Goldilocks & The Bearish Narratives

By Crest Capital Advisors on June 2, 2023

Dow: 2.02% to 33,762.76
S&P 500: 1.83% to 4,282.37
Nasdaq: 2.04% to 13,240.77
Russell 2000: 3.26% to 1,830.91
10-Year Yield: 3.70%
Outperformers: Consumer Discretionary 3.27%, Materials 2.87%, Industrials 2.56%, Health Care 2.19%, Financial Services 2.12%
Underperformers: All Major Sectors were positive for the week

US equities rallied sharply on Friday to finish the week firmly up across the board – with the Dow jumping 701.19 points, or 2.1%, for its biggest point gain of 2023 and its biggest percentage rise since January 6th. Not to be outdone, the S&P continued to surge ahead, posting yet another 9-month high – coming just 10pts short of ‘exiting’ the benchmark’s October low ‘bear-market’. The catalyst for this week’s strong performance can be largely attributed to a surprisingly robust May jobs report, a resolution of the debt-ceiling deal showdown, and bets that the Federal Reserve will not raise interest rates during its next policy meeting (June 13-14).

Wall of Worry

With the month of May now in the rearview mirror, we take a quick look back at all of the bearish narratives that continue to fall flat in the face of a surprisingly resilient 2023. This has been the story of 2023, confounding the bears and (delaying?) averting the onset of recession. Soft landing aspirations remain a possibility with odds increasing by the day…provided the Fed doesn’t mistake this resilience as an all clear to over-tighten. Almost every ‘fear’ or ‘reason to sell’ the market has fallen flat as the market averages closed the week at new YTD highs. Traders often refer to this type of condition as “climbing the wall of worry”…an old Wall Street proverb for when stocks advance to successive highs despite widely accepted risks. Here is a short list of the risky conditions the market knocked away over the past month…

• “Sell in May and Go Away” – Ah yes, the proverbial Wall Street nursery rhyme. Just because it rhymes, doesn’t mean it’s an investment strategy! Had one heeded this ‘advice’, they would have missed out on a historical upward move in the Nasdaq relative to the Dow Jones Industrial Average.
• Debt Ceiling Drama – If ever there was a manufactured crisis to eventually overcome and use as an excuse to rally, this was it. As we anticipated, this spectacle resolved itself at the 11th hour and was used as ammunition to support a stock market rally at month-end.
• Earnings Recession – Not this earnings season! The final tally for Q1 earnings was a ‘much-better-than-expected’ result, refuting calls for an imminent recession.
• Rising Interest Rates – Some upward pressure on rates through the month, but not nearly enough to derail the markets upward advance.
• Sticky Inflation – This is a matter of debate. We say inflation is rapidly heading lower, and the slow pace is primarily due to lagged data-sets rather than inflation remaining entrenched at elevated levels (hence “sticky”). Time will tell who is right as this ‘fear’ will be carried forward until the backward looking CPI finally reflects reality.

None of these bearish narratives played out in the market this past month, thereby sending the bears straight to counseling!

Baffle Them With…

This morning’s payroll report was much anticipated by Wall Street as it is one of a handful of key data points before the Fed meets again mid-month to determine whether to pause or plow ahead with yet another rate hike. At first blush, the headline figure of 339k net new jobs could have been cause for concern (after all, Powell has been prattling on about the ‘over-tight’ labor market for nearly a year now). However, this figure was from the establishment survey. Inside the report, we also have the household survey which showed almost an equal number of job losses at -310k net new jobs. And the final cap was the official unemployment rate jumping higher by 0.3% to 3.7% from last month’s record low 3.4%.

In the end, the confusing report was enough for Wall Street to conclude there is enough here to keep the Fed on hold at the next meeting. This bullish interpretation of conflicting signals resulted in sharp gains (and with greater market breadth than we have seen in recent weeks) on Friday, powering the major averages to slight gains on the week.

One report we saw described the report as “goldilocks”….with payrolls rising, but labor supply increasing to raise the unemployment rate, and labor costs in check. Not too hot, not too cold.

Cause for a Pause

According to an analysis of public and private lending data, the Wall Street Journal reports that lending conditions for companies, consumers, and real-estate developers tightened this Spring to levels not seen since the height of the Covid pandemic. This slowdown is a direct consequence of the Federal Reserve’s interest-rate-hiking campaign against inflation, and it means there is now less money available for US businesses and households to hire new workers, build plants, and pay the bills. To be sure, Wall Street strategists have been predicting a recession for months, and it hasn’t come.

But warning signs are flashing in the typically more conservative debt market, which moves money from banks and other lenders to businesses and families. The Fed would be wise to heed these warning signs in the banking system. Unfortunately, they continue to give us reasons to believe they are not wise.

