Equities up, up and away, rates and bonds mostly stable. The Fed surprises the markets by introducing a second 25 bps hike in the forecast in 2023. Japan star of the week, followed by the unstoppable Nasdaq. Continue to be positive on equities, even if the market does feel extended (Nikkei 225 and Nasdaq 100 in particular) and prone to consolidation/correction, and neutral on bonds.
Major market events 19th – 23th June 2023
Highlights for the week
Mon: US Markets closed (Juneteenth).
Tue: German PPI, US Building Permits.
Wed: BOJ Policy Minutes, UK CPI, UK PPI.
Thu: SNB Interest Rate Decision, BoE Interest Rate Decision, US Current Account, US Initial Jobless Claims, Fed Chair Powell testifies.
Fri: UK Retail Sales, DE Manufacturing PMI, EU Manufacturing PMI, UK Manufacturing PMI, US Manufacturing PMI, US Services PMI.
- Up, up and away. Equities’ rally proceeds relentlessly without any pause. I still think that the markets are due for consolidation after a great ride – they should catch their breath – but each time a hurdle surfaces (it was the Fed this week), they push easily away, and continue to rally. Overall a very strong week across the board, led by the Nikkei 225 (for which a tectonic shift in liquidity might be about to happen; the Japanese have waited for over 30 years for this). The Nasdaq 100 did follow suit and eked out another of those 3% weeks which seem so common in 2023, leaving the all-time high of 16,573.74 well within its sights. Oracle’s earnings were well received and bode well for a successful 2Q23 reporting season. This week there will be another interesting report for the quarter ended in May from FedEx, which is usually a good predictive indicator of the economy’s performance.
- Growth trumped value once again. The Nikkei 225 continued relentlessly on its march higher. It and the Nasdaq 100 are the two markets most likely of making a pullback but do not underestimate the power of liquidity. It is possible that there is ongoing an epochal change in how the Japanese savers manage their money with a possible shift out of JGBs and into Equities. Even a small increase in equity weightings would mean a lot for the market. To be clear: while I would not buy Japan at these levels, I would not short it either. If you would like to follow the strong liquidity which has been pouring in, please be careful and have tight 2-3% stops. I still think it’s probably best to stay on the sidelines, at least until the next BOJ meeting on July 27-28. If the economy continues to perform well, I think the JPY will continue to weaken (which in turn will be a positive for the economy) – look after your hedges!
- The S&P 500 survived unscathed for yet another week and has a positive technical picture pointing to more upside. The big week went well, and while the Fed was more hawkish than forecasted, signaling two and not one 25bps interest increases, the market managed to digest the new dot plots without any particular issues. The potential hikes – one of which is likely to happen in July and the second in September or November – seem to have done more harm to bonds/rates rather than equities. It must be mentioned that the Fed has categorically excluded the possibility of rate cuts in 2023 and the equity market seems to have digested that as well. European markets, while positive, rise in synch with the other markets and need a sustained performance of broader equities (not technology) to go higher still. 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 met on Jun 13-14 and, as mentioned, sounded more hawkish than forecasted. The CME FedWatch tool market is pricing a 66.3% probability of another 25 bps hike in June, and a 33.7% probability of a 50 bps hike (!) – which would be a tail risk. 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. Goldman Sachs is also forecasting a pause in June and a 25bps hike in July, but will there be more to follow? (It looks like). 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, although we need to see if earnings will indeed trough in 2Q23 and whether they will bounce in the back half of the year. 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 slowly tricking in, being in between the end of 1Q23 and the beginning of 2Q23. We will get the first glimpse of 2Q23 from FedEx on Tuesday, which will be closely watched.
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 slowly being shifted to 2024. 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 1.8% would account for very solid growth, revised lower from 2.2% 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, with the Blue Chips consensus moving towards 1%.
Source: Blue Chip Economic Indicators and Blue Chip Financial Forecasts
The S&P 500’s technical background is solid and points to further upside. After finding support earlier in the year on the 200 Week moving average, it is trading above it and the 40 Week moving average. Let’s see if it will be able to have another breakout above the current trading channel, or whether it will bounce back.
Source: Real Investment Advice
Furthermore, quantitative analysis shows that stocks have been very resilient in 2023. The returns the S&P 500 has made the day after a down day are some of the highest in a long history of about 100 years and testify to the strength of the market and its ability to digest and bounce back from possible negative data/news.
