Equities hang in there, rates up, and bonds down. NVIDIA’s stellar earnings bolster the Nasdaq to new highs, almost recovering in full its 2022 loss. The agreement on the debt ceiling is positive, though I suspect much is already in the prices. The Fed should be done after June, possibly after hiking one more time. Continue to be positive on equities (but watch out for stops!) and neutral on bonds.
Major market events 29nd May – 2nd June 2023
Highlights for the week
Mon: US Markets Closed (Memorial Day).
Tue: CH GDP, US Consumer Confidence.
Wed: CN Manufacturing PMI, FR CPI, IT CPI, DE CPI, US JOLTs Job Openings.
Thu: DE Retail Sales, DE Manufacturing PMI, UK Manufacturing PMI, EU CPI, US ADP Nonfarm Employment Change, US Initial Jobless Claims, US ISM Manufacturing PMI.
Fri: US Non-Farm Payrolls, US Unemployment Rate, US Average Hourly Earnings,
- Equities suffered early last week on the back of concerns regarding the debt ceiling deal in the US and possible continued tightening by the Fed. Everything turned around NVIDIA’s stellar earnings report which propelled the Nasdaq 100 to another remarkable week and to its highest levels since the late 2021 previous peak. Reports for 1Q23 were very positive, with 97% of S&P 500 companies having reported earnings, with 78% reporting a positive earnings surprise, and 76% reporting a positive revenue surprise.
- The Nasdaq 100 was the star of the week and the only index making solid gains. The Nikkei 225 continued on its positive path with another solid week after last week’s breakout, achieving the best performance for any major index YTD save for the Nasdaq, with a 20% gain, even though it will have been tempered by the JPY’s decline for those that did not hedge. The S&P 500 managed to end the week in positive territory, thanks to the performance of the leading technology stocks. Value declined for the week (Dow Jones and Europe), lacking the exposure to the key tech gorillas that represent an ever-growing portion of the S&P 500.
- When the test of the newfound support seemed to fail, NVIDIA turned the tables and, on a weekly basis, the support (for the S&P 500) did hold. I will be looking very closely at what happens next week, as it is likely to be retested (its previous Feb 2 peak – 4,179.76). Should it manage to go through the week unscathed, then it could be predictive of another leg up for equities. The Nasdaq 100 seems to know no limits, as it’s 1500 points clear of its previous top on Feb 2 (12,803.14), and well on the way to its all-time high of 16,057.44. Europe needs a sustained performance of broader equities (not technology) to go higher, and the rates environment might be more complicated and farther from the top than the US. Should it manage to reach its previous high set in July 2007 (4524.45) and make a breakout above that level it would signal another leg up for equities.
- The Fed meets on Jun 13-14 and expectations for a rate hike have meaningfully changed since last week, with the futures market pricing a 64% probability of another hike in June (which in all likelihood would be the last). There is growing consensus that the current level of rates is at a restrictive level for the economy, and therefore Governor Powell could continue to keep it at the same level for the rest of the year to further tame inflation, which he and other board members have acknowledged is still too high. After having gone past the rates tantrum, the baton passes on to the economy, which so far has performed admirably, despite the tough environment. In 2H23 it is expected that the economy will meet a more benign rate environment. The decline in earnings in 1Q23, -2.1%, was way ahead of expectations of -7%: this could be their trough. 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. It is also very important to check if the 7 leading companies (MAGMA – Microsoft, Apple, Google (Alphabet), Meta, and Amazon. plus Tesla and Nvidia) continue to perform in line with 1Q23 and if there is an expansion of breadth (which would be very important for the market) and a follow through to other companies.
- 1Q23 earnings reports are drawing to an end, with 97% of S&P 500 companies having reported, although they will continue this week with some notable companies reporting, with Hewlett Packard on Tuesday and Salesforce.com on Wednesday being the most important by far.
