Markets Wrap (24 April – 7 May)
The stock market may be more in line with historical valuations based on fundamentals (S&P 500 P/E currently stands at 18.9, a tad below its 10-year average value), but stocks are still richly valued if compared to bonds, as indicated by the ratio of S&P 500 and Bloomberg US aggregate fixed-rate bond index. The relative value of the two major asset classes is making investors uneasy, given that several other peaks preceded sharp stock market selloffs (Chart 1).
With 1st quarter earnings season approaching the end, 68% of 425 S&P 500 companies that have already reported beat sales forecasts and 78% earned more profit than analysts projected. Most of European companies have also exceeded expectations with the share of positive surprises at 65% (sales) and 64% (earnings).
Debt ceiling-related tensions are apparent in the US bond market, as indicated by the spread between 3-month and 10-year securities (Chart 2). US Treasury Secretary J. Yellen noted that the "X-day" (an estimate of the date at which the government can no longer pay its bills) may come as early as at the beginning of June. 43 Republican Senators have vowed to demand fiscal expenditure cuts in exchange for their approval. According to J. Yellen, the US President unilaterally lifting the borrowing limit may spark a Constitutional crisis.
The FED raised interest rates to the highest level in 16 years (5.0-5.25%) in what is thought to be the last hike in this tightening cycle. J. Powell acknowledged that the US is heading into a mild recession, but when asked about the possibility of rate cuts, the FED chairman said that inflationary pressures are too strong for that. SEB economists expect the first two cuts to be carried out at the end of 2023 and a total of seven in 2024, which would bring the rate interval, to 2.75-3.0%.
The ECB slowed the pace of monetary tightening at its May meeting following six 50 and 75bps hikes, and raised interest rates by 25 bps to 3.25% (deposit facility), 3.75% (main refinancing rate) and 4.0% (lending facility). Ch. Lagarde noted that significant upside risks to the inflation outlook still exist, and the ECB is not going to pause rate hikes yet (based on interest rate futures, the market expects two more). The ECB also announced it will no longer reinvest amounts received under the Asset Purchase Program from July.
The price of oil is on a downtrend as weakening demand from the US has added to the concerns that the global economy may be in a worse shape than previously thought. West Texas intermediate and Brent are down by 9.3% and 10.7% year-to-date respectively despite a surprise production cut by OPEC+ in April.
US labour market seems to be unaffected by high interest rate environment so far. April non-farm payrolls stood at 253k (versus the median forecast of 185k), jobless rate fell from 3.5 to 3.4%, and hourly earnings growth accelerated from 4.2 to 4.4%.