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August 10, 2023
Equity markets have produced surprisingly strong returns in the first seven months of 2023, driven by resilient U.S. consumers, improving inflation numbers, the continuing effects of government spending and better-than-expected earnings.
Through July 31, the large-cap S&P 500 is up 20.5%, small-cap and mid-cap stocks are up 10.8% and 12.8%, respectively, and foreign stocks are up 15.7%.
The S&P 500’s large lead is driven by the strong performance of technology-sector companies like Apple (+52%), NVIDIA (+220%) and Microsoft (+41%).
The seven largest contributors drove more than two-thirds of the S&P 500’s performance year-to-date, leaving the other 493 stocks to make up the other one-third.
And, despite the continued increase in interest rates (bond prices move in the opposite direction of interest rates), broad-based bond benchmarks are up 1.5% to 2.2%, as well, due to the income component of returns over the past seven months.
Resilient consumer
Consumers in the U.S. continue to increase their spending at a healthy pace, up more than 4% on average over the past three months.
We believe this spending is supported by a strong job market and the continued move higher in labor force participation.
The national unemployment rate remains historically low at 3.6%, and here in Wisconsin, it is an even lower 2.5%.
This environment is slowly drawing an increased number of people back into the job market, pushing up household incomes and supporting spending.
Wages have also continued to grow at a healthy pace.
With the confidence that another, possibly better, job is available, consumers remain comfortable with their spending.
Given consumer spending represents more than 70% of overall US economic growth, a resilient consumer can provide significant support to the economy.
Improving inflation
Inflation (as measured by the Consumer Price Index, or CPI) was stubbornly high through 2022, finishing the year at a 40-year high of 6.5% and causing concerns about impacts on consumer budgets and corporate earnings in 2023.
However, by the most recent report in June, that inflation rate had fallen to just 3%, substantially easing those fears.
With that, the markets now expect the Federal Reserve’s (the Fed) increase to 5.5% on the Fed Funds Rate in July will be its last for this cycle.
In fact, the interest rate markets now believe the Fed will reverse course and reduce interest rates as soon as next summer.
However, the Fed’s own forecast is ‘higher for longer,’ driven by the stubbornly high core inflation rate (excluding food and energy prices) that remained at 4.3% in June relative to the Fed’s official target of 2.0%.
Government stimulus
Starting with the response to the COVID-19 pandemic and continuing through the Inflation Reduction Act and the CHIPS and Science Act, the federal government has provided unprecedented levels of government-financed spending or fiscal stimulus to the U.S. economy in the past three years.
While those spending plans and tax cuts were approved and budgeted primarily in 2020 through 2022, the economic impacts are still being felt and will be for some time to come.
The direct stimulus checks to consumers from the pandemic period have largely come and gone, but elements like support for state programs, infrastructure spending and tax credits for transferring business operations back to the U.S., take much longer to work through the economy.
In addition, that spending has multiplier effects throughout the economy as the dollars flow from the government agency to a contractor to suppliers and employees and on to stores and restaurants.
The lingering effects of that stimulus are helping support economic growth today and likely will for many quarters to come.
Corporate earnings
The ultimate driver of stock prices over time is earnings – and growing profits eventually lead to increasing stock prices.
For the S&P 500, first quarter 2023 earnings were 3% higher than the prior year.
With slightly more than half of companies reporting for the second quarter, year-over-year earnings are expected to decline by about 7%, but about 80% of those reporting have reported earnings above Wall Street estimates.
More importantly, the forward 12-month estimates have stabilized, and the one-year and two-year forward expectations have started to tick higher again.
The three factors discussed above (resilient consumer, improving inflation and government stimulus) have resulted in a better-than-expected earnings picture for U.S. companies (as represented by the S&P 500).
As mentioned, consumer spending makes up roughly 70% of U.S. economic activity, so solid job and wage growth can support consumer spending and economic activity.
Inflation drives the cost component of corporate income statements – improving inflation drives more stable margins for companies.
Finally, government stimulus continues to support the revenue component of the income statement, adding to earnings.
Better so far
While we still have a way to go in 2023, financial markets are on pace for a good or better year so far, and the U.S. economy seems to be on strong footing with some momentum behind it. Further progress on inflation and continued consumer resilience will be key factors to watch for the rest of 2023 and into 2024.
Though risks and concerns will always be present for both the economy and financial markets, looking to the “finish line” for the year with a “lead” is a good place to be.
