Positive Tone Heading into Summer

Things are good. No, really — they are! As we head toward Memorial Day and the unofficial start to summer, the season of proms, graduations and backyard barbecues, our outlook for the U.S. economy and U.S. markets is positive.

After pulling back in April, the major equity indices have bounced back so far in May. As of filming, the S&P 500 is flirting with the 11% level year to date. The Dow Jones Dividend Select Index is back to about 8%, and the MSCI All Country World Index moved above 9% for the year.

Let's review what's driving these moves.

Messaging from the Fed that further rate hikes are unlikely reassured investors and calmed the markets from the April jitters, but more impactful was that earnings remain a source of support. With almost 90% of companies reported, 78% are beating estimates. First-quarter earnings are up about 5% year over year, powered by double-digit gains from the communication services, technology, utilities and consumer discretionary sectors.

Particularly encouraging has been the 4% revenue growth indicating demand is holding up, with gains spread across cyclical, growth, and defensive sectors. Profit margins have also been solid, signaling companies are benefiting from the ability to manage elevated costs.

Over the course of April, second-quarter estimates have also increased, marking the first time in 2+ years that estimates have risen during the first month of a quarter. This is good news — of all the variables out there, corporate earnings are a key driver in eventual stock gains.

The good vibes apply to fixed income as well. The Bloomberg U.S. Aggregate and the Bloomberg Municipal Bond blend indices are all positive month to date, making up some ground after a bumpy start to the year. This is encouraging, given the higher for longer than expected rate environment.

Expectations for an eventual rate cut continue to be pushed out, which means that opportunities to lock in relatively attractive yields remain for those looking to establish or increase fixed-income allocations.

In short, the bond market is open for business.

Chart 1: 2:38— Now, before I'm accused of being Pollyannish, we do have some concerns. Equity valuations and geopolitical risk remain at the top of our list. Regarding valuations, the aforementioned earnings growth certainly helps. Also, recall prior months' comments on the broadening market breadth. So far, the magnificent seven tech stocks have not driven returns like they did in 2023. However, they are driving the S&P 500’s price-to-earnings ratio into extended territory.

Ex the Magnificent 7 tech stocks, the remaining S&P 500’s 12-month forward PE ratio is not far from the 15-year average.

Chart 2 3:21— There's no denying that geopolitical risks are heightened. Two wars rage on, and U.S./Chinese relations remain strained. What is important to note is the strength of the underlying U.S. economic fundamentals, which are key during periods of heightened tensions. When strong, the S&P 500 tends to be relatively resilient. Concurrent recessionary risk is important as well. Recall, City National Rochdale thinks that a soft-landing, slow-growth scenario is the highest probability.

In short, we think it is unlikely that geopolitical risk meaningfully impacts U.S. economic activity or the long-term path of the U.S. stock markets. We continue to avoid international equities for now, given a less resilient outlook and those geopolitical concerns. Keep an eye on economic data releases, especially CPI and PPI reports for inflation, and data pertaining to labor and consumption. These will be closely watched by the Fed and ultimately determine the timing of rate cuts.

Potential rate cuts are bullish, and the markets will be forward looking. Maintain a focus on the U.S., on quality, and look to extend fixed-income duration opportunistically.