Equities slightly down, rates a touch down and bonds doing a bit better. Results for 1Q23 from US corporates were very good. Worries about the Fed’s hikes continue to persist in light of the strong labour market. Continue to be moderately positive on Equities (but watch out for stops!) and neutral on Bonds.
Major market events 8th May – 12th May 2023
Highlights for the week
Mon: BOJ Meeting Minutes, German Industrial Production.
Tue: CN Imports, CN Exports, CNTrade Balance.
Wed: German CPI, US CPI.
Thu: CN CPI, CN PPI, BOE Interest Rate Decision, US PPI, US Initial Jobless Claims.
Fri: UK GBP.
Nikkei 225: 2 May 2023
- Last week started with a decline in equities, which managed to recover some ground on Friday post-Apple’s earnings and NFPs; rates flat to down, and bonds flat to up. Early reports for 1Q23 were very positive, with 79% of S&P 500 companies reporting a positive earnings surprise, and 75% of S&P 500 companies reporting a positive revenue surprise. The Fed did hike by 25 bps in May, as widely predicted.
- While the indices barely budged, it was the Nasdaq again to lead the week, with Apple’s results on Thursday After Close in clear focus. Poor breadth and continued outperformance of the technology mega caps are continuing to be recurring themes.
- Technically we are still in limbo: the Nasdaq 100 is well clear of its previous top on Feb 2 (12,803.14), but the S&P 500 hasn’t managed to do that yet (4,179.76). On the positive side, if the S&P 500 manages to climb above its previous top, I can see an extension of the current rally; on the negative side, should the Nasdaq 100 fall below its previous top on Feb 2 then much more caution should be exercised (a chance of a double top and of the market re-testing recent lows). In addition, the Euro Stoxx 50 is approaching its previous peak set in July 2007 (4524.45) and a breakout above that level might signal another leg up for equities.
- The never-ending discussion on rates continues; after the Fed did hike by 25 bps in May as expected, questions abound on whether this is going to be the last increase and the top in rates. Friday’s NFP still signals that the labour market is still in strong shape, which could put additional pressure on the rates outlook. Goldman Sachs has confirmed its no hike in June forecast after the update on the economy on Friday. But in the process of a transition from a monetary risk to market risk, people have been focusing on the job market lately with a sense of increased worry, as its recent weakness portends the upcoming recession most see in 2H23. Although earnings are expected to decline in 1Q23, this could be their trough; so far reports are very encouraging. It is important to see if bottom-up forecasts for both 2023 and 2024 continue to be cut or, at some point, manage to find their feet.
- 1Q23 earnings reports are drawing to an end, although they will continue this week with some notable companies reporting.
Checking up on the economy: the good
The ‘good’ points to more sustained growth and no recession, albeit at the cost of higher rates (the ‘higher for longer’ moniker that is soon becoming a mantra). There does seem to be a change in the narrative though, at least according to what is being priced by the market, with rates becoming less of a concern and the economy’s performance becoming more of a concern. Introducing the Atlanta Fed GDPNow estimate for 2Q23, which at 2.7% would account for very solid growth. As before, there is a meaningful difference between this forecast and the consensus for Blue Chips; at some point, they will have to converge.
Source: Blue Chip Economic Indicators and Blue Chip Financial Forecasts
Another positive sign comes from earnings. Market pundits were so worried about them, but didn’t have to, as reports were very good, led by big tech. In particular, the size of the aggregate earnings beat rose above the historical average, taking us to levels seen not before the last recession.
Source: Bloomberg Finance LP, Deutsche Bank Asset Allocation
Finally, there is evidence that operating margins are finally recovering after 2 years of declines. This bodes well for a rebound of earnings later this year after the 1Q23 trough.
Source: Bloomberg Finance LP, Deutsche Bank Asset Allocation
Checking up on the economy: the bad
Let’s start with this chart with a very useful reminder: earnings do not survive recessions. So we absolutely must avoid one if we are to thrive. On top of that, the Fed is going to remain restrictive for a while. According to the chart below, it is unlikely that any reversion of the hiking course will take place this year, as Governor Powell has mentioned. The Fed will likely cut rates only in 2024 and beyond.
Source: Federal Reserve Board and Well Fargo Economics
Rates and the economy are not the only hurdles the market has to contend with. The market is currently pricing an elevated debt ceiling risk starting in early June. The issue, as you can see from the chart below, is hardly new; but the problem is the political brinkmanship that stems from such a renegotiation. Hopefully, this one will go smoothly.
Source: ICE Data Indices LLC
Source: Carson Investment Research
Finally, the overall liquidity is diminishing, creating yet another issue for the market to contend with. It also doesn’t help that the IPO market has been anemic, with new filings reaching a low point. This is another signal of low liquidity and low interest in risky assets.
Source: FMRCo, Bloomberg, Haver Analytics, FactSet
Source: Topdown Charts, Nasdaq, SEC, Datastream
Checking up on the economy: the ugly
Valuation certainly isn’t cheap. It is even less so considering such appealing yields, particularly on the short end. This has led some to speculate that the current P/E is unsustainable. The current forward P/E of 17.7 is higher than the 10-Year average of 17.3. Hence earnings are of paramount importance; hopefully, they will find their feet in 1H23 and can resume their growth in 2H23, but according to the below chart, this doesn’t seem a certainty.
Source: BofA Global Investment Strategy, Bloomberg
On the micro side, there seems to be evidence that the economy is softening somehow. Weak, or weaker demand was often mentioned in 1Q23 conference calls.
