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June 2024
Current Equity Exposure
Equities advanced in May following a favorable April inflation report and weaker activity data. S&P 500 and the Dow climbed by 4.8% and 2.3%, respectively, while the technology-heavy Nasdaq outperformed by rallying 6.9% for the month. Although the Consumer Price Index (CPI) moderated in April, on average, inflation figures have shown less cooling than the Fed would like. Our outlook remains cautious for equity investments with the Fed’s stance of holding rates high for longer, high investor positioning, rich equity valuation, and elevated geopolitical tensions. Adding to our concerns is the slowing growth, marked by a decline in real GDP growth from two quarters of above-trend growth to 1.3% in the first quarter, with high interest rates having an increasing impact and consumer spending starting to lose steam. With this backdrop, we trimmed our allocation to U.S. equities from 59% to 46% and maintained our international equity exposure at 72%.
The Factors
Valuation
Valuation metrics for equity remained negative. P/E increased from 24.1 at the end of April to 24.3 at the end of May.
Forward P/E increased to 21.5 at the end of May from 20.8 at the end of April.
Inflation-adjusted valuation metrics continued to be negative.
Equity valuation metrics relative to bonds remained negative with high bond yields.
Sentiment
U.S. manufacturing activity regressed into contraction territory in April, with the ISM manufacturing index falling to 49.2 in April from 50.3 in March.
The University of Michigan Consumer Confidence Index fell sharply to 69.1 in May from 77.2 in April, as elevated gasoline prices and stubborn inflation weighed on consumer outlook.
The NAHB index declined to 45 in May, below the 50 neutral threshold.
Technical
Technical indicators were positive overall, with positive momentum signals outweighing neutral reversal signals.
The S&P 500 was 11% above its 200-day moving average, 4% above the 100-day average, and 2% below the 50-day average.
The VIX index was on a downward trajectory in general this month with low realized volatility. It increased slightly in the last week and settled at 12.9 at the month-end.
Macroeconomic
Nonfarm payrolls rose by 175,000 in April, below consensus expectations. The initial jobless claims remained steady, with the four-week moving average edging up to 222,500 as of May 25.
Retail sales unexpectedly remained unchanged in April after rising 0.6% in March.
U.S. industrial production failed to grow between March and April.
What's Driving the Markets?
Inflation: The headline CPI and core CPI (excluding food and energy) increased by 0.31% and 0.29%, respectively, from March to April, marking a slowdown from previous months. On a year-over-year basis, the headline CPI decreased slightly from 3.5% to 3.4%, while the core CPI eased from 3.8% to 3.6%. Most encouragingly, shelter inflation (40% of the core CPI) rose 0.4% in April, the slowest pace since last October. However, healthcare costs increased, with the annual rate jumping to 2.7%. April’s CPI report should be received positively by the Fed as the easing CPI, together with weaker-than-expected retail sales data, should make the Fed feel more comfortable maintaining current interest rates. However, we believe the Fed will need a few additional months of sustained disinflation to begin loosening policy, especially given the first quarter’s inflation upside surprises.
Moderating Growth: The recent data on growth for April has moderated, and to some extent, bad news for the economy is becoming good news for risky assets, as they might enable an easing in financial conditions and increase the probability of a soft landing. Retail sales were flat in April after two strong months, indicating that consumers were cutting back on discretionary spending as their excess savings continue to shrink. Elevated interest rates make credit purchasing more costly and, together with tightened lending standards, have discouraged new borrowing. Additionally, U.S. manufacturing activity regressed into contraction territory in April, as shown by the ISM manufacturing index dropping to 49.2 after expanding in March. Sentiment signals have also weakened recently. Homebuilder confidence reversed the upward trend and declined 6 points to 45, below the 50-point neutral threshold. Higher mortgage rates were the major culprit behind the decline. Consumer confidence took a significant hit in May, with the University of Michigan consumer sentiment index decreasing to 69.1, the lowest reading since November, as elevated gasoline prices weighed on consumers.
Fed Policy: At May's meeting, the Federal Open Market Committee kept the Fed funds rate unchanged at 5.25% to 5.5% and acknowledged the lack of progress in their fight against inflation in recent months. The FOMC minutes shed further light on the Fed's current stance, indicating that many participants commented on their uncertainty about the degree of restrictiveness and how long the policy will need to stay restrictive. The initial response from financial markets to the release of May's minutes was moderately negative, with the idea forming around the possibility that the Fed might keep the current rate for an extended period. By the end of May, the futures market is now pricing only a 14% chance of a rate cut at the Fed's July meeting and a 45% chance in the September meeting.
As of 5/31/24. 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.
NorthCoast Asset Management is a d/b/a of, and investment advisory services are offered through, Kovitz Investment Group Partners, LLC (Kovitz), an investment adviser registered with the United States Securities and Exchange Commission (SEC). Registration with the SEC or any state securities authority does not imply a certain level of skill or training. More information about Kovitz can be found at www.kovitz.com.
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