By Ben Norris, CFA, Senior Investment Strategist, Vice President
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After a surprisingly strong 2023, economic activity appears to be cooling, based on recent data. The revised estimate for first-quarter GDP growth dipped from 1.6% to 1.3% in the latest reading. This is notably slower than the 3.4% growth rate reporting in the fourth quarter of 2023 and is the lowest quarterly growth rate since the second quarter of 2022. Additionally, April saw a slight 0.1% contraction in real consumer spending.
Meanwhile, the core Personal Consumption Expenditures (PCE) Index, the U.S. Federal Reserve’s (Fed’s) preferred measure of inflation, edged up by 0.2% last month, in line with consensus estimates. The index remained steady at a 2.8% annualized increase, marking the lowest reading since early 2021. The 2.8% reading is down from 4.8% a year ago and a peak of 5.6% set in early 2022. Despite lingering concerns about elevated inflation, recent trends indicate that the Fed’s tightening campaign is working, albeit more slowly than hoped.
Elsewhere, data indicated unsurprising weakness in both housing and manufacturing, sectors sensitive to the impact of higher interest rates. Pending home sales saw a sharp decline in April, while regional Fed manufacturing surveys for May reported sluggish activity. The Fed’s Beige Book, released last week, provided anecdotal evidence hinting at modest growth in most regionals, with an emphasis on slowing discretionary spending and increased price sensitivity among consumers. In fact, last week’s consumer spending readout was revised to a 2.0% annualized growth rate from 2.5% reported prior as households cut back spending on durable goods.
While economic growth is showing signs of slowing, the U.S. labor market has remained more resilient than many, including the Fed, had likely expected. Last week, the Department of Labor reported initial jobless claims of around 220,000 and continuing claims of 1.79 million, both at levels indicating a strong job market, despite recent increases. The U.S. unemployment rate is 3.9%, according to the latest data, which is up from 3.4% a year ago, but well below levels considered concerning by many economists. There are signs that the labor market is cooling, but the pace of cooling remains moderate, supporting the case that a soft economic landing is in the cards.
Stocks retreated during the holiday-shortened week, with each of the major U.S. stock indexes falling after a strong patch of performance through the preceding month. The S&P 500 (SPX) and NASDAQ Composite (COMP) fell 0.5% and 1.1%, respectively, meaning that each snapped a five-week streak of gains. Year-to-date performance remains strong, with SPX up 10.6% and COMP faring even better at 11.5%. The equal-weighted S&P 500 index, which reduces the outsized impact of mega-caps such as the “Magnificent Seven,” performed slightly better than SPX last week, with just a 0.2% loss. However, year-to-date performance of the equal-weighted index has lagged the market-cap weighted index significantly, managing just a 4.8% gain.
The impact of mega-cap stocks hasn’t been much of a focus so far in 2024 (the timing of interest rate cuts has dominated the narrative), but a few stocks continue to drive a large portion of the market’s performance. The Russell 2000, an index focused on small-cap stocks, has of course underperformed year-to-date, up just 2.7%. While the market’s rally remains relatively narrow, the underlying fundamentals of mega-cap outperformance are hard to argue with—large companies have grown their revenue and earnings at a faster rate than small and mid-sized companies have over the past two years. Consensus estimates from Wall Street analysts indicate that this trend may shift in the favor of smaller companies in 2025, with S&P 600 and S&P 400 indexes growing earnings faster than SPX.
While we’re on the topic of earnings, the first-quarter 2024 earnings season has finally concluded. The year-over-year earnings growth rate for SPX came in at 5.9%, which is the highest quarterly growth rate since the first quarter of 2022. The data showed that 78% of companies reported earnings that were better than estimates, while just 61% of companies reported better than expected sales. While this earnings season finished better than first expected, more companies issued negative forward guidance than those issuing positive guidance, a sign that we could see a pause in gains in the coming quarters. Given SPX’s nearly 11% year-to-date gain, I suspect that earnings for the remaining quarters of 2024 will have to impress to support a further rally. Stock prices follow earnings over time (valuations don’t fluctuate much over long periods), and the recent rally has been more reliant on expanding valuations than I would like to see. The forward 12-month price-to-earnings ratio for SPX is 20.3, higher than the five-year average of 19.2—and well above the 10-year average of 17.8.
