Where are we in the economic cycle?

Most of the time, earnings estimates slide into reporting season and then beat to the upside. Q1 was different, with less of a drop than usual—and more of a bounce. Yet even so, despite strong earnings, the S&P 500 remains stuck in its corrective range. Blended earnings growth (actual and estimate) has come down to 7.1% y/y this quarter vs. 10.1% in Q4 2023, but the growth remains broad, with eight of 11 sectors posting positive y/y earnings growth to date this season. Of the S&P 500 companies that offered 2Q outlooks, 39% have been above consensus vs. a historical average of 24%. On balance, beats this quarter have been less rewarded than in the prior three quarters while misses have been more heavily punished, especially with small caps. The market corrected without a sustained rise in credit spreads or the VIX. Defensive stocks have fared particularly well over the past month, with strong performance from Utilities and Consumer Staples leading the market recovery. Nvidia, which reports in less than two weeks, has a 0.9 correlation to the S&P 500 over the past year (just with more volatility). It will be interesting to see how the company fares and whether its market leadership can persist. As for the broader market, election years (and years after double digit gains) often rally between now and late summer before a pre-election consolidation. Then, irrespective of winner, markets tend to post big gains late in the year.

Is it late or is it early? For Wolfe, the easier credit implied in the Senior Loan Officer Survey will drive loan demand and consumer spending in the coming quarters. They say this puts the U.S. in the early acceleration phase of an economic cycle. Fundstrat agrees, noting that the sharp improvement from negative earnings momentum seen in Energy, Health Care and Materials is consistent with early-cycle behavior. Year to date, the biggest upward earnings revisions have come from semis & equipment, autos and consumer services. As Wolfe observes, this looks like a sign of solid or accelerating growth. Plus, Powell’s press conference suggests to the market that the Fed Put has returned. The risk here, says Yardeni, is that the market “melts up.” Bank of America says the U.S. is in recovery right now but that if the current pace of improvement holds, mid-cycle could be reached by June (at six months, a bit shorter than the usual nine-month recovery phase). Insider buying has improved some lately, with particularly strong activity in cyclical industries such as trucking, gaming, industrials and regional banks. Perhaps, after the Covid years, we are simply getting back to normal. Bull/bear ratios as recorded by Investors Intelligence and AAII are approaching long-term averages. Demand for labor has softened but into normal territory, with job postings on Indeed.com at their lowest since March 2021 yet still 15% above pre-Covid levels. So, all good then?

That depends on who you are. Small companies and less-well-off consumers are struggling even as big companies and the well-heeled thrive. A bifurcated economy. While they remain optimistic, Strategas wonders where next year’s expected 14% earnings growth can come from with companies reporting higher costs and lower volumes. Taking note of business’ anemic hiring plans, BCA expects labor demand to deteriorate further, bringing this cycle to an end. The market is pricing recession odds at the 7th percentile, a sign of complacency even as growth is slowing and inflation rises. How could Goldilocks say these conditions are just right? The strongest areas of payroll have been the stickiest ones—government, health care and education, while the more cyclical area of temp work is collapsing. The wage gains of middle and high earners are keeping inflation sticky, “much to the chagrin,” Piper Sandler notes, “of low-earners.” Until a recession arrives and brings unemployment, they note, the wages of middle-income workers (“the linchpin of overall consumer spending”) will keep inflation elevated. Savers love “higher for longer” interest rates, borrowers not at all. Cash paying 5%+ can be both stimulative and restrictive. It just depends on whom you ask.

Positives

• Inflation help on the way? Supply chain pressures eased in April and are now at very low levels globally. (An increase in supply chain pressure in the latter half of last year may help account for the recent revival of inflation.) Also, used car prices are down, falling 2.5% m/m, an annualized rate of 30%. Downside pressure remains, given the state of the car market, promising relief to the autos component of CPI.
• No CRE crunch in sight? The Fed’s Senior Loan Officer Opinion Survey showed most banks reluctant to tighten lending standards. Consumer loan demand was weak, particularly for mortgages. And a quarter of banks reported weak demand for commercial and industrial loans. Even with a decrease in banks applying stricter standards to commercial real estate, office buildings financed by floating rate commercial mortgage-backed securities reported a 20% default rate.
• Ready to stimulate Sweden became the second European country (after Switzerland in March) to cut rates this cycle. The Bank of England and the ECB are both thought likely to start their cuts in June. With data going back to 1960, the ECB (and before it the Bundesbank) has never cut before the Fed except in 2011 when the Fed was already at zero. The euro zone’s Sentix measure of investor confidence rose more than expected in April.

Negatives 

• Absolutely nothing good to report here The University of Michigan’s survey of consumer sentiment fell sharply in May, to 67 (vs. expectations of 76) from last month’s reading of 77. Consumer inflation expectations rose to 3.5% one year out and 3.1% five years out; both levels were the highest since last November. To add insult to injury, the decrease in sentiment was broad-based, with declines across income, age and education levels.
• Half empty or half full? Initial jobless claims rose to 231K last week, the highest level in nine months. On the other hand, it’s still below breakeven, meaning overall employment is growing for now. It’s also below a recession signal, which ISI suggests would be about 300,000. Quirks to the readings: the timing of spring break in New York City and the recent minimum wage hike in California restaurants.  
• Leaving recession is slow work German factory sales and orders fell as did industrial production (IP), which dropped 0.4% m/m in March. The good news is that this decline comes after two monthly increases, so the overall rate for Q1 is above that of Q4 of last year, marking the first quarterly gain for IP since Q1 of 2023.   

What Else

How AI can fight inflation How can real wages grow without sparking inflation? Through productivity gains. Over time, nominal wage growth should be roughly equal to the inflation rate plus the productivity growth rate. So, if we want to make more money (in aggregate), we need to produce more. 2% productivity growth is feasible based on history.

Liquid electioneering The Fed and the Treasury Department combined to quietly add some $273 billion of net liquidity through the end of Q3. The Fed, by slowing QT. The Treasury, by deciding last week to finance the deficit through T-bills. These actions will add $75 billion in net liquidity over the balance of Q2 (vs. neutral) and $200 billion in Q3.

Buy low sell high The Biden Administration has been accused of playing politics in the timing of its sales of oil from the Strategic Petroleum Reserve. Maybe so—but the timing for buys and sells has been fiscally advantageous. The average selling price has been $95 per barrel while the Administration so far has paid an average of $83 to replenish the reserve.