by Shawn Narancich, CFA
Executive Vice President
Equity Research and Portfolio Management
A New Bull Market
In an otherwise quiet week on Wall Street, the benchmark S&P 500 turned the page on one of its longest-running bear markets. Rebounding by over 20% from its October lows, the blue-chip index has officially surpassed the threshold marking a new bull market. What is notable about the advance from last fall’s lows is how few stocks have participated in the upturn. As the chart below shows, seven mega-cap technology stocks, including artificial intelligence-themed Microsoft, Google and Nvidia, represent more than 100% of this year’s double-digit advance in the S&P 500.
Source: Eikon
A Market with Bad Breadth
The “Magnificent Seven,” as these stocks have come to be known at Ferguson Wellman, account for almost 30% of the market capitalization of the S&P 500 and have averaged gains so far this year of 79%. In contrast, the remaining 493 stocks in the index have averaged roughly flat returns year-to-date. Market technicians would note that, compared to today, new bull markets typically display much broader upside participation, usually marked by more than 50% of stocks trading above their 200-day moving average. After handily outperforming last year amid elevated inflation and higher interest rates, value stocks from the energy and financials sectors have notably underperformed so far this year – up just 1% versus a 23% advance for growth stocks (Russell 1000 Value and Russell 1000 Growth respectively).
All Eyes on the Fed
Next week, the Federal Reserve will convene to decide its latest iteration of interest rate policy. Investors are expecting our central bank to pause its campaign of interest rate hikes for the first time since last January. As famed economist Milton Friedman observed, monetary policy works with a long and variable lag. Fifteen months into a campaign of raising rates to conquer inflation, the Fed is likely content to let over five percentage points of short-term interest rate increases impact the economy. While the housing market has slowed in response to higher long-term rates and retail sales are beginning to soften, the U.S. consumer is gainfully employed and the economy has continued to expand. The Fed wants to see excessive job demand disappear, but labor markets have been slow to cool, with job gains continuing to exceed expectations. Nevertheless, one of the most closely followed leading economic indicators – initial jobless claims – raised eyebrows this week as they unexpectedly increased by 12% sequentially, rising to levels marking the highest weekly claims since the Fed started raising rates last year.
Shifting Gears
While the Fed could hike rates once more in July, we believe the central bank’s work is mostly done. Inflation, as measured by the Consumer Price Index (CPI), is down by nearly 50% from highs reached last summer, and next week’s CPI report should confirm a further slowing of this key indicator to somewhere near 4.5%. As the chart below shows, stocks tend to do better once the Fed stops raising interest rates. The more nuanced view is that outperformance historically depends upon inflation – in past periods of top quintile inflation, stocks underperformed over the following 12 months, and when inflation was moderate, stocks outperformed.
Source: Bloomberg, Morgan Stanley Research
Proceed with Caution
Significantly higher interest rates, U.S. banks’ reduced willingness to make loans as they battle for deposits and historically rare declines in the money supply tell us that labor markets, consumer spending, inflation and the overall economy are likely to slow in the months ahead. Accordingly, our sector weightings and stock selection have become more defensive.
Takeaways for the Week:
Amid its fourth consecutive week of gains, the S&P 500 officially returned to bull market territory
While the economy has been resilient to higher interest rates so far, we expect slowing in the months ahead