Great Resilience

7.28.2023

The S&P 500 closed last week within earshot of a new high. The blistering rally of the past 10 months has largely been driven by optimism toward artificial intelligence, tempering inflation, and resilient consumer spending. Economic growth has proven more durable than anticipated and markets are increasingly reflecting this sentiment. However, the Fed continues to take a more measured approach against a growing wave of optimism. Fed Chairman Jay Powell remains firmly committed to seeing that inflation is well anchored. As such, monetary policy is likely to remain restrictive. To continue rising, stocks will need to depend on earnings growth rather than multiple expansion, and inflation must remain low.

Real GDP growth came in at 2.4% in the second quarter, surpassing economists' forecasts of 2%. The surprise was powered by healthier-than-expected consumer spending and a surge of investment in capital equipment and nonresidential structures. Despite higher interest rates and dwindling pandemic savings, consumers are still spending. Near record low unemployment remains a key source of confidence. Reshoring jobs initiatives, the Chips Act, an infrastructure package, and automation also appear to be driving a manufacturing renaissance. After 525 basis-points of interest rate hikes in just a year and a half, we stand on a much firmer economic footing than anticipated.

In the markets, performance has been narrow for much of the year. However, over recent weeks we have seen participation subtly broadening. More economically sensitive sectors like industrials, financials, and materials have joined in on the tech-led rally. Such broadening is critical for the bull market’s next phase. We also would like to see earnings growth coincide with the multiple expansion that has defined 2023. With roughly half of the S&P 500 companies reporting second quarter results, we are seeing just that. Earnings growth has surprised to the upside by 6% and many companies are raising their year-end guidance. Strength in the economy is emerging at the company level.

Still, it is important to remember that monetary policy can act with a long and variable lag. The pressure of higher interest rates will increase with time and may eventually weigh on some businesses more than others. Because of this, we remain highly selective of the companies we hold. A strong management team, visible growth opportunities, and a history of execution are of the utmost importance.

Thanks,
Preston May, CBE®
Research Analyst

This report was prepared by Donaldson Capital Management, LLC, a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Information in these materials are from sources Donaldson Capital Management, LLC deems reliable, however we do not attest to their accuracy.

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S&P 500: Standard & Poor’s (S&P) 500 Index. The S&P 500 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the broad U.S. economy through changes in the aggregate market value of 500 stocks representing all major industries.