One topic I want to touch on this week is the unique impact that investments in artificial intelligence (AI) have already had on markets in 2023. NVIDIA Corp. (NVDA) is up more than 120% year-to-date; the company’s revenue and earnings have soared thanks to surging demand for its semiconductors that enable large datacenters to support AI models. Similarly, other semiconductor stocks that directly support datacenter investments have also rallied—although nowhere near the magnitude that NVDA has. The PHLX Semiconductor Sector Index has gained nearly 23% this year, after a gain of 67% in 2023. While the hardware side of AI investment has powered the market higher, software has lagged as it appears investors are wary to declare winners and losers in a rapidly evolving environment. Salesforce Inc., historically a Wall Street darling, fell 20% in a single day last week after its latest earnings report revealed a slower pace of spending on its software and services as customers prioritize investments in hardware. The Dow Jones US Software Index is up just 2.8% year-to-date. I suspect that the fates of software and hardware will even out over time as corporations finally determine what to do with the data center investments they’ve made, but it could be a while until we know who the software winners are.
Finally, one of the most surprising developments we’ve been following this year is the recent surge in performance of stocks in the utilities sector. Over the past five weeks, the utilities sector has gained 9.9%, rocketing it to the top-performing sector year-to-date with a gain of 14.8%, outperforming the communication services sector’s 14.6% gain. Utilities are historically an interest-rate-sensitive group, so a nearly 10% rally during a period when interest rates have remained elevated is unexpected. AI is once again the driving force behind the rally here. It turns out that data centers and their new AI-focused semiconductors require a lot of power to run properly, and investors have been quick to make bets that certain utility companies will see the benefits of that increased demand.
This week’s economic calendar has a few data points that will be closely watched by the Fed and those who remain hopeful for rate cuts in 2024. Several updates on the state of the labor market are sprinkled throughout the week, and both the Institute for Supply Management (ISM) manufacturing and services reports will provide insight into economic activity.
| TIME (ET) | REPORT |
PERIOD |
MEDIAN FORECAST |
PREVIOUS |
| MONDAY, JUNE 3 | ||||
| 9:45 am | S&P flash U.S. manufacturing PMI |
May |
50.7 |
50.9 |
| 10:00 am | Construction spending |
April |
0.2% |
-0.2% |
| 10:00 am | ISM manufacturing |
May |
49.6% |
49.2% |
| TUESDAY, JUNE 4 | ||||
| 10:00 am | Factory orders |
April |
0.7% |
1.6% |
| 10:00 am | Job openings |
April |
8.3 million |
8.5 million |
| WEDNESDAY, JUNE 5 | ||||
| 8:15 am | ADP employment |
May |
179,000 |
192,000 |
| 10:00 am | ISM services |
May |
50.7% |
49.4% |
| 8:30 am | U.S. productivity (final revision) |
Q1 |
0.1% |
0.3% |
| 8:30 am | U.S. trade deficit |
April |
$76.3B |
-$69.4B |
| 9:45 am | S&P flash U.S. services PMI |
May |
54.7 |
54.8 |
| THURSDAY, JUNE 6 | ||||
| 8:30 AM | Initial Jobless Claims |
June 1 |
216,000 |
219,000 |
| FRIDAY, JUNE 7 | ||||
| 3:00 pm | Consumer credit |
May |
$10.7B |
$6.3B |
| 10:00 am | Wholesale inventories |
April |
0.2% |
-0.4% |
| 8:30 am | U.S. employment report |
May |
178,000 |
175,000 |
| 8:30 am | U.S. unemployment rate |
May |
3.9% |
3.9% |
Links to previously published commentaries can be found at benjaminfedwards.com/Latest Investment Insights/Market Commentary/Market