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Market Commentary

Q2 and the 2023 Outlook

We hope everyone is doing well and your Spring is off to a great start! 

As we move into Q2, many forces that were headwinds in 2022 could very well become tailwinds this year, but of course there are many risks to consider as well. Let’s look at three trends for Q2 on why we feel optimistic about 2023 overall:

1.       Inflation is slowing

Soaring inflation trends are showing signs of easing. Earlier in April, the Labor Department released CPI (consumer price index) confirming that inflation remains in a downtrend.  CPI registered at 5% year-over-year in March, down from February’s 6% year-over-year increase. Services prices remain elevated, but a close look at the data reveals that much of the pressure is coming from the shelter component, which makes up one-third of CPI. It’s important to note that shelter prices impact CPI with a significant lag. Since shelter prices measure what renters and homeowners pay for housing by including new and existing leases, it means that any meaningful declines would not show up in the CPI numbers for months. We’re showing that new leases have come down sharply in price, with an index of new leases declining at a 3-month annualized rate of slightly less than 3%. By our estimations, the shelter component should contribute significantly less to inflation starting in June and extending into the fall.

The reason the inflation question matters so much, of course, is because inflation data sets the stage for interest rate policy. As of today, the market is forecasting only one more 25 basis point rate hike in this tightening cycle, which hinges on inflation continuing in a downtrend. In our view, the table is set for inflation to continue falling – barring another commodity market shock or some other extraneous factor – and for interest rates to hit a peak, likely this summer.

2.       Gridlock

We have discussed this in previous commentaries, but ‘gridlock is good’ for the market.  With a Republican-controlled House and a Democratic-controlled Senate, we now have a divided Congress.  Since 1950, the S&P 500 gained 13.7% on average under a divided government. The truth is, markets don’t like one party to have too much power and checks and balances are a welcome sign. More extreme policies are likely off the table under a split Congress and that could be a good thing.

3.       Earnings

Expectations for the upcoming year are historically low. No one is bullish. A Bloomberg survey of Wall Street strategists showed they expect stocks to be lower in 2023. Various polls on both the retail and institutional fronts show sentiment near record-low levels. Our outlook, which runs counter to these sentiments, is that the low expectations actually give us more confidence because that means potential bad news is most likely already priced into stocks. There’s an old Wall Street adage that says “It’s hard to get hurt falling out of a basement window”. With general sentiment so low, any good news could spark a rally. What if we avoid a recession? What if inflation cools? What if the Fed pivots to dovish policies and lowers interest rates? What if the war in Ukraine resolves? The stage is set for a strong rally in 2023 should any (or all) of those scenarios happen.

Q1 Earnings: With the second week of earnings season in the books, the percentage of S&P 500 companies posting positive EPS surprises stands at 76%, according to FactSet. This “beat rate” comes in just shy of the historical 77% five-year average. Thus far, 18% of S&P 500 companies have reported actual results, with 68% of them additionally reporting positive revenue surprises, which we will be monitoring closely as earnings season continues.

Weaker U.S. Dollar: For U.S. companies selling products abroad, a stronger U.S. dollar presents major challenges in competing with local companies, which can offer significantly more affordable products. Essentially, a stronger greenback erodes potential profits. The stronger dollar likely took a toll on S&P 500 earnings growth in 2022. But if the dollar weakens this year, as we expect, earnings could get a healthy boost. We are a global economy, roughly 40% of the S&P 500 revenues are generated outside of the U.S. See chart below, but historically there is an inverse relationship between dollar strength and earnings.

Remember, the path to steady improvement may not be entirely smooth. There is no guarantee when we’ll see improvement. The key to staying on the financial track on the cusp of change is to avoid emotional reactions and regularly assess your long-term plan. No matter how stocks and other assets perform this year, you’ll want to maintain an actively managed financial plan that caters to your specific financial goals, circumstances, risk-tolerance level, and investing horizon. As always, you can be confident that we’ll continue to monitor economic conditions and let you know if there’s anything that needs to be changed or addressed. If you have questions or concerns, we’re always available to talk.