Evaluating the Economy and Corporate Earnings

Telemus Weekly Market Review May 1st - May 5th, 2023

The last two weeks have been filled with considerable news and incremental inputs for investors. On the economic front, there has been a slew of various economic readings. In addition, companies have been actively reporting first quarter earnings results. Markets have been reasonably tame as they adjust to reflect ever moving expectations around the cadence of economic growth, the future direction of interest rates, the debt ceiling, and the ability for corporate earnings to hold up.  

On the economic front, data has been mixed. On a positive note, home prices have experienced a slight uptick, a constructive change in trend after seven consecutive months of falling home prices. In addition, employment data shows that employers continue to add workers reinforcing that the labor market remains highly robust. Conversely, manufacturing activity remains in decline, while the persistent strength among service-oriented business has shown indications of softening. The Bureau of Economic Analysis released the first quarter U.S. Gross Domestic Product (GDP), which came in lower than expected and showed a downshift in economic activity in the fourth quarter of 2023. 

All of this data was incorporated into the past week’s decision by the Federal Reserve to increase the interest rate it controls, the federal funds rate, by 0.25%. What was noteworthy about this announcement was the Fed indicating that it was no longer committing to additional interest rate hikes and would be relying on incremental data to determine any future actions. While it’s too early to say whether this marks the end of the Fed’s interest rate hiking campaign, it does seem to indicate barring an unexpected acceleration in inflation data, we are unlikely to see any material increases in rates going forward. 

Adding more color to the economic environment has been an active last couple of weeks of corporate earnings results. Over 80% of S&P 500 constituents have reported first quarter earnings. Results have not been too bad, which is a positive as many market participants had been concerned that results might falter as a function of economic activity pulling back following the failure of Silicon Valley Bank. All told, of the companies releasing data, it appears revenues of S&P 500 constituents have in aggregate risen by 3.5%, while declining margins have resulted in earnings falling by -0.7%.  This marks the second consecutive quarter where earnings for the S&P 500 have declined. Expectations are for S&P 500 earnings to inflect toward much stronger growth in the second half of 2023, including forecasts for double digit earnings growth in 2024.

Ambiguity remains on whether these expectations are too lofty or not. We take comfort in how corporate earnings have thus far held up despite what has been decelerating consumer spending, declining manufacturing activity and softer than expected GDP. Some of the softness in GDP was due to companies reducing inventories, which can only be done for so long. Given that the Federal Reserve appears set on ensuring inflationary pressures are out of the economy, it seems less likely they will cut rates back to the low level achieved in the past cycle as they don’t want to risk a resurgence of an additional inflationary episode.  On top of that, the stalemate in Washington makes it unlikely that there will be any additional fiscal stimulus. Barring an unexpected acceleration in economic data, there is a reasonable probability that double digit earnings growth expectations heading into 2024 may be too optimistic. More lofty expectations aren’t unusual, as wall street analysts tend to have a bias toward more optimistic forecasts in future years.  

As we reflect on this data, we take comfort that the economy appears to be holding its own. There are clearly signs of activity slowing, but we maintain our expectation that should a recession happen, it’s likely to be shallow given the health of the labor market. Stock and bond markets continue to calibrate expectations, with many investors waiting for additional clarity on the direction of the economy prior make any significant moves in portfolios. Following this past week’s Fed meeting, the Treasury market appears to be normalizing and more reasonably reflecting expectations of future actions. Stocks remain rangebound, amid soft volumes, as market movements are being fueled by narrow, speculative trading activity. We expect this to persist for a little longer as longer-term fundamentally driven investors assess the direction of the economy, the reasonableness of corporate earnings expectations and await a resolution around the debt ceiling. 

All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable, however Telemus Capital cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. Investment decisions should always be made based on the client's specific financial needs, goals and objectives, time horizon and risk tolerance. Current and future portfolio holdings are subject to risk. Risks may include interest-rate risk, market risk, inflation risk, deflation risk, currency risk, reinvestment risk, business risk, liquidity risk, financial risk, and cybersecurity risk. These risks are more fully described in Telemus Capital's Firm Brochure (Part 2A of Form ADV), which is available upon request. Telemus Capital does not guarantee the results of any investments. Investment, insurance and annuity products are not FDIC insured, are not bank guaranteed, and may lose value. Any reference to an index is included for illustrative purposes only, as an index is not a security in which an investment can be made. Indices are unmanaged vehicles that serve as market indicators and do not account for the deduction of management fees and/or transaction costs generally associated with investable products.  The S&P 500 index includes 500 leading companies in the US and is widely regarded as the best single gauge of large-cap US equities.

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