Although the S&P 500 Index finished lower last week by 0.8%, giving back the previous week’s slight gain, the Index has moved less than 1.0% for the fifth straight week. On the week, the NASDAQ Composite rose fractionally (+0.07%), supported by Technology, which gained +0.6%. The Dow Jones Industrials Average (down 1.2% on the week) was pulled down by Energy (down 5.8%) and Financials (lower by 2.7%). April’s nonfarm payrolls report, a Federal Reserve rate decision, and ongoing volatility across the regional banks, loomed large over the market and weighed on investor sentiment last week.
U.S. Treasury prices were mixed across the curve, with the 2-year Treasury yield falling back below 4.00%, finishing the week at 3.90%. The 10-year Treasury yield ended last week at 3.43%. Outside of stocks and bonds, West Texas Intermediate (WTI) crude dropped 7.1% last week. But crude finished well off the week’s worst levels after rallying by +4.1% on Friday to finish at $71.34 per barrel. Gold ended at $2025.90 per ounce, up +1.3% on the week.
The more bullish views on the market and economy continue to center around a strong labor market, with the April jobs report recording its 13th straight month of an upside surprise in the number of jobs created versus the estimate. April nonfarm payrolls grew by +253,000, well ahead of the +179,000 jobs expected and March’s pace of +165,000. While downward revisions for March and February subtracted roughly 150,000 jobs from the original prints, job growth over recent months remains well above the pace needed to sustain population growth. In addition, the unemployment rate sank to 3.4% last month, a 50-year low. However, average hourly earnings (an important measure of labor inflation) came in hotter than expected and above March’s pace. Bottom line: Job growth in the U.S. is slowing but remains firm. April’s report confirmed labor conditions are still tight, unemployment is historically low, and wage inflation remains a concern the Federal Reserve is unlikely to ignore.
Investors Continue to Ignore the Fed’s ‘Higher for Longer’ Message
On that point, the Fed’s Federal Open Market Committee (FOMC) lifted the fed funds rate by 25 basis points to 5.00% - 5.25%, raising its target rate for the 10th time in the current hiking cycle. The decision was unanimous among the Committee. Notably, the policy statement eliminated language stating further rate hikes may be needed, instead focusing on data dependency. The market quickly interpreted this subtle change in forward policy guidance as a signal the Fed is finally on the edge of pausing interest rate hikes, likely as soon as the June meeting. However, Fed Chair Jerome Powell stressed in his press conference following the policy decision that if inflation forecasts play out as the Fed expects, “it would not” be appropriate to cut rates this year. And here’s the rub for investors, despite that crystal clear message, directly from the Fed Chair himself, the market doesn’t buy it. Based on the CME FedWatch Tool, nearly 100% of the market believes the fed funds rate will be lower than where it stands today by December. Importantly, a significant number of market participants believe the fed funds rate will be substantially lower than current levels by year-end. We believe this dynamic could become a problem for stocks at some point, particularly if inflation remains stubborn in core/services/labor areas.
Bottom line: The Fed is very likely preparing to pause its interest rate hiking campaign to finally allow the 500+ basis points of rate hikes over the last year or so to set into the economy and let the Committee measure if further rate hikes are needed to bring inflation back to its 2% target. At the same time, there is a Grand Canyon-sized gap between how the market and the Fed see policy evolving through the rest of the year, again increasing the risk of stock price volatility at some point. In our view, the market is ignoring consistent and direct Fed messaging on the rate outlook and simply refuses to accept the higher-for-longer messaging the Fed believes is required to slow growth enough to bring inflation pressures down for good. Nor do we believe the market fully appreciates how sticky inflation pressures become when left to linger, given many of today’s market participants have not navigated such an environment. Our advice? Take what the Fed is saying at face value. Believe officials over the coming weeks when they reiterate a higher-for-longer rate environment. And don’t be too surprised if stocks go through another adjustment period, one where abnormally low volatility rises and stock prices wobble.
Regional Banks Continue to be the Center of Market Stress
Speaking of wobbling, regional banks continue to be the epicenter of market stress, despite JPMorgan acquiring First Republic at the start of last week. The rescue deal orchestrated with government officials was supposed to calm contagion fears and quell the further risk of bank failures. Instead, traders quickly turned their attention to the perceived weakness across PacWest and Western Alliance. Both banks closed the week materially lower, as reports swirled that each was exploring strategic options, including a sale. That said, Western Alliance pushed back on such reports, calling them false. Nevertheless, regional banks as a whole lost 8.0% on the week and were down as much as 15.0% week-over-week at one point before the group rallied higher on Friday. Over the weekend, The Wall Street Journal noted that in the middle of last year, nearly all community banks and all regional banks with assets up to $100 billion reported capital ratios above their requirements, according to the Federal Reserve. That said, investors are rightfully concerned that current asset and liability mismatches across some smaller regional banks and reduced lending could not only lead to lower bank profits but create further cracks in the economy and markets.
Yet, in our view, recent bank volatility is being exasperated by short-selling and near-term trading activity that has less to do with banking fundamentals and more to do with predatory and opportunistic behaviors meant to stress target banks. We believe this market dynamic is now weighing on regional banks specifically and could be mitigated with a short-term moratorium on traders' ability to short (i.e., bet against) regional bank stocks. While this would not address deposit/liquidity/profit/lending concerns directly, it may reduce the severe volatility the group is experiencing today. As such, temporarily putting short sellers on the sidelines (similar to what was done during the Financial Crisis) could help quiet the more extreme confidence disruptions across the banking sector. This could allow banks, regulators, and investors to map out a thoughtful approach to navigating the current environment without the severe disruptions/influence of short sellers. One additional point, Congress acting to boost deposit insurance thresholds would also help restore confidence in smaller banks and likely reduce stress across the sector. However, thus far, regulators and Congress have not felt compelled to act.
Earnings Appear to be on a Downward Trend, but are Beating Low Analyst Expectations; Markets Becoming Increasingly Concerned about the Debt Ceiling
In other items that helped shape markets last week, companies continued to hurdle over the significantly lowered bar for first quarter earnings growth. On a year-over-year basis, Q1’23 S&P 500 earnings per share (EPS) growth is down 2.2%, with 85% of company reports complete. That’s significantly better than the 6.7% decline expected at the end of March. While earnings growth remains on a downtrend, S&P 500 companies, in the aggregate, are on pace for their biggest profit outperformance versus analyst expectations since Q4’21, according to FactSet. In addition, the March JOLTS report showed a larger-than-expected decline in job openings, April ISM Manufacturing contracted for the sixth straight month, and ISM Services expanded above expectations as well as March’s level.
This week, a debt ceiling showdown at the White House, reads on inflation, evolving bank conditions, and Michigan sentiment will be the key items to watch. After an extended impasse with almost no negotiations between Democrats and Republicans, President Biden will host House Speaker Kevin McCarthy and other congressional leaders at the White House on Tuesday to try to negotiate a deal on the debt ceiling. Markets are becoming increasingly concerned that the political brinkmanship that often accompanies lifting the debt ceiling could spill over past the June 1st deadline. That’s the date the U.S. Treasury Department has said it could exhaust its current use of extraordinary measures to pay obligations on government bonds and Social Security, for instance. While the date remains a moving target, it would be unwise for the President and GOP leaders to test the date on which the U.S. could potentially default on its obligations.
Bottom line: Markets usually tolerate the unnecessary political theater around differing opinions and ideologies on debt and spending issues when the debt ceiling arises because it always ends the same way. The debt ceiling is raised and extended regardless — every time. Seventy-eight separate times since 1960, to be exact, according to the U.S. Treasury Department. And while that is very likely to be the case this time around, the added drama amplifies the anxiety due to other ongoing uncertainties currently weighing down investor sentiment. Not to mention, the closer Congress moves to the ex-date of a government default without a deal, the higher the chances for a misstep.  
Lastly, Wednesday’s April headline Consumer Price Index is expected to remain unchanged at +5.0% year-over-year, partly due to higher gasoline prices. However, core CPI is expected to tick lower in April. Thursday’s April headline Producer Price Index is forecast to decline to +2.4% year-over-year from +2.7% in March, marking yet another shift lower from the +11.7% level seen in March 2022.                      
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A rise in interest rates may result in a price decline of fixed-income instruments held by the fund, negatively impacting its performance and NAV. Falling rates may result in the fund investing in lower yielding debt instruments, lowering the fund’s income and yield. These risks may be heightened for longer maturity and duration securities.
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An index is a statistical composite that is not managed. It is not possible to invest directly in an index.

