With the debt ceiling debacle finally resolved, the S&P 500 sits at a new year-high. Still, the index performance remains frustratingly narrow. Though up 12.3% on the year, the five largest stocks account for over 100% of the index return. For the average company, the story has been quite different. The equal weight S&P 500 is up just 0.13% this year, but there is hope that the skies can clear. With the US avoiding default, continued labor market strength, inflation trickling lower, and an AI-driven tech boom, the economic outlook is promising. But, the Fed remains firmly committed to meeting its 2% inflation goal and we are still a long way away. A strong economy is a double-edged sword. With more rate hikes likely on the way, we might simply be in the calm before the storm.

As has often been the case, Congress managed to pass a last-minute debt ceiling increase last week.  The deal raises the debt limit by $2.5 trillion through January 2025. In exchange, nonmilitary discretionary spending will be capped, unspent funds will be clawed back from the IRS and covid programs, enhancements will be made to work requirements, energy permitting will be reformed, and student loan payments will resume in September. From a high level, this bill will be a modest economic drag to roughly 0.7% of 2024 GDP. This is far from catastrophic, but a reminder that consumers are largely swimming alone with fiscal aid on the back burner. 

The key question remains how quickly inflation will moderate. The downshift in government spending will undoubtedly help, but the tight labor market remains a steep hurdle. Job reports continue to blow past economists' expectations and unemployment continues to sit near record lows. Wage pressures have moderated from their 2022 highs but remain at levels inconsistent with the Fed’s inflation target. With the economy seemingly on solid footing, the Fed will likely press on with rate hikes. We expect deposits to continue leaving the banking system and credit to tighten. Historically, such conditions have resulted in job loss and recession. 

With this backdrop, we remain on guard and focused on holding high-quality businesses. Our top priority is ensuring our companies have strong balance sheets, excellent management teams, and resilient business models. Such companies can weather the current economic uncertainty and focus on their long-term goals. In addition, we maintain exposure to our highest conviction themes like rising geopolitical tension, a constrained supply of fossil fuels, aging demographics, and AI/Automation. These ideas can be a foundation for sustainable dividend growth in the years ahead. 

Thanks,
Preston May, CBE®
Research Analyst