United States
Domestic markets calmed by better-than-feared earnings amid weakening economic data
As investors moved past initial fears of a widespread banking crisis, they entered April searching for signs of continued disinflation or evidence of a wider slowdown. Given persistently high inflation, there remains an increased probability the Federal Reserve (Fed) continues to tighten monetary policy, whereas evidence of a material economic slowdown signals the Fed may have overtightened rates, raising recession worries.
The higher-for-longer interest rate environment is still a key driver for equity and fixed income markets going forward.
In April, market leadership narrowed to favor the largest capitalization stocks. As such, the S&P 500® posted gains, while the S&P MidCap® and Russell 2000® generated negative returns. Even within the S&P 500, the monthly return was largely driven by only five stocks. The top two — Apple Inc. and Microsoft Corp. — have a combined weight of 13.3%, the highest combined weight of the S&P 500’s largest two stocks on record.
During the first half of the month, domestic equity markets were led by large cap, defensive sectors and quality as investors braced for first quarter earnings reports. However, an equity market rally ultimately ensued into month-end as many companies reported positive surprises, driven by lower expectations, positive revenue growth and consumer strength.
While economic activity remains positive, it continues to slow. The initial first quarter GDP reading slowed to a 1.1% annualized rate, below both the consensus estimate of 1.9% and the prior quarter’s growth rate of 2.6%. The headline number was negatively impacted by large declines in inventories and business investment, yet consumer spending grew 3.7%. Additionally, housing investments appear to be stabilizing, declining 4.2% versus more than 25% in the previous two quarters. PNC Economics expects a mild recession to begin later this year, as tighter credit conditions and the cumulative effects of the Fed's aggressive monetary policy tightening continue to dampen economic activity.
Labor market strength continues to support the economic backdrop and fuel consumer spending, which could help buffer an impending slowdown. The 4-week moving average for weekly initial jobless claims ended April at 236,000, the lowest level in over a month. Despite falling claims data, consumer confidence weakened as the Conference Board Consumer Confidence Index fell to 101.3, below the consensus estimate of 104.0, representing the lowest level since July 2022. Historically, consumer confidence has a strong correlation with consumer spending and the trajectory of corporate earnings.
First quarter earnings season for the S&P 500 has proven to be better than feared. The blended earnings growth rate (consensus estimates combined with actual results) of -3.7% has improved from the initial consensus estimate of -7.0% at quarter-end, due to an above-average upside surprise of nearly 650 basis points (bps). In our view, this year’s anticipated economic slowdown is not yet reflected in consensus earnings estimates, which have been rising in recent weeks.
Figure 1. S&P 500 Forward Earnings Per Share Estimates
Improving estimates amid quarterly upside surprises
As of 4/30/2023. Source: FactSet®. FactSet® is a registered trademark of FactSet Research Systems, Inc. and affiliates.
View accessible version of this chart.
The Fed’s favored reading on inflation, the Core Personal Consumption Expenditure Index, came in as expected at 4.6%, proving high inflation is sticky. We believe persistently high inflation paved the way for the Fed to increase the fed funds rate by 0.25% at its May 3 Federal Open Market Committee meeting. We expect this raise to be the last of this rate hike cycle.
For the first time in nearly two years, the Bloomberg U.S. Aggregate Index delivered two consecutive months of positive returns. Long-term interest rates and credit spreads were essentially unchanged in April. For example, the Bloomberg Corporate High Yield Index option-adjusted spread fell by only 5 bps, yet the index delivered a 1% return. With interest rates at the highest levels in 15 years, fixed income investors can generate meaningful returns purely from income. High interest rates lessen the need for investors to assume more aggressive fixed income allocations compared to the previous business cycle.
Developed International Markets
Tightening credit conditions have amplified the risk of recession
Developed international equity markets held up well in April, despite recent bank failures and continued weakening of global economic growth. Performance was positive in 9 out of 11 MSCI World ex USA Index sectors, with Energy leading the charge and Information Technology declining most.
Milder-than-usual weather conditions combined with falling energy prices have helped the Eurozone avoid a recession scenario thus far. However, the Conference Board’s leading economic indicators still indicate a recovery remains elusive. We believe recession risks will continue to build in developed markets due to a significant tightening of credit conditions from restrictive monetary policy.
Because tightening monetary policy has a lagged effect, we believe we are just beginning to see the impact of credit tightening on consumers and businesses. This could pose a downside risk to earnings estimates in the second half of 2023. Even if the region avoids recession, we believe margin pressures will persist and lead to negative earnings revisions.
Figure 2. Credit Conditions in Europe
Lending conditions continue to tighten while leading indicators suggest weaker growth
As of 4/30/2023. Source: Bloomberg, L.P.
View accessible version of this chart.