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), even though expectations for rate cuts are mounting. 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 1.9% would account for very solid growth, albeit revised lower from 2.7% previously. As before, there is a meaningful difference between this forecast and the consensus for Blue Chips; at some point, they will have to converge. It is good and notable to see that these are in positive territory and that they have been improving (=no recession) in the last two months or so.
Source: Blue Chip Economic Indicators and Blue Chip Financial Forecasts
As mentioned, in 2H23 companies should face a more benign rate environment, Performance in 1Q23 has been remarkable, and managed to quash all fears regarding a possible slump. Instead, we have witnessed the opposite, with EPS tracking a 5% beat, which is double the typical beat. This is very important as valuations are quite full; it also bodes well for the rest of the year.
Source: FactSet, BofA US Equity & Quant Strategy
If we look at consensus, EPS should decline only by 2% in 2023 before recovering. And while there has been an earnings decline in 1Q23 for the second straight quarter, results came well ahead of expectations. I further note that 2023 and 2024 estimates have been stable of late, as a way of finding their feet before hopefully bouncing later in the year. The current, bottom-up level of $221.31 for 2023 compares with top-down forecasts of $224 for Goldman Sachs, $205 for J.P. Morgan, $ 200 for Bank of America, and $ 195 for Morgan Stanley.
Source: Bofa Global Investment Strategy, Bloomberg
And finally, 88.5% of the times in which the S&P 500 was up 7% on day 100 of the year brought further gains in the back half, which in recent times have been almost always in double digits. I believe this is possible if there is an expansion of breadth, and if the US economy continues to perform admirably as it has done so far in 2023 (notwithstanding the high rates).
Source: Carson Investment Research, FactSet
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. The probability of recession as calculated by the yield curve stands at 79.3% in May. This is something we should all monitor closely and be wary about.
Source: Federal Reserve Board, Federal Reserve Bank of Cleveland, Haver Analytics
The current US Market-Implied Terminal Rate is higher than a couple of months ago (though not as high as where it was prior to Silicon Valley Bank). Indeed, it is very possible that the Fed might decide to hike again in June before pausing. Rates are probably going to be higher for longer, and this pushes out (probably to 2024 if there are no big disasters in the economy) the timing of the first Fed cut.
Source: The Daily Shot
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 17.8 is higher than the 10-Year average of 17.3. Hence earnings are of paramount importance. It is true that the market is expensive, but it much depends on the outlook for earnings in 2H23. If the economy can continue to perform, it would seem feasible to see the market trading around such multiples, perhaps with a slight compression due to the better results reported. One of the issues is that inflation appears to be unrelenting; in fact, even the Fed recently noted that inflation is taking longer to return to its desired value (2%). Continued strong inflation could put pressure to the major central banks and force them to raise rates to even higher levels.
Source: BofA Global Investment Strategy, Bloomberg
Despite expectations of lower rates eventually, trading in bonds has been really choppy this year, and quite difficult. High Yield bonds are seen as a mirror of the economy; so far they have traded mostly lower. This has caused some market pundits to posture that all is not well with the economy. Let’s hope this has been caused by a difficult rate environment rather than real issues in the economy itself.
Source: BofA Global Investment Strategy, Bloomberg
AI Boom? MAGMA has been driving the performance of both the S&P 500 and the Nasdaq 100, with AI being the next trend that nobody wants to miss. In particular, Alphabet, Microsoft, Meta, Amazon, and Nvidia all spoke about AI during their conference calls and highlighted one of the areas of major focus for them and one of the greatest opportunities of our time. The risk from a stock market perspective is a replica of 1999 and of the dot com boom (and then bust). Performance should be more evenly distributed to avoid inflating valuations and focusing only on a few leading companies like it was at the time (I was there!).
Source: Bloomberg Finance LP, Deutsche Bank
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 67, equal to a previous reading of 67. It is curious that the Nasdaq 100’s second 3% move did not propel the index to go any higher.
