US Perspectives: Getting fundamentals aligned
- US equity returns have been quite different in the first two months this year. In January, the S&P rose more than 5.5 per cent led by consumer discretionary, communication services, and real estate. Some of the sectors that had suffered in 2022 rallied to start the new year
- In February, markets have struggled as we have seen that the economy looks stronger than ex-pected, and inflation is not slowing at the pace as hoped. Both of these factors could keep the Fed to raising rates longer than forecasted earlier. It is hard to be overly optimistic until these factors are resolved
- The latest inflation data created problems in markets, as the January PCE inflation data caused them to raise expectations for future Fed rate hikes. As of 27 February, market consensus expects the Fed to tighten three more times to 5.5 per cent through the June meeting. Consensus then has the Fed will lower the Fed funds rate twice before year-end
- Based on our analysis, in the six prior Fed tightening cycles, once the FOMC pauses - or stops rais-ing rates - on average, in the ensuing twelve months, US equities have provided investors with a to-tal return of 19 per cent. That would exceed the 13.7 per cent average annual returns we have seen in the S&P 500 in the last decade
- Economic growth looks healthy throughout the first quarter. Through its latest reading, the Atlanta Fed estimates that first quarter GDP could be in the 2.5 to 3.0 per cent range. However, there are signs of weakness in the economy. We anticipate the economic growth will slow to below 1 per cent throughout most of 2023, which should result in lower volumes
- As inflation continues to slow, corporations will struggle to pass on higher prices to the end consum-er. As a result, we should expect margin compression to continue for most of this year
- The combination of slower economic growth and tighter margins has led financial analysts to down-grade earnings for the S&P 500 this year
- In the short term, we continue to expect further consolidation for US equities to reflect the down-grade in earnings expectations in 2023. However, we remain optimistic about the prospects of re-turns in the US equity markets in the long term. This is especially true given the potential for better earnings growth in 2024