Equities on a roll, with S&P 500 and Nasdaq 100 making new all-time highs, rates up and bonds down. Positive scenario in 2024 but watch out for high multiples, rates, geopolitical conflicts, and elections. Keep a long position in equities (with a 3% weekly stop), and start purchasing some bonds (max 20% of invested capital). The biggest tail risk is inflation staying high(er for longer), forcing Central Banks to postpone easing until later in the year. 

Major market events 22nd – 26th January 2024 

Highlights for the week

Mon: CN PBOC Loan Prime Rate, US Leading Index

Tue: JP BOJ Interest Rate Decision, JP BOJ Core CPI, JP Trade Balance 

Wed: FR Services PMI, DE Services PMI, UK Services PMI, US Manufacturing PMI, US Services PMI  

Thu: DE Ifo Business Climate Index, EU ECB Interest Rate Decision, US Core Durable Goods Orders, US GDP, US GDP Price Index, US Initial Jobless Claims, US FED’s Balance Sheet 

Fri: US Core PCE Price Index

Performance Review

Index	15/1/2024	19/1/2024	WTD	YTD
Dow Jones	37,592.28	37,863.80	0.72%	0.39%
S&P 500	4,783.83	4,839.41	1.16%	2.04%
Nasdaq 100	16,832.92	17,314.00	2.86%	4.66%
Euro Stoxx 50	4,480.02	4,448.83	-0.70%	-1.42%
Nikkei 225	35,577.11	35,963.27	1.09%	8.04%

Source: Google

InflectionPoint reports:

* Welcome back! I’ve been swamped over the Christmas Holidays and the first two weeks of January, but I’m delighted to restart my weekly musings about markets. 2024 so far has been a story with two opposite sides: equities on a roll, and bonds on a rout. A lot of speculation is ongoing about when the World Central Banks will start to ease, and by how much; meanwhile equities continue their bull run, with the S&P 500 and the Nasdaq making fresh all-time records, and – last but not least – the Nikkei 225 being in scintillating form and conquering the title of best major equity market of the year so far. Europe is chugging along in its usual way, with lackluster results in both equities and bonds and is well suited for yet another year of relative underperformance. All this happened while the US Economy (recession, what recession?) was proceeding admirably, and the first earnings for 4Q23 have been solid. Bumpier ride for bonds ahead, with the idea that: i) the easy money has been made and that ii) the second half of the year will be better than the first (but watch out for Trump’s possible comeback!). Still long equities, still think the Fed is going to ease before the ECB (although the USD has been strong lately), and still like Japan (Warren Buffett’s endorsement was the best thing that could happen to the country), but watch out (=hedge) for the JPY. 
* Growth did really shine last week, with the Nasdaq 100 being once again the best market. We will have a solid earnings week coming, with Netflix and Tesla reporting, plus a very usual check-up on the state of semiconductors, which has been piping hot since the advent of AI. Earnings are good, but they are still projected to have negative growth in 4Q23, which would be the fourth of the last five quarters (the exception was 3Q23). This gets me to one of the main points: equities ARE expensive. Personally, I have been focusing more on the historic valuations of the S&P 500 rather than on relative ones (which are also not cheap, to put it mildly). And while everyone is saying that European Stocks are cheap (no disagreement there), they still fail to perform, never mind outperforming their peers across the pond. The other problem is that inflation is taking a long time to go down. Central Banks will eventually ease, but I fear not by as much and not as soon as the market expects. The recent issues in the Red Sea (watch the movie ‘Captain Phillips’ with a great Tom Hanks if you’d like to know more) are disrupting global shipping and adding costs and inflation. I feel we are in another sort of limbo, playing the waiting game, at least for the first half of the year. Meanwhile, it is fine to be long equities (always with the weekly 3% stop!), and you could start putting some money in bonds as well, as yields on the 10-year Treasuries rise towards 4.50% (I really cannot see them going back to 5% – that would be WAY too much). 

*  The CME FedWatch Tool is signalling that chances of a cut in March are 50/50, which in my view accurately reflects the current situation. If I had to flip a coin, I’d bet on May over March. All central banks will be in holding mode for now; the only one that might trigger a surprise could be the BOJ. Noticeably, the yield on the 10-year JGB never reached even 1%; a possible renewal of its dovish stance (we can call the BOJ the bank that never hiked) might have a repercussion on the JPY, which is now testing previous supports against all major currencies. We need (lower) yields and (higher) earnings to support some of the highest multiples since my heyday (the fated 1999-2000), but at least the US can continue to enjoy a solid economy; if and when disinflation does happen, you might want to look at small caps. For now, still stick with the best (large caps, and yes, the infamous Magnificent 7). 

* November and December were very positive months in terms of lower yields; January, less so. Some profit-taking might have been expected, but I have been surprised by the recent retracement of those gains. I look forward to yields on the long bond to return below 4% to have a more constructive scenario. Earnings for 4Q23 are currently estimated at -1.7%. Let’s see if they can repeat the feat of the past quarter, 10% of S&P 500 companies have reported now, but the bulk is yet to come – particularly NVDA, which is such a massive contributor, so let’s wait and see. The current forward P/E ratio for the S&P 500 is 19.5x – and while it is higher both than the 5-year (18.9x) average and the 10-year average (17.6x), it is not cheap enough to withstand such high interest rates. (Yes, back in 1999, multiples AND rates were both higher – but that is a past unlikely to return, as earnings for most of the magnificent 7 have disappointed so far). Bottom-up earnings for 4Q23 are now estimated at 222.55, not too far from Goldman Sachs’ own top-line forecast of 224.  Introducing a 2024 S&P 500 bottom-up earnings estimate of 243.52, which almost matches the top-down consensus of 245 (Goldman Sachs 237, Morgan Stanley 229, J.P. Morgan 225, Bank of America 235). 