Source: BofA Global Research
Sentiment and what the market is telling us
The Fear and Greed Index is still in Greed territory, ending the week with a reading of 59, down from a previous reading of 65. It seems to move in synch with the market’s recent moves.
Source: CNN Business
The AAII Sentiment sees a prevalence of bearish views, way ahead of the historical averages, with neutral views broadly in line, and leaving the bulls in the minority. This reflects the current dilemma in the market, torn between making higher highs (despite the high valuations) and retracing recent gains.
Source: AAII Sentiment Survey
What are the Flows telling us?
It should be no surprise that there are positive flows to money market funds, even with a distinct choppiness in performance in the last few weeks. The current yields offered are attractive, and with the peak in rates coming soon, a very strong performance is within its sights. Usually, there is talk that surfaces calling for the Fed to cut rates based on the high inflows to money market funds, but I remain highly skeptical of that – they won’t stop until they feel their job (taming inflation) has been completed.
Source: BofA Global Investment Strategy, Bloomberg
The forward 12-month P/E ratio for the S&P 500 is 17.7x, down from last week’s reading of 18.2x, which is below the 5-year average at 18.6x but above the 10-year average at 17.3x. The present, bottom-up level ($221.35) is beginning to slip from Goldman Sachs’ top-down $224 forecast, but it did manage to reverse its course after 1Q23. As we have been going down steadily for a while, I just wonder if at some point down the year the US Corporates will find in them what it takes to reverse this trend, as forecasted to happen in the back half of the year.
For 1Q23 the blended EPS decline for the S&P500 on aggregate is -2.2%. If correct, it will mark the second consecutive quarter in which there has been an earnings contraction. The upward revision to 2Q23 earnings growth (-5.7%), has been surprisingly negative if compared to 31 Mar’s -4.6%, but it is still very early days. Despite the concern about a possible recession next year, analysts still forecast a positive growth in earnings for the overall market in CY 2023 of 1.2% year on year, revised upwards from 0.8% last week, while revenue is forecasted to grow by 2.4% vs 2.1% on Mar 31.
With estimates now measured against the forecasts as of Mar 31st, there are very few differences yet. Of note, Information Technology growth is negative -0.9%. While Amazon issued weak guidance for AWS in April, all large tech companies made upbeat comments, so the softness is surprising.
The S&P 500 has its revenue growth estimates revised upwards from last week at 2.4%. Financials are still leading the pack in terms of revenue forecasts. Information Technology revenue growth has been cut to 0.9% from 1.3% on Mar 31st. The sector seems to be doing better on the top than on the bottom line, perhaps signaling the reason for some of the layoffs.
Let’s take a look at EPS for 2023 and 2024, which last week had the first upward revision in quite a while. The forecast for 2023 has now been updated to $221.35 from last week’s reading of $220.24; while 2024 is currently forecasted to be $246.62, compared to last week’s reading of 246.16.
This is the detail for 2Q23. While the market might be more concerned about rates and recession than earnings at this point, the latter’s deterioration is continuing to get me worried as the downward revisions have been relentless and guidance very muted. It seems almost a miracle that the market managed to stay afloat with these shrinking earnings. 1Q23 is almost over, but 2Q23 looks to start much in the same fashion, with a significant earnings decline.
Earnings, What’s Next?
The earnings season is now entering in full its 1Q23 reports. Here’s a list of companies reporting this week. Highlights include PayPal (Monday, After Close) and Disney (Wednesday, After Close).
Source: Earnings Whispers
Revenue growth estimates for 2024 are forecasted to grow by 4.9% (5.0% on Mar 31st) and earnings growth estimates for 2024 are predicted to grow by 10.3% (11.0% on Mar 31st), so the future looks to be bright. While we continue to debate whether the US economy will fall into a recession or not and what will be the peak rates for Fed Funds, we should take note that almost every strategy has seen a more defensive positioning in the last month.
We are probably shifting from a monetary risk to a macro risk, where the performance of the economy is more important than what the Fed does. We should be mindful that the economy is probably just doing ok, even though passing the peak in rates will remove the overhang present on the market. If and when rates will diminish in importance, earnings (and top-line growth) will hopefully pick up their pace.
The Nasdaq has been able to climb above its peak of 12,803.14 on 2nd February, and now it’s time for the S&P 500 to follow through (its peak is 4,179.76 on the same day). Despite being several pressures against Equities, tactically continue to suggest staying long on Equities, as long as the Nasdaq 100 stays above the Feb 2nd peak. Either the S&P and the Euro Stoxx 50 will be able to climb above their previous peak, which would open a new leg up for equities and for the market, or they won’t, and we fall in double-top territory with the markets possibly revisiting their recent lows. Regarding bonds, the trajectory is that yields will eventually fall, albeit with a few bumps on the road.
For the less volatility prone of you, it may make sense to take all opportunities to alter the weights of your asset allocation by increasing the weights of safety assets at the expense of more risky assets by lightening up in equities and reinvesting in bonds at attractive (approx 4%) yields. For those willing to look besides US treasuries, investment grade bonds (LQD ETF) could also be a good compromise: 1.2% pickup over government bonds for the safest part of the credit complex may still be compelling. 10-Year yields were turbulent last week, both in the US and Europe, though the ceiling should be near for both. For those wishing to keep their money in Equities with lower volatility, suggest switching to Japan as the company with the most stable outlook (the country with the more precise picture of rates at the moment) until rate perspectives become clearer in the US and Europe. They got a boost given the recent buy recommendation by Warren Buffett, and the oracle is very rarely wrong. So Japanese Equities are now investable regardless of the lower volatility derived by being the only nation in G7 not to raise rates in the current environment.
Happy trading and see you next week!
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