Investment Committee Meeting Highlights
Equity markets rallied in July, with the S&P 500 gaining 9.22% and the MSCI EAFE gaining 4.98%. Much of the rally happened in the latter half of the month with a final surge in the days following the Fed’s decision. The notable exception was emerging markets, which lost 0.25%. Fixed income also rallied, despite the Fed hiking 75 basis points and inflation accelerating to 9.1% in June.
With mounting inflationary pressures, the Fed raised rates by another 75 basis points, putting the target range at 2.25% to 2.50%. Equity markets rallied and yields fell in the afternoon following the announcement. However, over the month, the very short end of the yield curve rose while most of the curve fell. Several sections of the yield curve are now inverted, including the 10-year versus the 2-year, though crucially not the 10-year versus the 3-month.
Despite the strong market, headlines were focused on the economy and fears of recession with the economy shrinking for the second quarter in a row, where Q2 GDP fell at a 0.9% annualized rate. The consumer continues to be resilient with consumer spending slowing but continuing to grow. Surging exports also helped but wasn’t enough to offset the pullback in business investment, weakness in real estate spending, a drop in inventories, and less government spending.
The economy is weighing on earnings, but perhaps not as much as many feared. Earnings season is just over halfway done, and the results are showing slower than average growth rates, but still resilient top-line growth. Through the end of July, over three-fourths of the S&P 500 that have reported results were able to grow sales, and over 60% grew earnings. So far, quarterly revenue and earnings have increased over 13% and just shy of 6.0%, respectively with over 70% of companies beating analyst earnings estimates.
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The S&P 500 had one of its best monthly performances since 2020, climbing from its recent lows in June. However, the economy just posted its second quarterly decline in a row, but The NBER (National Bureau of Economic Research) are the ones who make the official recession call. The current economic data set is undoubtedly mixed and weakening, giving investors and businesses trepidation at what the near-term trajectory may be. However, there hasn’t been widespread and consistent negative readings in the major data points the NBER calls out.
We are halfway through earning seasons, which helped markets post positive gains. Across the over 270 companies of the S&P 500 that have reported so far, top-line revenue has grown 14.3% over the quarter and earnings have grown just under 6%. Relative to analyst estimates, 73% of companies have exceeded earnings, though this is below the five-year average of 77%.
Markets continue to focus on Fed policy and how quickly rate policy may change throughout the year to combat inflation and how they may navigate the inflationary environment with a potential recession. The Fed hiked another 75-basis point hike in July, but expectations are for the Fed to slow down rate hikes over the coming meetings. The market is now considering the potential for the Fed to return to easing in the middle of next year, though expectations that far away should only be taken with a grain of salt.
Growing concerns over the current state, as well as near-term prospects, of the economy created an odd movement in the yield curve in July. The short end rose substantially while the 2-year and beyond fell. While the popular 10-year yield minus the 2-year yield inverted again, the more academically studied 10-year minus the 3-month still has not and is far away, relatively speaking, from doing so.
Inflation continues to be a hot topic and one likely on the mind of many investors. With that in mind, we want to keep an eye on how economists are viewing inflation. Near-term expectations continue to rise, and while the high and low forecasts can be outliers, the gap between them in the latter half of 2023 widened considerably.
While positive movements in equity markets reduced equity implied volatility, credit spreads remain elevated, indicating potential risk in corporate balance sheets. Markets continue to try to digest mixed economic news with persistent inflation, as well as trying to anticipate what the Fed may do for the rest of the year, which can lead to sudden shifts in anticipated market risks.
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