The economic and stock market backdrops have changed a bit over the past three months.
Long-term inflation expectations are higher.
Economic growth continues at a faster pace than was expected.
Valuations don’t appear to have adjusted to higher interest rates.
The U.S. economy’s resilience in the face of much higher interest rates has been one of the biggest surprises of the past two years. And it appears that trend could continue. In April, the International Monetary Fund raised its forecast for U.S. economic growth to 2.7% on an annualized basis, outpacing Europe (0.8%) and Japan (0.9%). The primary reason for that strength has been consumer spending as the labor market remains quite strong.
The Federal Reserve still expects that its next move will likely be to cut interest rates, but it is in no rush to do so. The central bank left its benchmark interest rate unchanged at a range of 5.25% to 5.50% for the sixth consecutive meeting in May. Comments from chair Jerome Powell reinforced the idea that the Fed is comfortable staying where it is, as the road to its 2% inflation target has been bumpier than anticipated. The Fed also announced it would slow its quantitative tightening program, reducing the monthly cap on the amount of Treasuries it can run off its balance sheet from $60 billion to $25 billion.
Short-term interest rates are not as important as longer-term rates when determining the price of a stock. The 10-year Treasury yield sits near 4.5%, a full 60 basis points higher than when it started this year. Stock prices have not moved lower due to that change primarily because earnings continue to surprise to the upside. With 88% of the S&P 500 companies having reported their first quarter earnings, they have come in 8.5% above consensus expectations with positive surprises in every sector. Despite rising costs, companies have been able to exceed estimates of their profit margins.
Our team analyzes and discusses each earnings report and management forward-looking comments for every stock you own. If the reason we bought the stock is no longer valid, we will sell the stock. Given our focus on quality, financial strength, and free-cash-flow generation, those changes are typically quite limited.