening is appropriate. A notable comment from the FOMC statements was that the central bank, is already or is very near to, its terminal rate (the level at which the Fed is expected to stop raising interest rates). Analysts believe that the Fed has increased the rates enough to fight inflation, as they are sufficiently restrictive, and the Fed will likely hold them there until inflation starts rapidly moving closer to its 2% target. Services are keeping inflation elevated, and once there is a meaningful decline in the services sector, that will help bring the overall inflation down.
April’s job market data shows that the labor market remains too strong in the Fed’s fight to lower inflation: 253,000 nonfarm payrolls were added in April, after only 165,000 were added the previous month. This upside surprise shows that the labor market remains resilient despite challenges in the banking sector and slowing economic growth. Other signs of labor market resilience include the decline in the unemployment rate and the acceleration in wage growth. The unemployment rate fell to 3.4% in April from 3.5% the prior month. Despite the acceleration in job growth in April, nonfarm payroll gains in February and March were revised lower, bringing down the three-month average payroll growth to 222,000, its weakest since January 2021.The slowing three-month moving average payroll growth along with the slower average earnings growth suggests that the jobs market is slowly weakening. Economists expect job growth to moderate as economic growth slows, due to high interest rates, high inflation, and tighter lending standards.
According to FACTSET data S&P 500 companies are recording their best performance relative to analyst expectations since Q4 2021. Both the number of companies reporting positive EPS surprises and the magnitude of these earnings surprises are above their 10-year averages. However, the index is still reporting a year-over-year decline in earnings for the second straight quarter. Till now approximately 85% of the companies in the S&P 500 have reported results for Q1 2023. Of these companies, 79% have reported EPS above estimates, which is above the 5-year average of 77% and above the 10-year average of 73%. Eight sectors are reporting year-over-year growth in revenues, led by the Utilities, Financials, and Consumer Discretionary sectors. On the other hand, three sectors are reporting a year-over-year decline in revenues, led by the Materials sector. The forward 12-month P/E ratio is 17.7, which is below the 5-year average 18.6 but above the 10-year average 17.3.
Within equities, we continue to favor U.S. Large Cap exposure and Developed International equities. For fixed income, we remain defensive in our credit positioning and higher in credit quality.