* Growth is still plentiful according to Atlanta and New York Federal Reserve Banks. Looking at 4Q23, the former’s GDPNow model is forecasting growth of 2.4%, with the Blue Chips consensus now firmly above 1%, and hovering around 1.5%. The latter’s Nowcast, which produces an annual forecast that is less volatile, sees annual growth at 2.42%, down 0.03% from last week, but up from 2.05% in December. Even more interestingly, there is no recession forecast in their model, up to one sigma. Earnings are expected to come in at -1.7% in 4Q23, compared with an estimate of 1.6% as of Dec 31st.  Revenue growth is faring a little better, at 2.9% in 4Q23, vs 3.1% as of Dec 31st. For 2023, earnings growth is forecasted at 0.1%, vs 0.9% as of Dec 31st, with revenues coming in at 2.3%, vs 2.4% as of Sep 30th. Finally, it’s worth noticing that the chance of a recession, as calculated from the yield curve, according to the Federal Reserve Bank of Cleveland, has now risen to 66.47%, given the rebound in yields, from a bottom of 53.36% in September.

Source: Blue Chip Economic Indicators and Blue Chip Financial Forecasts; Federal Reserve Bank of Atlanta

Source: Federal Reserve Bank of New York, New York Fed Staff Nowcast

Source: Federal Reserve Board, Federal Reserve Bank of Cleveland, Haver Analytics

* Earnings are finally here – likely to overall meet/exceed estimates but watch out for the guidance. The November bottom-up estimate of $225.55 matches with the following forecasts: $224 from Goldman Sachs, $205 from J.P. Morgan, $200 from Bank of America, and $ 185 from Morgan Stanley. However, geopolitics and rates are likely to obscure everything for a while. Hang tight!

Earnings, What’s Next?

The reporting season – with 10% of S&P 500 companies having reported – is now about to get started. Here’s a list of companies reporting this week, highlights include: Netflix (Tuesday, After Close); Texas Instruments (Tuesday, After Close), Tesla (Wednesday, After Close), and Intel (Thursday, After Close)

Source: Earnings Whispers

Market Considerations

Source: BofA Global Investment Strategy, Refinitiv Datastream, ISABELNET.com

Revenue growth estimates for 2024 are forecasted to grow by 5.5% (5.5% on Dec 31st) and earnings growth estimates for 2024 are predicted to grow by 12.2% (11.7% on Dec 31st), so the future looks bright. As previously mentioned, the Fed probably has stopped hiking and we have reached the peak in rates, so the next move will be down, either in March or May. Apart from the cut from quite high levels, which will probably help make these lofty multiples seem more bearable than offering a real stimulus to the economy, what will be important is to see the extent to which the Central Banks are willing to cut rates and their timeframe. This is obviously connected to the chances of the US Economy going into a recession, which we’ll likely hear less and less (while paying a lot of attention to the data) until November, as the current US Government has indeed been a big spender of late.

On the economy, we are probably shifting from a monetary risk to a macro risk, where the economy’s performance is more important than what the Fed does. Obviously, we should not overlook geopolitical scenarios and the upcoming elections, in which possibly the UK will see the first Labour government since the Tony Blair-Gordon Brown years, albeit immersed in a global shift to the right (more protectionism, less globalisation). 

Both the S&P 500 and the Nasdaq 100 made new all-time highs last week; that of the tech-heavy index was remarkable after the strong performance in 2023. Europe unfortunately looks like the ugly duckling, and Japan (minus the JPY) has completely stolen the show this year. I continue to recommend a long position in equities (with the now famous 3% weekly stop), and I’m warming up on bonds as these reach interesting yields. Watch out for any resurgence of inflation, as this can significantly alter the scenario if persistent.

There are three main headline risks to what is otherwise a constructive view for 2024: i) any resurgence/stickiness in inflation; ii) any negative geopolitical outcome (which could see an expansion of the current conflicts); and iii) elections, particularly in the US, where a new Trump presidency looks quite likely. 

Regarding bonds, the expected disinflation in 2H23 indeed came more slowly than expected. It should continue in 1H24, but watch out for potential spanners in the works, like the issues in the Red Sea. Once again, until we have more clarity on any peaceful resolution of the conflict between Israel and Hamas or further progress in rates with yields on the US long bond going < 4.00% once again, I advise starting buying bonds in waves, keeping the overall duration below 10 years. Obviously, it still makes sense to invest any liquidity in the money market (up to 1/2 years).

Don’t neglect Japan – it is the more investable part of equities right now (together with US Equities, of course), thanks to good economic performance and a still dovish Central Bank. The JPY tried a rebound earlier in the year but faltered once again, and I personally have the feeling it may weaken further. Watch out for any ‘surprises’ coming out of the BOJ this week.  It is still the safest part of equities, as long as you hedge the JPY. 

Happy trading and see you next week!

InflectionPoint

Disclaimer

All views expressed on this site are my own and do not represent the opinions of any entity with which I have been, am now, or will be affiliated. I assume no responsibility for any errors or omissions in the content of this site and there is no guarantee for completeness or accuracy. The content is food for thought and it is not meant to be a solicitation to trade or invest. Readers should perform their investment analysis and research and/or seek the advice of a licensed professional with direct knowledge of the reader’s specific risk profile characteristics.