The Standard & Poor’s 500 Index (S&P 500® Index), an unmanaged index of common stocks, is frequently used as a general measure of market performance.

The index reflects reinvestment of all distributions and changes in market prices but excludes brokerage commissions or other fees.  It is not possible to invest directly in an index.

The NASDAQ composite index measures all NASDAQ domestic and international based common type stocks listed on the Nasdaq Stock Market.

The Dow Jones Industrial Average (DJIA) is an index containing stocks of 30 Large-Cap corporations in the United States. The index is owned and maintained by Dow Jones & Company.

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The CME FedWatch Tool analyzes the probability of FOMC rate moves for upcoming meetings. Using 30-Day Fed Fund futures pricing data, which have long been relied upon to express the market’s views on the likelihood of changes in U.S. monetary policy, the tool visualizes both current and historical probabilities of various FOMC rate change outcomes for a given meeting date. The tool also shows the Fed’s “Dot Plot,” which reflects FOMC members’ expectations for the Fed target rate over time. 

The Institute for Supply Management (ISM) manufacturing index is a national manufacturing index based on a survey of purchasing executives at roughly 300 industrial companies. It is an index of the prevailing direction of economic trends in the manufacturing and service sectors.

JOLTS report is a monthly survey of U.S. job vacancies, hiring, and job separations released by the Bureau of Labor Statistics of the U.S. Department of Labor.

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