The Weekly Edge

Another week, another string of better than expected data in the U.S., suggesting that forecasts for economic growth in the second half of 2023 remain far too low. It’s a growth party in the U.S.A.

In this piece, we revisit our thesis for the economy and markets from the beginning of 2023, identifying the divergence of equity valuations from yields/Fed policy as the key source of our surprise. We then look at the two main drivers of this yield divergence and equity strength (liquidity and AI optimism).

This week we are taking stock of the year-to-date performance of the U.S. equity market, which could be adequately summarized by Queen’s 1979 song, “Don’t Stop Me Now”, especially in the context of the recent 11% surge from the mid-March lows.

US equities were higher on the week and notched sizable daily gains on Friday. Growth-oriented indices like the NASDAQ and Russell 1000 Growth were again the biggest winners as the names that comprise these indices continued to shrug off higher real rates and expand valuation multiples.

Broad US equity indices marched higher on the Friday leading into Memorial Day Weekend, resulting in the S&P 500 notching a slight weekly gain while the tech-heavy NASDAQ and Russell 1000 indices produced weekly gains of 1.5% – 2.5%.

There are multiple “problems” (maybe not 99!) that are driving the bond market to price in such a different outcome than the Fed’s guidance. These include concerns about the debt ceiling, regional banking crisis, geopolitical tensions, concern about flagging U.S. growth, and optimism that inflation will continue to moderate.

The first week of May proved to be action-packed: another bank failed and was acquired out of receivership, the Federal Reserve met and raised interest rates, earnings continued to roll in, equity markets experienced renewed volatility after a lull, and economic data continued to be resilient “in spite of it all”.

Congress’s gridlock and battling is a lot like two bucks fighting. Most of the time the party disputes carry manageable market risks, but occasionally this gridlock has the potential to wreak havoc on the U.S. economy and financial markets.

Don’t fight the Fed. Fighting the flow of Fed-related liquidity is like trying to swim against a powerful river current: you can swim as hard as you can, but you will make little forward progress if the flow of the current is working against your efforts.

The return of Bruce Springsteen to New York City last weekend reminded us of his 1978 song “Prove it All Night”, which he has said conveys the message “success requires sacrifice”. This is a fitting analogy for the coming U.S. corporate earnings season, which kicks into gear next week with some of the largest index constituents and economic bellwethers reporting first quarter results on April 14th.