Celebrating 17 Years of Service

May Newsletter

May 17, 2023


The Federal Reserve increased its policy rate by another 25 basis points to 5-5.25% at the most recent Federal Open Market Committee (FOMC) meeting. While the recent rate hike was widely anticipated, the Fed’s policy statement no longer suggests further rate hikes, marking a “meaningful” shift in Fed policy. Chairman Powell reiterated that future Fed policy decisions will be data dependent and made on a meeting-by-meeting basis.

Banking sector strains emerged in early March and have led to tighter credit conditions for households and businesses. Although the Fed views the U.S. banking system as sound and resilient, stress in the banking sector will likely impact future policy decisions, and the Fed will carefully monitor these developments.

Even if macro data surprises on the upside, the Fed may still refrain from hiking rates at the next FOMC meeting due to ongoing concerns in the banking sector. It is also wary of the upcoming debt ceiling debate in Congress, which could inject further uncertainty into the financial markets.

The Fed is unlikely to use rate cuts to counter banking stress, instead, it would likely halt its quantitative tightening (QT) program. However, regulatory policy changes involving the Treasury and the FDIC could be more effective in addressing the banking sector’s issues

Once the banking stress subsides, the Fed may return to policy tightening to achieve its long-term goal of nudging inflation to 2%. Inflation has been slower to decrease than expected, with core PCE at 4.6% YoY in March, more than double the Fed’s 2% goal.

Despite the current level of inflation, the market is already pricing in rate cuts starting in September. Chairman Powell continues to try to dismiss these expectations, but market has been slow to follow.

We believe these rate cut expectations are misplaced, and the Fed is much more likely to pause interest rate policy and let the data drive future policy decisions. 

Once the banking sector stress subsides, if economic growth and inflation remain resilient, the Fed is likely to return to policy tightening.


Entering earnings season, the consensus forecasts for Q1 earnings had been adjusted downward by more than 6% since beginning of the year, a considerable downward revision compared to average adjustments. This downward shift indicates that the expectations had been set low, creating a relatively low bar for companies to positively surprise the market.

The majority of the S&P 500 companies have shared their earnings reports and fascinatingly, 78% of these companies reported earnings per share (EPS) that exceeded estimates. This rate is higher than the 10-year average of 73% and is the best performance since the third quarter of 2021 according to FactSet.

A trend that has caught the attention of market watchers is the difference between companies’ projected earnings and their expected sales (revenues). In recent months, while companies’ earnings projections have been decreasing, their sales predictions have been going up. This has led to two differing viewpoints. Some people believe that strong sales will eventually boost earnings, while others see the high sales figures as unsustainable and predict a fall in earnings, which could affect profits.

We believe that the continued increase in sales expectations should be viewed with a bit of caution. This is because the economic momentum is slowing down and inflation is showing signs of moderating and both of which could reduce revenue growth.

One of the challenges companies are facing is a shortage of workers. This makes it hard for businesses to cut costs, especially if sales slow down. On the positive side, some costs that don’t involve labor are going down, which could help businesses. But we do not expect a sudden, sharp decline in business activity, which could severely impact revenues and earnings. Instead, we think earnings will slowly decrease over the next six to twelve months.

Another important point to note is the variation in earnings within the U.S. stock market, which is due to several factors, including the ongoing effects of the pandemic, supply-chain issues, and the war in Ukraine.  Some sectors are still dealing with the after-effects of the pandemic, while others are benefiting from people’s desire to spend on services and travel now that they can.

Despite these challenges, U.S. companies with significant operations abroad have reason to be optimistic. The economies in China and Europe are improving, and the U.S. dollar is losing value, which is good for these companies. These factors should help boost their revenues and earnings and offset some of the impact of the slowing U.S. economy.

As you can see from the chart below, S&P 500 earnings and the price of the S&P 500 index are correlated over the long term. Earnings growth will drive stock prices higher over time.

Chart of the Month

“I can’t say enough about the fact that earnings are the key to success in investing in stocks. No matter what happens to the market, the earnings will determine the results.”

– Peter Lynch


Over the years, market participants have come to anticipate that any deadlock over the debt ceiling would be resolved in time to avert a default, even if it means going down to the wire. This expectation is rooted in the belief that policymakers are aware of the severe implications of a default, such as destabilizing the global financial system and potentially inducing a recession in the U.S. and possibly the global economy.

Historically, Congress has always managed to adjust the debt ceiling, even in situations where the Treasury had to operate on a bare minimum, resorting to “extraordinary measures” to keep the debt within the statutory limit. These so-called “extraordinary measures” have progressively become more routine as the Treasury has repeatedly invoked them. Politicians also opportunistically attempt to gain leverage from the negotiations.

Looking at the debt ceiling deadlock of 2023 in comparison to 2011, there are significant risks. While we anticipate another adjustment to the debt limit, there is a substantial risk of financial market turbulence between now and the projected deadline date of June 1.

The current situation is reminiscent of 2011, when a divided Congress and a Democratic   President led the nation to the edge of default. Partly due to the political gamesmanship, the U.S. lost its AAA rating from Standard and Poor’s.

At present, the gap between the President and Congressional Republicans seems almost unbridgeable. Given the Republican control of the House, the chances of both sides agreeing on a budget for the next year, let alone the long-term, are very low. The federal debt ceiling, not the budget itself, is the biggest fiscal issue facing the U.S. in the near term. However, the budget deficit over the next decade is unsustainable. It seems inevitable that there will be cuts to Social Security spending and Medicare savings. The tax burden will also inevitably rise to at least partly accommodate the financial needs of the nation’s aging demographics.

Policymakers will battle over the most effective ways to bring down the budget deficit and stabilize or reduce the federal debt. History indicates that rapid nominal GDP growth is the primary means to achieve fiscal sustainability. Higher inflation may be the easier political path to take as it erodes the real value of debt. However, if investors come to believe that governments are accepting of permanently higher inflation, then the risk is that interest rates on new Treasury issuance will rise to above the growth rate of nominal GDP, thereby exacerbating the underlying debt problem and requiring a subsequent policy response.

May Newsletter PDF