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Monthly Market Commentary

| June 02, 2023

The few versus the many and income versus credit are important considerations in the current economic cycle.  We have had a historic tightening cycle in which the Fed has raised rates just over 5% in a little more than a year, while running a $95 billion per month quantitative tightening program.  The result thus far has been a lower unemployment rate than when they started.  This is an unusual cycle.  The cycle leading up to the Great Financial Crisis was driven by debt, in particular mortgage related debt.  Household debt to GDP was over 100% coming into the Great Financial Crisis, so raising rates could slow things down very quickly.   Now we are at 76% and a great percentage of that is termed-out at low rates.  Rising rates have less of an impact.  This cycle is far more driven by income, rather than debt.  Household income is up over 80% since the Great Financial Crisis, and savings have nearly quadrupled.  The economic pain so far has been felt by the higher income and asset owners in technology, finance, and real estate.  Unemployment claims by those earning over $200k are up more than 5x, while the majority of industries are hiring.  The most recent job openings data showed an increase to over 10 million openings.  The overall economy has been generating over 200k/month in new jobs.  Perhaps the bigger picture is that a top-heavy economy is now transitioning to benefiting the many rather than the few.  An economy driven by the income of many, means that the Fed will be higher for longer. 



Not only has the unemployment rate declined, we are starting to see revisions higher in GDP.  The Atlanta Fed GDPNow is running just under 2% for the quarter.  Bloomberg consensus GDP estimates have steadily risen throughout the year.  Housing and PMIs look like they are bottoming.  It is not just domestic estimates that are increasing, it is global GDP estimates.  Earnings estimates for the full year are now turning up.  77% of companies beat first quarter earnings estimates by an average of 6.6%.  Cyclicals had a higher beat rate at 79% by a higher amount at 8.3%.  The market will soon focus on 2024 earnings when they are expected to grow 11.6%.  The bull case for the market centers around that the Fed is just about done, inflation continues to fall, so far there has not been a recession, GDP estimates are turning up, earnings are turning up, a weak dollar helps loosen financial conditions, and positioning and sentiment are poor.  The key to the case is employment, especially in an economy that is transitioning to the income growth of the many.    




The market has been driven by the few at the expense of the many.  The rally this year is almost all driven by large cap technology.  Early in the year it had to do with positioning, during the height on the regional banking crisis it had to do with safety, and in recent weeks it has been about excitement over AI.  Goldman Sachs estimates that generative AI could potentially lift US productivity by roughly 1.5% per year over the next 10 years. This jolt could lift S&P 500 net profit margins by 4% over that decade.  That would be a meaningful lift to earnings and valuation.  The market thus far has rewarded the producers of the technology, notably the large cap technology names.  We are starting to enter the next phase where the market rewards the next level winners, which includes semiconductor and software names.  Over-time, the market will start to focus on the producers of AI spending on capital expenditures, while the margin improvement is accruing to the consumers of the technology.  For instance, Microsoft has invested more than $10bn in OpenAI, while AI is expected to add incremental revenue of just $150 million.  The ROI will surely improve over time.  However, the more immediate impact and margin improvement will go to the consumers of the technology.  We are seeing early use cases in healthcare, advertising, journalism, education, and certain service businesses.  Small caps will be able to leverage the technology and punch above their weight.  They will be more efficient and productive leading to margin improvement.  Just like the economy, the market will eventually reward the many over few.            



Looking forward the market will focus on the Fed, the latest on AI, and the economic data.