As one quarter ends and another begins, it’s tough to ignore the best first quarter for stocks in several years with the S&P 500 up more than 7% and the NASDAQ up 16.8%. As is often the case, the stock market activity does not match up well with headline information or what is expected for earnings going forward. This was a period marked by heavy layoffs (particularly in the High Tech which is a large component of the NASDAQ), but it is also a period of recovery from a rough back half of 2022 AND structural lift from workers filling up their 401k plans. With the S&P 500 trading at more than 21x forward earnings (alternatively 4.8% earnings yield), it is difficult to imagine a repeat this quarter. With Federal Funds Rates at 4.85%, there is very little logic for taking the additional risk presented by the public equity markets at the moment. The large investment houses are now predicting ~5% declines in earnings in Q1 and this will clearly create a difficult situation for the asset class.
Another benefit to the market in Q1 was a declining oil price (down 5.7% in the quarter) and its deflationary effects across all other assets. The move in oil muted the data that the Federal Reserve uses to calculate inflation. With this in mind, two weeks ago, the Biden administration declined to refill the Strategic Petroleum Reserve (SPR) despite the decline in prices and this bothered Saudi Arabia. In response, they along with OPEC+ cut oil output by approximately 1M barrels a day. For reference, this is approximately 1% of daily global production. 1% may not sound like a lot, but when the supply and demand dynamics change even a little, pricing can change significantly. This is especially true when Russian supplies have been disrupted due to the war in Ukraine.
How does oil effect stocks you might ask? Well first there’s the obvious, input costs will go up and earnings will be lower. Second, inflation becomes a more difficult foe for the Fed and they have to continue raising rates because that’s what the data says they have to do. Rates trend higher, cost of capital increases, discount rates increase and the competition between risk free securities and equities becomes even more difficult. Might the stock market ignore all the data and head higher anyway? Of course. But eventually the data catches up to the market and stocks look like a slog in the short term.