Equities march higher, rates down, and bonds up. The Nasdaq recovers in full its 2022 loss; the Nikkei 225 builds on an amazing performance YTD; Europe underperforms. Is the Fed going to hike again in June and then stop? Continue to be positive on equities (but watch out for stops!) and neutral on bonds.
Major market events 5th – 9th June 2023
Highlights for the week
Mon: CH CPI, DE Services PMI, UK Services PMI, EU PPI, US Services PMI, US ISM Non-Manufacturing PMI.
Tue: AU Interest Rate Decision, DE Factory Orders, UK Construction PMI, EU Retail Sales.
Wed: AU GDP, CN Trade Balance, DE Industrial Production, US Trade Balance.
Thu: JP GDP, AU Trade Balance, EU GDP, US Initial Jobless Claims, US Fed’s Balance Sheet.
Fri: CN CPI, CN PPI.
- Equities were tested early last week, but when everything seemed to start falling, the market surprised once more. It was a negative week for Europe, which almost closed the gap in terms of performance vs the US – recall that in earlier reports I supported investing in US Equities over European Equities, due to a different dynamism of their economies and – obviously – the power of the Information Technology in the US. Reports for 1Q23 were very positive, with 99% of S&P 500 companies having reported earnings, 78% reporting a positive earnings surprise, and 75% reporting a positive revenue surprise.
- Last week, value trumped growth (although growth did not do too badly). The Dow Jones was the star performer of the week, followed closely by the Nikkei 225, and then by the S&P 500 and the Nasdaq. The Japanese index is mimicking the Nasdaq 100 in its impressive performance, with another solid week, and both look to be on their way to chasing their all-time highs (easier for the Nasdaq than for the Nikkei). 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!
- There was a second test of the S&P 500’s breakout level, which the index passed with flying colors, now leaving some room between its actual level and its support (its previous Feb 2 peak – 4,179.76). It could very well be retested for the third time this week, but should it manage to go through the week unscathed, then it could be predictive of another leg up for equities. Be aware that Morgan Stanley is out with a forecast that the recent breakout above the 3,800-4,200 trading range is a bear trap (see below in Market Considerations) – the jury is still out (however with a third successful test the verdict would be reached), but, in principle, I disagree. As per the Nasdaq 100, with this week’s performance, it has completely recovered from the 2022 loss, is well clear of technical hurdles, and is well on the way to its all-time high of 16,057.44. Europe is in a more tricky position: it 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 CME FedWatch tool market pricing a 75% probability of another hike in June (which in all likelihood would be the last and would take the target value for the Fed Funds to 5% to 5.25%) and a 25% chance of a further hike in July. 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. What happened to the break? We got another blowout Non-Farm Payroll last Friday, although the unemployment rate ticked higher to 3.7% and the average hourly earnings came in below expectations. This might well convince Governor Powell and the board that it is necessary to continue hiking for a while. 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 -6.7%: 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 99% of S&P 500 companies having reported, although they will continue this week with some notable companies reporting, with Paypal on Monday and Disney on Wednesday being the most important by far.
- Ah, and before I forget – President Biden has signed the debt ceiling bill into law. No more of that for the next two years (what a relief)!
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 in 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 2.0% would account for very solid growth, revised higher from 1.9% 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
From a technical perspective, the S&P 500 recently managed to cross its 40-week moving average, which is a bullish signal. The long-term trend is supported by the 200 weeks moving average, which was tested late last year, but with a subsequent rebound of the market. This should offer support for further upward moves.
Source: Real Investment Advice
If we look at the past 70 years of monthly returns for the S&P 500, we will find that both in the last 10 years and particularly in pre-election years, it has had a positive return (80% of the time). With the NFP behind us, the next hurdles are CPI and PPI, and, of course, the Fed. The following week we will get early reports on 2Q23, starting with Oracle on Jun 12.
