All About the Labor Market, Debt Ceiling and Earnings

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May 2023

Current Equity Exposure

Major equity indexes ended the month of April higher: the Dow and the S&P 500 gained 2.6% and 1.6%, respectively, while the technology-heavy Nasdaq was flat (up 0.07%) for the month. We stayed underweight U.S. equities as we believe the risks remain skewed toward the downside with tightening financial conditions, macro risks, deteriorating economic leading indicators, and corporate earnings pressure. Notably, we increased our international equity exposure from 53% to 65% as we see recent activity data pointing to the upside for Europe and China. April PMI data in Europe and the U.K. painted an optimistic picture of business activity driven by the robust service sector. China’s recovery remains on track, with Q1 GDP surprising to the upside and leading indicators suggesting upside dynamics.

The Factors

Valuation

Valuation metrics for equity remained negative. P/E increased slightly from 19.7 at the end of March to 19.9 at the end of April.
Forward P/E increased to 19.0 at the end of April from 18.8 at the end of March.
Inflation-adjusted valuation metrics continued to be negative.
Equity valuation metrics relative to bonds remain negative with high bond yields
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Sentiment

U.S. manufacturing activity contracted for the fifth month, with the ISM manufacturing index falling to 46.3 in March from 47.7 in February.
University of Michigan Consumer Confidence Index remained weak at 63.5, battered by continuing high inflation, recession fears, and financial market stress.
The NAHB index inched up 1 point in April but remained below neutral level at 45
.

Technical

Technical indicators were positive, with increasing momentum signals outweighing neutral reversal signals.
The S&P 500 was 5% above its 200-day moving average, 4% above the 100-day average, and 3% above the 50-day average.
The VIX index decreased and settled at 15.8. The low volatility is largely driven by technical factors.

Macroeconomic

Nonfarm payrolls rose by 236,000 in March, in line with expectations. The four-week moving average of initial jobless claims increased to 236,000 as of April 22.
Retail sales fell 1% after dropping 0.2% in February, with slow growth of real income and spending shifting from goods to services.
U.S. industrial production expanded 0.4% in March.

What's Driving the Markets?

Slower economy and signs of softness in the labor market: U.S. GDP grew by a disappointing 1.1% over the first quarter. Leading indicators such as the deep inversion of the yield curve and Conference Board Leading Economic Index also indicate a looming downturn in the economy. While the robustness of the labor market has supported the U.S. economy so far, recent data suggested some emerging signs of weakness. The initial jobless claims showed an upward trend since the beginning of February, and the continuing claims jumped to their highest level since November 2021. The new signs of labor market softness were taken by some investors as welcome news as it could lead to slowing wage growth and ultimately less restrictive Fed policy. However, we still expect another 25-basis point hike from the Fed in their May meeting as core inflation remained elevated, and March’s FOMC minutes demonstrated the Fed’s confidence in the soundness of the banking system.

Debt ceiling in focus again: In the wake of weaker-than-anticipated tax receipts so far, fears intensified that the U.S. Treasury will reach the “x-date” (the date it runs out of cash to pay the government’s bills on time) as soon as early June. We anticipate the “x-date” to be in late July as non-withheld tax payments are due around June 15 and another tranche of extraordinary measures will provide Treasury with a few more weeks of cash. We believe that it is likely that the impasse will eventually be resolved. Even if the debt ceiling is breached, the outcome will be disruptive but not disastrous, as the situation usually does not last more than a few weeks. However, we anticipate this recurring issue will begin making headlines in the next few months and could potentially generate market volatility including a stock market selloff, a wider credit spread, and a falling U.S. dollar.

Quarterly earnings: Earnings reports have surprised to the upside so far: among 53% of S&P 500 companies reporting actual results, 79% of them have reported a positive EPS surprise, and 74% have reported a positive revenue surprise. The equity market was encouraged by better-than-expected Q1 earnings results from tech companies including Microsoft, Alphabet, and Meta. However, the blended earnings decline for the S&P 500 was -3.7%, and the S&P MidCap 400 Index suffered a more significant year-over-year aggregate decrease in earnings. Companies continued to struggle as margin pressures were high, with slowing sales, elevated input costs, and high wages.

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As of 4/30/23. Data provided by Bloomberg, NorthCoast Asset Management, Federal Reserve History.

¹ The NorthCoast Navigator is a market barometer displaying NorthCoast's current U.S. and international equity exposure and outlook. This aggregate metric is determined by multiple data points across four broad market-moving dimensions: Technical, Sentiment, Macroeconomic, and Valuation. The daily result determines equity exposure in our tactical strategies.

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