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. Introducing some new, very bearish forecasts from Morgan Stanley which see S&P 500’s earnings cut from $195 to $185 (bottom-up consensus: $221; top-down consensus: Goldman Sachs $ 224, J.P. Morgan $205, Bank of America $200). Should such a scenario (which would include a rather severe recession) come true, the market would undoubtedly be under much pressure, hammered by a powerful double whammy of a hit on its multiple and its earnings.
Source: FactSet, Morgan Stanley & Co
The market will have to wait to get the rate cuts it craves so much. Now even the futures market seems resigned that ‘nothing good’ will happen in 2023. It is still more optimistic than Goldman Sachs’ own forecast, and hence prone to disappointment if the desired event does not materialize or is delayed.
Source: Goldman Sachs
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 18.5 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.
The staggering performance of the Magnificent Seven (MAGMA + Nvidia and Tesla) was in part fuelled by the AI boom, as these are the companies most exposed to this trend. This has, in turn, inflated their market capitalization, and increased their weighting in the index to a level never seen before, not even at the peak of the dot.com boom, where it must be noted that 2/5 of the group belonged to different sectors other than technology. Should any of these falter (and if one does, it might trigger a falling domino effect), then the index, with its ‘engines’ out, would fall precipitously. Watch out! (You will see that Bank of America is already calling this a bubble).
Source: BofA Global Investment Strategy, Bloomberg
Down in the depths – according to this survey of fund managers, only 15% expect stronger economic growth. That’s not a particularly rosy outlook for the economy, earnings, and the market. Let’s see however what the expected (by Goldman Sachs) disinflation in 2H23 will bring and if and how it may change the forecasts of the Fed.
Source: BofA Global Fund Manager Survey, Bloomberg
Sentiment and what the market is telling us
The Fear and Greed Index eventually made it into Extreme Greed territory, ending the week with a reading of 82, up from 77 last week, This is another reason which brings me to approach the next week with a bit more caution. Still – things can continue to go the way they have these past few months – up!
Source: CNN Business
The lagging AAII Sentiment Survey asked a different question this week, which brought the bulls out of hibernation. I share their constructive view on equities, despite any weakness that there might be near term.
Source: AAII Sentiment Survey
What are the Flows telling us?
Flows into equities might be turning, after abundant caution earlier in the year. Flows into Japan Equity Funds were the strongest in 12 weeks, certainly buoyed by the markets’ impressive performance.
Source: BofA Global Investment Strategy, EPFR
And in a week of strong equity inflows, we could not do without mentioning the bellwether of all equity markets – the S&P 500 – which witnessed strong inflows to US equities last week.
Source: BofA Global Investment Strategy, EPFR
There were no updates this week so this section is unchanged from its previous version.
The forward 12-month P/E ratio for the S&P 500 is 18.5x, up from last week’s reading of 18.0x, which is below the 5-year average at 18.6x but above the 10-year average at 17.3x. The present, bottom-up level ($222.61) is hovering around 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 2Q23 the blended EPS decline for the S&P500 on aggregate is -6.4%. If correct, it will mark the third consecutive quarter in which there has been an earnings contraction, and it will represent the largest decline since 2Q20, when it was -31.6%. The upward revision to 2Q23 earnings growth (-6.4%), has been surprisingly negative if compared to 31 Mar’s -4.8%, but it is still 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, 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 1.4% from as low as 0.7% and is now above 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 $221.66 from last week’s reading of $222.05; while 2024 is currently forecasted to be $247.31, compared to last week’s reading of $247.59.
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 will also 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 and a few 2Q23 reports are starting to trickle in. We will have another glimpse of 2Q23 (or at least the first two months of it) from companies, such as FedEx, that report a month early. Here’s a list of companies reporting this week. Highlights include FedEx (Tuesday, After Close), and Accenture (Thursday, Before Open).
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 12.3% (12.6% 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 welcome the arrival of a new bull market for the S&P 500 (+20% from the October lows), near-term it is quite possible that we see a consolidation around current prices after such a big jump.
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.
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 tactically continue to suggest staying long on Equities, despite a possible consolidation/correction, as long as the S&P 500 Nasdaq 100 stay above their 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, although given the new Fed’s forecast, we might have to wait 2024 for that.
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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