Core inflation across the Eurozone remains high, with strong demand in services and solid labor market fundamentals, like in the United States. That said, easing headline inflation in key economies, such as Germany, continues, albeit at a slow pace. We do not expect the European Central Bank (ECB) to meet its 2% inflation target in 2023, which may pressure the ECB to keep monetary policy tight for the foreseeable future. As a result, we continue to favor high-quality equities and are underweight business cycle-sensitive small and mid-caps.
More than 35% of the MSCI World ex-USA Index has reported first quarter earnings, with a current blended growth rate of 11.2%, well above the S&P 500. However, for context, much of that growth stems from Financials, which is largely benefiting from the positive interest rate regime in Europe versus last year’s negative rate environment. Consumer Discretionary, Industrials and Utilities have had the largest percentage earnings surprises thus far, due to a rebound in demand in Asia and falling energy costs. We continue to believe current earnings estimates are overly optimistic and have yet to adjust for slowing global growth and tightening credit conditions.
Emerging Markets
Emerging market equities yet to reflect China's continuing recovery
The MSCI Emerging Markets Index lagged both U.S. and developed market counterparts in April, as Information Technology stocks in China, Taiwan and South Korea were key market laggards. Major commodity-producing countries such as Brazil, India and Saudi Arabia, however, had strong gains for the month.
While China was the largest detractor from monthly performance, we believe the country has several attractive investment attributes, even beyond low absolute valuations. In our view, China’s low inflation, combined with accelerating credit growth expectations, point to a positive outlook for the country. First quarter GDP growth beat the consensus estimate due to strong consumer and real estate activity as the service economy continues to recover back to pre-pandemic levels.
Figure 3. China Credit Impulse Index
Healthy credit expansion supporting China's recovery
As of 4/30/2023. Source: Bloomberg, L.P.
View accessible version of this chart.
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TEXT VERSION OF CHARTS
Figure 1: S&P 500 Forward Earnings Per Share Estimates
Improving estimates amid quarterly upside surprises (view image)
Date |
S&P 500 Forward Earnings Per Share Estimate |
4/28/2023 |
$229.49 |
2/28/2023 |
$227.01 |
1/30/2023 |
$226.83 |
12/30/2022 |
$230.30 |
10/31/2022 |
$231.88 |
8/30/2022 |
$237.58 |
6/30/2022 |
$239.78 |
4/29/2022 |
$235.75 |
As of 4/30/2023. Source: FactSet®. FactSet® is a registered trademark of FactSet Research Systems, Inc. and affiliates.
Figure 2: Credit Conditions in Europe
Lending conditions continue to tighten while leading indicators suggest weaker growth (view image)
Date |
Bank Lending Conditions (Overall Tightening of Credit) |
OECD Conference Board Leading Indicator YoY |
Recession |
3/31/2022 |
1.5 |
8.13 |
-1.00 |
3/31/2020 |
1.2 |
-4.21 |
1.00 |
3/31/2018 |
-0.5 |
10.43 |
-1.00 |
3/31/2016 |
-4.2 |
3.22 |
-1.00 |
3/31/2014 |
2.2 |
3.09 |
-1.00 |
3/31/2012 |
30.5 |
-3.26 |
1.00 |
3/31/2010 |
4.4 |
-2.93 |
-1.00 |
3/31/2008 |
42.6 |
-0.97 |
1.00 |
As of 4/30/2023. Source: Bloomberg, L.P.
Figure 3: China Credit Impulse Index
Healthy credit expansion supporting China’s recovery (view image)
Date |
Total Properties Under Construction |
Total Building Starts |
Total Real Estate Investment |
Total Building Work Completed |
Total Sales of Commercial Buildings |
3/31/2022 |
1 |
-17.5 |
0.7 |
-11.5 |
-22.7 |
3/31/2021 |
11.2 |
28.2 |
25.6 |
22.9 |
88.5 |
3/31/2020 |
2.6 |
-27.2 |
-7.7 |
-15.8 |
-24.7 |
3/31/2019 |
8.2 |
11.9 |
11.8 |
-10.8 |
5.6 |
3/31/2018 |
1.5 |
9.7 |
10.4 |
-10.1 |
10.4 |
3/31/2017 |
3.1 |
11.6 |
9.1 |
15.1 |
25.1 |
3/31/2016 |
5.8 |
19.2 |
6.2 |
17.7 |
54.1 |
3/31/2015 |
6.8 |
-18.4 |
8.5 |
-8.2 |
-9.3 |
3/31/2014 |
14.2 |
-25.2 |
16.8 |
-4.9 |
-5.2 |
3/31/2013 |
17 |
-2.7 |
20.2 |
8.9 |
61.3 |
As of 4/30/2023. Source: Bloomberg, L.P.
