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S&P 500 closes lower as Fed hikes rates, hints at a pause

Great investors are not unemotional, but are inversely emotional – they get worried when the market is up and feel good when everyone is worried. – Bill Miller, famous value investor, fund manager and philanthropist

Stocks rallied on Friday after the release of a better-than-expected April employment report and strong earnings from Apple, but it wasn’t enough to prevent modest losses for the week for the S&P 500 Index and the Dow Jones Industrial Average. The technology-laden Nasdaq Composite bucked the trend and finished the week with a slight gain. The week began on a perceived positive note when it was announced that JP Morgan Chase agreed to acquire all the deposits and assets of failed First Republic Bank, which seemed to avert a broad collapse in the regional banking sector.  But renewed fears of contagion and a banking crisis surfaced later in the week and regional banks such as PacWest Bancorp and Western Alliance Bancorp saw their stock prices plunge. Investors hoping that the Federal Reserve would leave the federal funds interest rate unchanged were also disappointed as the Fed raised the rate for the 10th time by 25 basis points (a basis point is one hundredth of one percent) to a target range of between 5% and 5.25%. Rates are now at the highest level in 16 years, but Fed Chairman Jerome Powell did hint that the current tightening cycle could be over. The Fed believes that inflation will come down but gradually so it is not appropriate to cut rates, while the markets anticipate slower economic growth and the possibility of a recession which will force the Fed to cut rates later this year. Either way, the Fed emphasized that it will be data dependent in its approach to monetary policy. The labor market also remains resilient as the April jobs report showed an increase of 253,000 jobs, topping estimates of 180,000, and the unemployment rate dropped to 3.4%. Average hourly earnings were also higher than forecast and increased 4.4% from a year ago. But the jobs number was misleading as the February and March job totals were revised lower by a total of 149,000. It was another busy week for quarterly earnings reports and, for the most part, the results were positive, including Apple which beat estimates on the top and bottom lines as iPhone sales were strong. The company did not provide formal earnings guidance for the rest of the year but did authorize $90 billion in share repurchases and raised its dividend. While the stock market ended the week on a positive note, concerns about the debt ceiling, regional bank fears and uncertainty over future Fed rate policies will continue to weigh on sentiment.

Last Week

ADP reported that private payrolls rose by 296,000 in April, well above estimates and the highest monthly increase since July 2022. Weekly jobless claims totaled 242,000, higher than expected, and the Job Openings & Labor Turnover Survey (JOLTs) showed a decline in job openings, which is a positive for inflation as it helps put less pressure on wage increases. The ISM Manufacturing Purchasing Managers’ Index (PMI) in April was higher than estimates and higher than in March but was still contracting for the sixth straight month, while the ISM Services PMI increased from the March reading, was better than forecast and expanding.

For the week, the Dow Jones Industrial Average fell 1.2% to close at 33,674 while the S&P 500 Index dropped 0.8% to close at 4,136. The Nasdaq Composite Index edged higher by 0.07% to close at 12,235.

This Week

Inflation data will be in the spotlight this week as the consumer price index (CPI) for April is expected to increase 5% year-over-year, well below its peak of over 9% last year but still much higher than the Federal Reserve’s target of 2%. The producer price index (PPI) for April is forecast to increase by 2.7% year-over-year, less than in March. The May University of Michigan consumer sentiment index is expected to be slightly lower than in April.

The Bank of England meets to review its monetary policy and is expected to increase its benchmark interest rate by 25 basis points to 4.5% as inflation remains at about 10%.

Among the most notable companies scheduled to report first quarter earnings this week are Walt Disney, Tyson Foods, Wendy’s, Under Armour, Airbnb, McKesson, H&R Block, Occidental Petroleum, Duke Energy, Devon Energy, Toyota Motor and Honda Motor.

Portfolio Strategy

As if investors didn’t have enough to worry about already, the deadline to raise the debt ceiling is fast approaching and Treasury Secretary Janet Yellen said over the weekend that the Treasury Department could run out of measures to pay its debt obligations by early June. While this timeframe is earlier than most economists had been expecting, it is still imperative that Congress raise the debt ceiling to avoid default, which could lead to a steep economic downturn and cause financial chaos. President Biden and Congressional leaders are scheduled to meet this week to discuss the debt limit and negotiate a settlement of their differences that will enable the U.S. to pay its bills on time and avoid a government shutdown. With worries over the banking crisis, inflation, a slowing economy and the path of future Federal Reserve interest rate hikes, investors may be tempted to heed that old Wall Street saying, “Sell in May and go away”, which implies that investors should move to the sidelines until the fall. Historically, returns in the stock market have been better from the six-month period November through April than the period May through October, hence the reason for the popular adage. However, since 2012, the S&P 500 has risen by an average of nearly 5% during the period from May to October with positive returns in 10 of the 12 years. Such a strategy is also a form of market timing, which is next to impossible to implement since one must accurately predict not only when the market will go down but when it will go back up. The stock market has been in a trading range recently and sentiment among retail investors has been almost as bearish as levels seen in the financial crisis of 2008, which could be a contrarian buy signal that points to a rally in stocks. With a quick resolution of the debt crisis, a Fed pause in its interest rate hiking cycle, improved inflation data and an end to the banking crisis, the S&P 500 Index might be able to overcome resistance at the 4,200 level and trade higher. But it’s a lot to ask of the market which has been treading water in the second quarter.