Uphill Battle Likely as Skittish Market Eyes Debt Ceiling Debate, FOMC Meeting

Despite Washington, D.C. dabbling with possible default, stocks spent much of May dressed in green for the season. Resilience was the theme, though the rally mainly reflected a few mega-cap tech stocks scampering ahead, while most of the market jogged in place.

The challenge in June—assuming Congress and the White House can avoid a first-ever default on U.S. debt payments—is to keep the market’s late-spring pace intact. That may be tough given next month’s uncharacteristically heavy schedule for potentially market-moving economic events.

Seasonally, June tends to be weak, though historical trends aren’t guaranteed to repeat. The dollar and interest rates rebounded in May and could form speedbumps for Wall Street in the new month. So could expectations of a weak Q2 earnings season beginning in July.

There’s also been the constant drumbeat of hawkish talk from Fed officials ahead of the next Federal Open Market Committee (FOMC) meeting June 13 – 14. Between that and some relatively hot economic data late in May, the CME FedWatch Tool recently indicated investors dialing back hopes for a rate pause in June and rate cuts later this year. By May 30, the tool indicated a 60% probability that June would bring another 25-basis-point rate increase. Chances of rate cuts by late 2023 have declined steeply, as futures market trading suggests.

There’s plenty happening around the world too as June begins. Geopolitics remain fraught as China just slapped new restrictions on U.S. chipmaker Micron (NASDAQ:MU), and the Ukraine war shows no sign of easing. Rates keep rising in Europe as the European Central Bank (ECB) struggles with inflation. There’s also technical resistance as major U.S. indexes bump against long-term levels they haven’t been able to sprint past since last summer.

In the background, banking worries haven’t completely retreated. The credit “crash” some analysts had expected after three major bank failures this spring hasn’t happened, but credit tightening is underway, possibly slowing economic growth later this year.

All of this assumes the month isn’t overtaken by debt ceiling misfortunes. The Treasury Department pegs June 5 as the likely date the United States might run out of money to pay its bills. If there’s a default or even a close call, June could grow volatile very quickly, but it’s too soon to say how this might play out.

On Wall Street, Tail Wags Dog

June opens after a May rally led by a handful of major info tech and communication services companies accounting for roughly 25% of the S&P 500 index’s market capitalization. The SPX is market cap-weighted, meaning the index can rise while most stocks in it fall.

As of late May, the SPX was up 9% year to date, reflecting robust gains from $1 trillion market-cap stocks like Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), and Alphabet (NASDAQ:GOOGL). Other huge stocks making news at month’s end included Nvidia (NASDAQ:NVDA) and Meta (NASDAQ:META), also in the tech and communications sectors.

However, the equal-weight S&P 500 Equal Weighted (SPXEW), which weighs all 500 stocks the same, tells a different story. SPXEW is up barely 1% since December 30, and other major indexes like the small-cap Russell 2000 (RUT) have also struggled in 2023.

While this year’s banking turmoil continues to slow the financials sector, lower Q1 earnings from retail leaders like Home Depot (NYSE:HD), Target (NYSE:TGT), Lowe’s Companies Inc (NYSE:LOW), and Foot Locker (NYSE:FL) demonstrated how consumers are juggling credit, inflation, and recession worries. Traditional dividend sectors like utilities and staples got dragged by strong yield competition, with money market funds and Treasuries offering competitive or higher rates.

Wall Street’s bifurcation heading into summer might remind veteran investors of mid-2018, when the so-called FAANG stocks dominated Wall Street and most other companies shares sagged. That proved untenable in the long run. The market broke down in September that year and eventually fell almost 20% when investor enthusiasm waned for big tech. Some analysts fear if tech stocks dominating this year’s action lose ground, the entire SPX rally could quickly vanish.

This isn’t a prediction or a guarantee. It’s just a reminder that we haven’t had a broad-based, healthy rally where most sectors climbed.

What did climb is interest rates, not generally helpful for stocks.

And interest rates may go higher, especially if the FOMC decides not to pause at the June meeting. Recent remarks from Fed officials suggest additional rate increases if inflation growth doesn’t ease more quickly. Data in May featured resilience, especially in housing and wages. The Fed’s worried that even after raising rates 500 basis points in 14 months, the economy hasn’t slowed enough to stop the disheartening price increases on anything from a pound of beef to a used car.