As Expected

Late last night, the US Senate took the final step in the negotiation and legislative process to pass a debt ceiling package by a vote of 63-36, sending the legislation to the president’s desk in time to stave off a catastrophic default. The bill suspends the debt limit until Jan. 1, 2025, in exchange for some measures that cap non-defense discretionary spending, stiffen work requirements for some recipients of food assistance, and allow the Mountain Valley natural gas pipeline. In a conciliatory tweet after adopting a position of there would be no negotiation, President Biden said “No one gets everything they want in a negotiation, but make no mistake: this bipartisan agreement is a big win for our economy and the American people. Our work is far from finished, but I look forward to signing this bill into law as soon as possible and addressing the American people directly tomorrow.”

As we said last week, the US has raised the debt ceiling 78 times since 1960 and we did not anticipate 2023 would be any different. We’ll also go out on a limb now and tell you that in 2025, when this current debt ceiling deal expires, a new one will be negotiated (at the last minute) and the US will continue to fund the government and make good on its debts. All the rest is just noise to be tuned out.

A Nightmare on Wall Street

Through last Friday’s close, the 5 largest S&P 500 weights accounted for over 24% of the index. To add to this, both Apple and Microsoft are now each greater than 7% weights, a feature we haven’t seen in over 40-years of data. It’s a passive investors’ dream – mega-cap names carrying the indices to decent returns – but a nightmare for active managers who can’t own enough of those names for various reasons.

Active managers in the Large-Cap Growth space particularly may have a difficult time overcoming the heavyweights…and if you’re passive, these names are helping carry almost all of the gains.

Take a look at the table below. It shows the weightings of Apple, Microsoft, Alphabet, Amazon, and Nvidia in each of the top growth index funds. For example, the Vanguard Growth ETF comes in with a whopping 40.7% of the index accounted for in just these 5 stocks. Out of 244 holdings, just 5 accounts for nearly 41% of the performance! And Vanguard is not alone, all of the other major index providers have similar skew to the top 5 with percentages ranging from 33% to 45%. Maybe investors aren’t as diversified as they think they are! And in a strange year like 2023, gains have been tough to come by if you are not heavily allocated to these mega-cap technology names.

Economic Funnies

In honor of this week’s Goldilocks jobs report…

Crazy Stat(s) of the Week

Here is this week(s) crazy stats!

• Timberrrr! After surging 545% from the April 2020 lows to May 2021 highs, lumber futures prices have collapsed 80% and are now 25% below pre-COVID prices seen in February 2020. The sharp drop in this key input for homebuilders is one reason why the S&P 1500 Homebuilder group is up 44% over the last year and near all-time highs.
• It’s a Good Year…for Mega Caps. In the three months that ended 5/24, the 50 largest stocks in the S&P 500 by market cap were up an average of 9.2%, while the 50 smallest stocks were down an average of 10.8%. Over the same three-month span, the seven largest S&P 500 stocks were all higher and up by an average of 24.7%, while the seven smallest were all lower and down by an average of 34.5%.
• No Love for Dividends in 2023. In the large-cap Russell 1000 index, the 300+ stocks in the index that pay no dividend were up an average of 9.6% year-to-date (YTD) as of mid-May. Conversely, the 230 stocks in the index that began 2023 with a dividend yield of 3% or more had declined by an average of 5.2% YTD over the same period.
• Not as Easy as it Appears…The average performance in May…of the 10 largest S&P 500 stocks: +8.9%. Of the 490 smallest S&P 500 stocks: -4.3%

Quote of the Week

“In investing, what is comfortable is rarely profitable.”

-Rob Arnott

Calendar of Events to Watch for the Week of June 5th

From an economic point of view, we’re expecting a quiet week with very little in the way of market moving events. The highlight will be Monday’s ISM Services Index for May which gives a recent glimpse into the health of the services segment of the US economy. Earnings reports will continue to be fairly light, and the main events will be Washington politics and “Fed watch” in front of the next FOMC meeting slated for June 14th.

Monday 6/5 – The ISM Services Index for May is expected to remain in expansionary territory at 52.1, up a tick from last month’s 51.9 reading. BEA Vehicle sales data is expected to decline by -4.4% to 15.2m. And rounding out the reports, the final reading on April Durable Goods is expected unchanged at 1.1% month-over-month.

Tuesday 6/6 – No major US economic reports due today. Looking overseas, we’ll get Eurozone Retail Sales which is expected to bounce back to a 0.2% month-over-month rate from last month’s -1.0% decline.

Wednesday 6/7 – April Consumer Credit is expected to be lower at $20b from last month’s $26.5b expansion.

Thursday 6/8 – Final US Wholesale Inventories are expected to contract -0.15%, similar to the prior month at -0.20%.

Friday 6/9 – No major US economic reports due today.

Source: FactSet