April 2023 Stonemark Market Commentary

In the aftermath of the banking chaos in March, the market found itself digesting a slew of economic data and corporate earnings throughout April. Seemingly facing a crossroads between bullish and bearish sentiment, all major indices remained relatively flat throughout the month. In the first half of the month, the banking turbulence slowed and began to stabilize while economic data for March was released. For the second half of the month, companies reported earnings for the first quarter of 2023, providing the market with a myriad of data to digest ahead of a pivotal Federal Open Market Committee (FOMC) rate hike decision on May 3rd.

Inflation has remained the most important piece of economic data throughout 2022 and into 2023. On April 12th, the Bureau of Labor Statistics released the CPI and Core CPI numbers for the month of March, which showed inflation slowing but continuing to be sticky despite the Federal Reserve’s ongoing fight against it. The headline Consumer Price Index (CPI) rose 0.1% in March and 5% year-over-year, which was slightly below estimates. Core CPI, which excludes the more volatile food and energy inputs, rose 0.4% in March and 5.6% year-over-year, which was in-line with estimates.

The core Personal Consumption Expenditures (PCE) price index is one of the Federal Reserve’s preferred measures of inflation. Released on April 28th by the Bureau of Labor Statistics, core PCE increased by 0.3% for the month of March and increased 4.6% year-over-year, slightly above market estimates. This core PCE report tells a similar story to the CPI and core CPI reports – inflation is continuing to slow from its peak in the summer of 2022, but it remains persistent across all measures and likely warrants continued Federal Reserve action.

The other major component the Federal Reserve has pointed to in its fight against inflation is the labor market, which has remained exceptionally resilient throughout the economic woes of the past twelve months. The January jobs report rocked the market, with nonfarm payrolls increasing by over 500k, beating expectations by over 300k jobs. The February jobs report was not the blowout that January was, but nonfarm payrolls still increased by 326k, showing a slowing trend but a continually hot labor market.

The March jobs report, released on April 7th by the Bureau of Labor Statistics, had an increase in nonfarm payrolls of 236,000, just below expectations of 238,000. The unemployment rate also ticked slightly lower to 3.5% versus expectations of 3.6%, though average hourly earnings rose 0.3% and 4.2% annually, which was the lowest since June of 2021. The labor market has returned to quarter 4 of 2022 numbers after the January and February explosions, but it remains strong. A strong labor market runs contrary to the Federal Reserve’s goal of fighting inflation, meaning the Federal Reserve is likely to continue its rate hiking campaign for at least one more FOMC meeting.

For the first time since October 2022, there was no FOMC meeting for April. However, there were multitudes of “Fedspeak” with notable Federal Reserve regional presidents like Raphael Bostic and James Bullard providing hawkish commentary about the need for additional rate hikes to return price stability. Contrarily, Chicago Fed President Austin Goolsbee took a more dovish tone, suggesting that tightening credit conditions from the banking turmoil coupled with retail sales data suggests the Federal Reserve should take a more conservative approach to rate increases. This divergence of opinions within the Federal Reserve has left the market trying to read between the lines for a gauge on future movements in the Federal Funds Rate, ultimately arriving at a 90% likelihood of a 25-basis point rate hike on May 3rd.

A key focus regarding the Federal Reserve has been their balance sheet, which rapidly expanded in March during the banking turmoil but has since begun tapering off as banks borrowing from the discount window has slowed.

The Federal Reserve’s balance sheet exploded by nearly $400 billion in new assets in the span of two weeks, as the Fed created the Bank Term Funding Program (BTFP) to backstop the banking industry by providing liquidity and allowing banks to avoid realizing losses on Held-to-Maturity securities. This trend reversed throughout April as banking woes subsided, however recent trouble for First Republic Bank (FRC) has brought the regional banks back into the spotlight and could cause the Federal Reserve’s balance sheet to grow again.

Heading into the first quarter earnings for 2023, analysts and the market were expecting earnings to decline by 6.7% following quarter four of 2022 earnings’ decline of 4.9%. However, as of the market close on April 28th, the blended earnings decline for the first quarter was 3.7%, well below initial estimations of a 6.7% decline. Just over half of all S&P 500 companies have reported earnings so far, with key reports coming from both major and regional banks, energy giants like Chevron and Exxon, and technology juggernauts like Microsoft, Amazon, and Meta.

Overall, earnings have been better than initially expected, but they are still contracting on a year-over-year basis. Additionally, net profit margins continue to contract on a year-over-year basis across the board, except for Energy and Industrials which had a slow start to 2022. Margin contractions prompt cost-saving measures across companies, which has been seen through numerous layoffs in the technology and financial sectors. Continued margin compression means decreased earnings and equity underperformance moving forward, which is particularly pertinent when the market is currently priced at 19 times current earnings and just over 18 times forward earnings.

Coinciding with contracting first quarter earnings, the Q1 2023 Gross Domestic Product (GDP) report was released on April 27th, showing that the economy grew by 1.1% in the first quarter. This was well below the market expectations of 2% and marks the third consecutive quarter of slowing GDP growth. Of particular importance regarding this Q1 GDP report is that market expectations for real GDP growth in 2023 is 0.9%. With the first quarter coming in at 1.1% real GDP growth, this means that the subsequent 3 quarters expected real GDP growth is -0.2%. Current earnings, incoming economic data, and composite leading indicators all flash a macroeconomic slowdown in the second half of 2023 and potentially into 2024.

The market found itself trading largely sideways for the month of April, as it awaited guidance from corporations and the Federal Reserve to gain a better picture of what the rest of the year looks like. Inflation is slowing but remains sticky and persistent throughout, the labor market continues to remain tight with historically low unemployment and strong job growth, and the Federal Reserve remains committed to maintaining interest rates at current elevated levels. There is a high degree of uncertainty across the market, with a particular focus on regional banks and commercial real estate. While the S&P finished April up over 8%, we think there is much uncertainty and turbulence ahead that will negatively impact stock performance as the market comes to grips with elevated interest rates, a weakening consumer, and contracting profit margins. We continue to look for companies that are well positioned to withstand an economic drawdown, with strong balance sheets, a disciplined executive suite, and resilient profit margins.