Source: CNN Business
The lagging AAII Sentiment Survey, as usual, paints a different picture: the bears seem in charge (and they certainly weren’t last week), followed closely by those with a neutral position. A lot of new buyers, perhaps?
Source: AAII Sentiment Survey
What are the Flows telling us?
Flows into equities might be turning, after abundant caution earlier in the year. Last week there was a positive inflow of $0.92B; for this to last, once again, breadth has to improve, even though the S&P 500 did ok last week.
Source: EPFR Global
It is also noteworthy to consider the allocations to equities done by Bank of America’s private clients, which seem high at 59%. While it is true that the 60/40 portfolio is back in vogue after a disastrous 2022, this does show a certain confidence in the market.
Source: BofA Global Investment Strategy
The forward 12-month P/E ratio for the S&P 500 is 17.8x, down from last week’s reading of 18.3x, which is below the 5-year average at 18.5x but above the 10-year average at 17.3x. The present, bottom-up level ($221.31) 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 -2.1%. If correct, it will mark the second consecutive quarter in which there has been an earnings contraction. The upward revision to 2Q23 earnings growth (-6.3%), has been surprisingly negative if compared to 31 Mar’s -4.7%, 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 1.3% year on year, vs 1.1% on Mar 31, 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’s growth is now positive, and greatly outstripping both earlier negative forecasts (of as much as -1%) and their Mar 31st previous reference.
The S&P 500 has its revenue growth estimates at 2.4%, level with last week’s. Financials are still leading the pack in terms of revenue forecasts. Information Technology revenue growth has been revised upwards to 1.3% from as low as 0.7% and is now equal to 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 $221.31 from last week’s reading of $221.09; while 2024 is currently forecasted to be $246.66, compared to last week’s reading of $246.37.
This is the detail for 2Q23. While the market might be more concerned about rates and recession than earnings at this point, the narrative is changing from rate risk to macro risk where earnings will be of paramount importance. While the negative revisions to 2Q23 are a bit troublesome, I’m encouraged by the fact that on a yearly basis, there have been no more declines lately, which is remarkable considering the very limited breadth of the market. It is also well possible that earnings for 2Q23 too will surprise on the upside following a very positive 1Q23. Stay tuned.
Earnings, What’s Next?
The earnings season is now drawing to an end in its 1Q23 reports. In June we will have a first glimpse of 2Q23 (or at least the first two months of it) from companies, such as Oracle, that report a month early. Here’s a list of companies reporting this week. Highlights include Hewlett Packard (Tuesday, After Close), and Salesforce.com (Wednesday, After Close).
Source: Earnings Whispers
Source: Stage Analysis
Revenue growth estimates for 2024 are forecasted to grow by 4.8% (5.0% on Mar 31st) and earnings growth estimates for 2024 are predicted to grow by 11.6% (12.1% 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 two charts above point to an opposite picture. The first tells us that, unless 2023 is an exceptional year, all gains in the Nasdaq have already been made. The second tells us that, from the previous bottom, the Nasdaq has risen less than in previous cycles and that its long-term upward trend is intact. Which is right? I tend to align with the second one; I believe that the Nasdaq this year will – at the very least – recover all the losses from 2022 (which it has almost done), with an opportunity for further upside if the economy does hold. One quarter is not enough to call the entire year, but I am encouraged by what I am seeing so far.
So the breakout happened, with both the S&P 500 and the Nasdaq 100 ahead of their previous Feb 2 highs. The strong performance of the Nikkei is a contributor to the global rally in equities. I suggest seeing if the Feb 2 highs will be tested again this week and what will be the outcome; however, despite being several pressures again, tactically continue to suggest staying long on Equities, as long as the S&P 500 Nasdaq 100 stays above the Feb 2 peaks. If those levels hold, it would open a new leg up for equities and for the market; if they don’t, 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. Just watch out for the JPY – if the current strength in the economy and markets is to continue, you may want to hedge it as it will likely continue to slide (against all major currencies).
Happy trading and see you next week!
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