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Economic Review: May 2023

Robert R. Teeter

Robert R. Teeter

Managing Director

According to the latest survey from the American Association of Individual Investors, only 24% of investors have a bullish outlook. It’s easy to see why, given bank failures, continued inflation, fear of recession, an earnings slowdown, and a Fed rate hike cycle. Nonetheless, returns on the S&P 500 Index for the year-to-date period through the end of April are +9%, primarily because inflation has improved, lifting valuations.

Stable earnings and improved valuations have driven equity gains this year.

sp500, eps, pe

In June of 2022, the Consumer Price Index (CPI) registered a +9.1% year-over-year reading. Comparatively, the most recent figures show CPI running at +5.0%. While clearly not back to normal, this represents a significant improvement. Valuations have responded accordingly, with the PE ratio moving up nearly a full point.

Aftershocks from bank failures will lead to a drag on lending throughout the year. Officials from the Fed, Treasury, and FDIC are committed to protecting bank deposits, though in the face of additional regulatory scrutiny the outlook for bank earnings is less clear. It remains to be seen how much market share of lending can be absorbed by stronger banks (large or small) from their troubled brethren. We expect lending to contract throughout the year and weigh on economic growth.

Despite persistent calls for recession, the economy remains positive. First quarter GDP rose +1.1%, with strong growth in personal consumption expenditures of +3.7%. The consumer remains strong due to a solid labor market—to illustrate, 155.6 million people are currently employed in the United States, an increase of +3.5 million compared to December 2019. Although wages have increased, these gains lag behind inflation rates, resulting in slightly negative real earnings. Nonetheless, the consumer remains well-positioned for spending consistent with a small positive growth rate for GDP.

total u.s. employment

The Atlanta Fed and New York Fed indicate growth of +2.75% and +1.45% respectively. That growth will trend down as lending contracts. For the remainder of the year, we expect lackluster readings on GDP, hovering around a range of –0.5% to 1.5%, before returning to a long-term trend of 2.0%.

Earnings season has been better than expected. With over 400 companies reporting, earnings have contracted slightly, though not as much as feared. Overall, companies are beating expectations by +6.7%. One consistent theme of the past few years has been the ability of strong management teams to dynamically manage their businesses in the face of extreme adversity and uncertainty. Like the economy, earnings will remain rangebound.

The good news is that much of last year’s adversity and uncertainty has subsided. As recently as December, the Global Supply Chain Pressure Index metric was still at +1.0, lower than peak stress readings around 4.0, though still above the pre-pandemic high of +0.7. Last month, this metric registered a reading of –1.3, showing that supply chains have returned to normal and then some, with the negative reading indicating a lack of stress, and indeed some slack, in global supply chains.

Many sources of inflation have improved. Money supply growth has evaporated, supply chain problems have disappeared, inflation expectations have eased, and wage gains are positive but not running so far ahead of inflation as to cause a wage price spiral. As inflation slowly fades away, bonds will build on recent gains, bringing down interest rates. That process will help equity valuations and will give the Fed some additional policy flexibility. In fact, whenever inflation finally returns to 2.0%, we expect the Fed to loosen policy, in hopes of boosting growth and employment. For now, the Fed will continue to talk tough on inflation, even if rate hikes are paused.

In the near term, disagreement amongst politicians in Washington, DC may increase market volatility. As the date for the depletion of government funds looms (perhaps as soon as early June), market stress will increase, though we expect a negotiated settlement at the very last possible moment. While Treasury Secretary Yellen has provided an estimate—the “X date”—the language was hedged somewhat with the phrase “[a default] could be a number of weeks later than these estimates.” Republicans in the House of Representatives have already passed a bill and, with a fast-approaching date laid out by Secretary Yellen, all signs point to a done deal in coming weeks, though the process won’t be elegant.

This leaves investors in a complex spot, similar to the past few years. With numerous important issues in an unclear state, each and every data point and news item will be heavily scrutinized. Inflation is improving and the economy is slowing, leaving the outlook in a short-term stalemate until bank concerns or inflation more fully evaporate. In the long term, gains will result from modest economic growth and a gradual improvement in valuation metrics.

This communication contains the personal opinions, as of the date set forth herein, about the securities, investments and/or economic subjects discussed by Mr. Teeter. No part of Mr. Teeter’s compensation was, is or will be related to any specific views contained in these materials. This communication is intended for information purposes only and does not recommend or solicit the purchase or sale of specific securities or investment services. Readers should not infer or assume that any securities, sectors or markets described were or will be profitable or are appropriate to meet the objectives, situation or needs of a particular individual or family, as the implementation of any financial strategy should only be made after consultation with your attorney, tax advisor and investment advisor. All material presented is compiled from sources believed to be reliable, but accuracy or completeness cannot be guaranteed. © Silvercrest Asset Management Group LLC

About the Author

Robert R. Teeter

Robert R. Teeter

Managing Director Contact