Source: Carson Investment Research, YCharts
The current, bottom-up level of $222.05 for 2023 S&P 500 earnings 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. This is both a stabilization and an improvement over the most recent weeks. Finally, corporate buybacks are still strong, with the second largest pot in the last decade or so, and are likely to offer further support and upside.
Source: Goldman Sachs Global Investment Research
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 Temporary Help Services were at -2.7% in May. The red line is at -3.5% and I note that the index has bounced against it already in 2023. Still, this does not match last Friday’s strong payrolls, which are more of a leading indicator than the THS. Still, one to watch.
Source: Federal Reserve Board of St. Louis
Speculators are positioned for a deflationary/recessionary scenario, line in 2022 when markets did fall. One of the concerns is definitely the inverted yield curve, but I believe we will gradually move to a more traditional rates environment after we reach the terminal rate and the Fed’s intentions will become clearer.
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 18.0 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 own valuation, and by the effect of an ever-growing weight, those of the market. In order to have a much stronger market we will need a positive contribution from the rest of the Index, bearing in mind that the Magnificent Seven are just about the only thing that went up this year.
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!). This is echoed by the chart below, which portrays the relative performance of the Nasdaq 100 vs the Russell 2000, and anything that takes us back to March 2000 gives me the creeps. If I had to guess, AI is probably in its infancy from what we can see, although the hype (also for investment banks, with the news that J.P. Morgan was ahead of other banks in hiring AI specialists) has to moderate. Still, this could be a revolution as big as the arrival and deployment of the Internet and of the www in the late nineties/early noughties. Ah, and Apple’s mixed reality visor debuts on Monday.
Source: BofA Global Investment Strategy, Bloomberg
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 65, down from last week’s reading of 67. If the Nasdaq 100’s 8% move in the last 3 weeks was not enough to propel the Index into Extreme Greed then I do really think the rally has legs!
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 the highest positive inflow of the year; for this to last, once again, breadth has to improve, even though the S&P 500 (and the Dow Jones) did ok last week.
Source: EPFR Global
The only game in town – AI (ahem, IT!) is back with a vengeance and with the highest monthly inflow since 2021. If and when you are looking at a new trend (and the opportunity offered by AI could be one), you’d better look at the concept than at valuations. If AI is able to make all those ubiquitous chatbots intelligent, it would create a real opportunity, as well as make all of our lives easier. Like in the movie Elysium, it would be fine to speak to an (intelligent) machine first, resorting to a human only in a few circumstances.
Source: BofA Global Investment Strategy, EPFR
The forward 12-month P/E ratio for the S&P 500 is 18.0x, up from last week’s reading of 17.8x, which is below the 5-year average at 18.6x but above the 10-year average at 17.3x. The present, bottom-up level ($222.05) 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 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 (-6.4%), has been surprisingly negative if compared to 31 Mar’s -4.8%, 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, 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 $222.05 from last week’s reading of $221.31; while 2024 is currently forecasted to be $247.59, compared to last week’s reading of $246.66.
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 PayPal (Monday, After Close), and Disney (Wednesday, After Close).
Source: Earnings Whispers
Source: Bloomberg, Morgan Stanley Research
Revenue growth estimates for 2024 are forecasted to grow by 4.8% (5.1% on Mar 31st) and earnings growth estimates for 2024 are predicted to grow by 8.5% (9.1% on Mar 31st), so the future looks to be bright, although the rather severe cuts to 2024 earnings are not welcome. 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 two different considerations. Morgan Stanley – which has a bearish earnings forecast for the S&P 500 of $195 – calls the move above 4200 a bull trap. It is probably a breakout, though it could be confirmed by a possible third testing of the Feb 2 peak – 4,179.76 – next week. The second chart points to the fact the Nikkei 225 is now paying more generous dividends than the S&P 500 for the first time. opposite picture. This does offer a cushion and support to anyone investing in Equities and improves the standing of Japanese Equities even further.
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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