SPX YTD Daily

Data source: S&P Dow Jones Indices. Chart source: thinkorswim® platform.

Why Weight? The S&P 500 index (SPX—candlesticks) rose around 9% year to date by late May, but the equal-weight SPX (SPXEW—purple line) is barely up. The two kept pace earlier this year, but over the last two months, the SPXEW fall far behind amid pressure from financials and some traditionally defensive sectors even as mega-cap tech kept the market-cap-weighted SPX rolling along.

Wages in Focus When Jobs Report Bows

June, like all months, begins with a look at the U.S. jobs picture. The May Nonfarm Payrolls report comes out this Friday, and analysts expect it to show 180,000 new jobs created, according to Trading Economics. That would be down from 253,000 in April and represents moderate growth historically.

Look for possible revisions to previous data, which could end up being nearly as important as the headline number. In its April report, the Labor Department sliced a combined 149,000 jobs from February and March, raising questions about just how robust jobs growth really is. Any similar bite out of April jobs might suggest economic slowing. Keep in mind, however, analysts have consistently underestimated monthly jobs growth for the last year.

Wages are another key metric. They rose 0.5% in April, another warning sign of elevated inflation. That said, the mix of jobs created that month tended toward sectors with higher pay and less toward the low-paying leisure and hospitality industry that dominated job creation earlier this year.

Earnings Take a Back Seat, but Watch These

June is quieter on the earnings front, which might be appreciated by those trying to catch their breath after April and May. The Q1 earnings period finished with far better performance than analysts had expected, but overall earnings per share (EPS) still fell for the second quarter in a row. In addition, May ended with analysts expecting the current quarter to bring more sad tidings with about a 6% annual EPS decline, according to research firm FactSet. Even if the decline narrows, it’s still hard to see any kind of earnings-driven rally in the near future.

The June earnings calendar may be light, but the companies expected to report could be revealing. Nike (NYSE:NKE), for instance, saw shares drop in mid-May when customer and competitor FL posted disappointing earnings and a tepid outlook. Can NKE escape the impact of consumers putting off discretionary purchases? Also, how is its China business amid tensions between China and the United States?

Lennar (NYSE:LEN), a major homebuilder, could offer insight into the next New Home Sales report in June. An unexpected April increase in New Home Sales came even as mortgage rates clicked toward 7%, but average and median new home prices fell as customers appeared to gravitate toward the lower end of the market. More sales at lower prices represent a mixed picture for the homebuilding industry, so it’ll be helpful to get LEN’s ground-floor view.

Oracle (NYSE:ORCL) is another big hitter expected to report in June, and its wide global exposure often serves as a barometer for info tech sector demand.

There’s corporate stuff happening in June beyond earnings too. AAPL’s Worldwide Developers Conference is likely to draw some headlines. The American Society of Clinical Oncology’s (ASCO) annual meeting also takes place in early June, and it typically reveals data that could help or hurt the fortunes of major health care and biotech firms.

Fed Still Front and Center

Of course, none of this dominates quite like the June 13 – 14 FOMC meeting. As of late May, market participants had reversed their earlier expectations of a rate pause and built-in higher odds of a hike. If the FOMC does pause, it would be the first time since early last year, when rates were essentially zero. The range is now 5% to 5.25%, the highest since 2007.

It’s hard to get a handle on what the Fed will do because we still await the jobs data in early June and the Consumer and Producer Price Indexes (CPI and PPI) in mid-June. Both the CPI and PPI come out as the Fed meets and could play into any last-minute FOMC thinking.

The CPI, due Tuesday, June 13 as the FOMC begins deliberating, rose 0.4% in April, in line with Wall Street analysts’ expectations. The closely watched annual core inflation rate, which strips out volatile food and energy prices, was up 5.5% year over year, still well above the Fed’s 2% goal. PPI data is scheduled to arrive hours before the Fed’s expected rate announcement on June 14. PPI rose 0.2% in April.

Will the Fed eventually be able to tame inflation even if it takes a pause next month? June will help tell the tale, even if the race is far from over.

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