Earnings Continue to Beat and Fed Refuses to Retreat 

1. Employment Stays Hot. Initial unemployment claims remain healthy and continue to moderate from historically low levels over the past year. The 4-week moving average for initial unemployment claims is 239,250 per week. This is higher than the September trough of 190,500, yet well below the 2009 spike to 659,250 and the 2001 spike to 489,250. When excluding 2020, the 30-year median weekly initial claims is 332,500. The labor market remains historically tight but moving in the direction of the Fed’s intent. 

Friday’s jobs report showed nonfarm payrolls rose 253,000 last month, blowing out the 180,000 estimate, while the unemployment rate fell to 3.4% against a 3.6% estimate, marking the lowest level since 1969. Average hourly earnings are +4.4% y/y and unit labor costs are +6.3% y/y, both leading indicators for consumer resilience and sticky inflation. The labor data reinforces the Fed’s higher for longer narrative, yet bond markets are pricing stark contraction. 

Chart 1: Initial Claims Higher Year-to-Date, but Labor Market Remains Historically Tight¹ 

2. Hawkish Fed Raises 25 bps. Last week, the Fed raised interest rates by 25 bps bringing the federal funds rate to its highest level since 2007 at a target range of 5% to 5.25%. The bond market does not like what it is seeing on the horizon – whether it be banking volatility or other factors – and is pricing in eight cuts by mid-2024 and a 60% chance for a cut in July. Something major needs to break if the Fed is to refocus its attention towards supporting the economy and put fighting inflation on hold. 

Treasury yields fell after the Fed raised rates Wednesday, then rose higher on Friday after the jobs report. The 2-year yield finished the week at 3.91% and the 10-year finished at 3.43%. Municipal yields ended the week largely unchanged.  

3. Strong Earnings. Earnings have held up: 84% of the S&P 500 has reported and 77% are beating expectations. Earnings growth is expected to be, in aggregate, -0.7% y/y. That is much better than the -5.9% y/y expectation at the end of the quarter. Consumer discretionary, industrials and energy are reporting the highest annual earnings growth. 

Low sentiment heading into reporting season produced elevated earnings surprises and has contributed to significant earnings yield for select companies. In the energy sector, for example, aggregate forward earnings yield is 10.3% and we are finding companies with upwards of 15% earnings yield. Consumer staples surprised with healthy organic growth in the face of huge price increases. This underscores strength in the consumer (remember low unemployment, higher wages) and preference for quality brands. Industrials reported broad strength with 35 out of 37 companies reporting an EPS beat and raise. This Industrials strength reflects the impact from infrastructure spending, plus inelastic efficiency trends with global demand for fuel efficiency and innovative technology. REITs have continued to surprise markets in the face of negative sentiment, reporting high occupancy rates and ready capital to deploy. This combines to generate significant yields at compelling valuations. 

While the market has been stuck in a trading range, we are finding ideas. Muted market reaction to material confirmation of thesis and positive trends are generating opportunity in the face of apathy. In Q2, the S&P 500 has been in a range +1.6% to -1.2% and it ended last week +0.8% qtd. 

4. The Week Ahead. 

Earnings – Tuesday: WYNN. Wednesday: OXY, DIS. 

Economics – Wednesday: CPI (April). Thursday: PPI (April). 

Stephanie Link: CNBC TV Schedule 

Return for Selected Indices² 

Sources

1. FactSet (chart). As of 5/8/2023.
2. Bloomberg. As of May 7, 2023.

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