Key week verdits: earnings are there aplenty, but high valuations do hurt, and with such a strong labor market you should not expect any rate cut soon (June?). S&P 500 and Nasdaq 100 made further records; 10-year Treasuries and other long bonds lost a little last week as rates jumped following the surprise Nonfarm Payrolls. Keep a long position in equities (with a 3% weekly stop), although it does make sense to take some money off the table now, 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, followed by adverse geopolitical outcomes, and elections.
Major market events 5th – 9th February 2024
Highlights for the week
Mon: US FED Chair Powell Speaks, JP Services PMI, CN Manufacturing PMI, FR Services PMI, De Services PMI, EU Services PMI, UK Services PMI, US Services PMI, US ISM Non-Manufacturing PMI, JP Household Spending
Tue: AU RBA Interest Rate Decision, DE German Factory Orders, UK Construction PMI
Wed: UK Halifax House Price Index, DE Industrial Production, US Trade Balance, US Atlanta Fed GDPNow
Thu: CN CPI, CN PPI, US Initial Jobless Claims, US FED’s Balance Sheet
Fri: DE CPI
|Euro Stoxx 50
* Once again, the make-or-break week continued with the same pattern we have witnessed so far in 2024, with equities slightly up and bonds slightly down. The busiest week in earnings reports did not disappoint; while Microsoft, Alphabet, and Apple did not quite make their mark, Meta and Amazon did, lifting the overall earnings for the whole index. There has been a lot of noise lately regarding the impressive market cap of the Magnificent 7; Meta’s. following a big beat last Thursday, increased by more than $200B on Friday (the entire present market capitalization of Cisco Systems). To most market pundits the (equities) markets feel extended, and rightly so – as on Friday the S&P 500’s multiple reached a multiple of 20x, a recent record. This was bolstered by the blowout in Nonfarm Payrolls, which showed the buoyancy of the US Economy (recession, what recession?). At the same time, Governor Powell’s comments late on Sunday quashed hopes of a March cut, and he was eager also to reduce the number of cuts for the whole of 2024 to 3. Still long equities (but it may make sense to take some profits here), still think the Fed is going to ease before the ECB (although this means in all likelihood May or June, plus I note that 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 (which has been mostly stable in the last two weeks).
* Unstoppable growth continued to trump value last week, with Europe taking a breather after the massive comeback in the previous week. The very strong Nonfarm payroll convened talks of ‘no landing’ – growth is strong, particularly in the labor market (even though most of the new additions were part-time), and also slightly inflationary, with all eyes on the CPI next week. The conundrum is how the Federal Reserve can cut rates with unemployment at 3.7%? This never happened in recent times; in 1999 the US Central Bank was hiking, not easing as people expect it to do now. Esteemed Goldman Sachs Strategist David Kostin has been calling for a rotation to the names/sectors left behind so far, and this is more likely to happen if the US Economy is strong. Next week reporting in the US will continue, albeit without any very big/significant names, but it will be good to get a feeling about what’s going on for the 493 companies in the S&P 500 who are not a part of the Magnificent 7. Earnings are good and improving, and no longer projected to have negative growth in 4Q23, but the positive trend must continue to counter expensive valuations. 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). 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. Meanwhile, it is fine to be long equities, although I would lighten up a bit at this point (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 January Fed meeting is now behind us. More eventful was Governor Powell’s ’60 Minutes’ interview in which he played down the perspectives for easing, saying that the Fed will be very careful in reducing rates (= they will take their time). According to the CME FedWatch Tool March is a non-event as well – with chances of the US Central Bank easing currently reduced to barely 14.5%. The real call now is in May, and while chances of a 25bp ease are still dominating at 63.8%, I believe we haven’t seen the whole story yet. So while before I preferred May over March, now I believe the first cut might happen in June (or later), although I would be delighted to be proven wrong. 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, although I would avoid Meta after its huge jump to find a better entry point).
* The impact of the very strong payroll number was felt mostly on 10-year Treasuries, with yields now firmly above 4% once again. While in 1999 yields were even higher, and the Fed was hiking not easing (well they haven’t started yet), we definitely need yields to return below 4% to have a more constructive scenario. Earnings for 4Q23 are currently estimated at 1.6%, from -1.4% (!) last week, and last week showed that most of corporate America is indeed doing just fine. The current forward P/E ratio for the S&P 500 is 20x – 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). Introducing a 2024 S&P 500 bottom-up earnings estimate of 242.65, which is not too far from the top-down consensus of 245 (Goldman Sachs 237, Morgan Stanley 229, J.P. Morgan 225, Bank of America 235). For reference, the current 2025 S&P 500 bottom-up earnings estimate is 274.41.
* Growth is still plentiful according to Atlanta and New York Federal Reserve Banks. Looking at 1Q24, the former’s GDPNow model is forecasting growth of 4.2%, revised up from last week’s 3%, with the Blue Chips consensus around 1.5%. The latter’s Nowcast, which produces an annual forecast that is less volatile, also saw a big jump last week and now sees annual growth at 3.31%, up 0.51% from last week, and 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 1.6% in 4Q23, revised upwards from -1.4% last week, and compared with an estimate of 1.5% as of Dec 31st. Revenue growth is faring better, at 3.5% in 4Q23, vs 3.1% as of Dec 31st. For 2023, earnings growth is forecasted at 0.7%, vs 0.9% as of Dec 31st, with revenues coming in at 2.4%, vs 2.3% as of Dec 31st. 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 70.36%, 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. However, geopolitics and rates are likely to obscure everything for a while. Hang tight!
Earnings, What’s Next?
The reporting season – with 46% of S&P 500 companies having reported – is about to enter another very busy week.
Source: Earnings Whispers
Revenue growth estimates for 2024 are forecasted to grow by 5.4% (5.5% on Dec 31st) and earnings growth estimates for 2024 are predicted to grow by 11.2% (11.7% on Dec 31st), so the future looks bright. Introducing estimates for 2025, which sound again very positive, with revenue to grow by 5.7% (5.6% on Dec 31st) and earnings to grow by 9.5% (9.2% on Dec 31st). 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 May or June. 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 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 been a big spender of late.
The highlight this week is about the amazing earnings growth turnaround, which is nothing short of impressive although growth rates have fallen meaningfully from 8% at the start of the forecast. It shows that the strength of the US Economy is here to stay, and people should focus more on earnings and less on rate cuts in building their investment scenarios.
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 globalization).
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 made a remarkable comeback after a slow start, and Japan (minus the JPY) stole 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 Nikkei 225’s performance is based on solid fundamentals as Nominal GDP has stormed past resistance to new highs. 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.
Finally, I wanted to introduce two portfolios that Tom and I have published on Wikifolio. Tom’s a multi-asset portfolio, whereas the one I manage (with substantial input from Tom) is a global income and growth with a heavy US tilt. Check them out!
Happy trading and see you next week!
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