The unstoppable bull run in equities continues. CPI on Tuesday might complicate the Fed’s job further after some data signalling strong economic activity. Earnings rebound, following a very positive 3Q23. The S&P 500 and the Nasdaq 100 made further records; 10-year Treasuries and other long bonds lost a little last week as rates nudged higher. 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 10% of invested capital), but hold the bulk of your fire as yields on the 10-year Treasuries get close to 4.50%. 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 12th – 16th February 2024 

Highlights for the week

Mon: IN CPI, JP PPI 

Tue: UK Unemployment Rate, CH CPI, EU ZEW Economic Sentiment, US CPI, US Core CPI 

Wed:  UK CPI, EU GDP, EU Industrial Production, JP GDP

Thu: JP Industrial Production, UK GDP, UK Manufacturing Production, US Retail Sales, US Philly Fed Manufacturing Index, US Industrial Production, US Atlanta Fed GDPNow 

Fri: UK  Retail Sales, FR CPI, US PPI, US Michigan Consumer Sentiment 

Performance Review

Index	2/2/2024	9/2/2024	WTD	YTD
Dow Jones	38,654.42	38,871.39	0.04%	2.54%
S&P 500	4,958.61	5,026.61	1.37%	5.98%
Nasdaq 100	17,642.73	17,962.40	1.81%	8.58%
Euro Stoxx 50	4,654.55	4,715.87	1.32%	4.50%
Nikkei 225	36,158.02	36,897.42	2.04%	10.84%

Source: Google

InflectionPoint reports:

* Nothing changed – the sky’s still the limit (for equities), the US Economy is powering ahead, and while earnings are indeed making their mark, unfortunately, the fat multiple does not retreat. Another busy reporting week propelled markets to new highs (S&P 500 and Nasdaq 100), and the Nikkei is in its best form since 34 years ago and is seen again flirting with 37,000. Forecasters did not quite get that earnings were going to be so powerful, as they were on a wild sheep chase of a recession that – like Godot – never came. Estimates are being smashed, but as these relate to 4Q23, the forward multiples aren’t benefitting yet – we need another quarter of teeth-grinding before we can get a feeling for what 2024 looks like. Some are just wondering if the Magnificent 7 should lose Tesla, given its dismal performance YTD. 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 20.3x, a recent record.  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, and with Japan ruling the markets once again. While all eyes will be on the CPI this Tuesday, few expect further moderation after the blowout Nonfarm Payrolls, and this might well complicate the upcoming interest rate decisions by the Fed. I believe it’s prudent to speculate that unless there is further moderation in inflation in the coming months, the US Central Bank will stick to its guns and remain on hold. The reporting season in the US will continue, and it will be important to see if Corporate America can continue in its stride of beating estimates which it has now done for two quarters in a row: 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). Tom thinks that yields might go up a bit more, but he would be pounding the table once the top has been reached. Probably that means more towards 4.50% than anything else (my own take, not his, for what it’s worth).

*  It is difficult to write about what the Fed might do just ahead of such important data as the CPI. If anything, the US Central Bank will cut interest rates just a little and late, even though Tom acknowledges that it’s a nice tailwind to have (and I obviously agree). At the moment, according to the CME FedWatch Tool the chances of a cut in March are still very slim, having risen to 15.5% from 14.5% last week. The real call now is in May, and while chances of a 25bp ease are still dominating at 57.3%, albeit revised downwards from 63.8% last week, I believe we haven’t seen the whole story yet. My own bet is still in June, in which chances of a cut are a dominant 93.7%, but I would not be shocked if the Executive Committee decided to wait until July. 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, and also Tesla, after its dismal performance this year). 

* Yields on US 10-year Treasuries are hovering around 4.15%, and if anything they tend to go up other than down, bolstering the dollar.  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 2.9%, up from 1.6% last week and from -1.4% (!) two weeks ago, 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 20.3x – and while it is higher both than the 5-year (18.9x) average and the 10-year average (17.7x), 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 243.42 up from 242.65 last week, 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 275.34.

* 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 3.4%, revised up from last week’s 4.2%, 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 3.33%, up 0.02% 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 2.9% in 4Q23, revised upwards from 1.6% last week, and compared with an estimate of 1.5% as of Dec 31st.  Revenue growth is faring better, at 3.9% in 4Q23, vs 3.1% as of Dec 31st. For 2023, earnings growth is forecasted at 0.9%, vs 0.9% as of Dec 31st, with revenues coming in at 2.5%, 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

Market Considerations

Source: BEA, Haver Analytics, Bloomberg, Deutsche Bank, ISABELNET.com

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 10.9% (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 13.0% (12.7% 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 GDP forecasts, particularly near term. Deutsche Bank has raised its estimates for 2024, particularly near term. While it is possible that the S&P 500 might be vulnerable to a correction, as suggested by J.P. Morgan last week, this data is encouraging, and I wonder if stronger (top-line) growth will eventually turn out in better earnings (and lower multiples). I know the market does feel extended, but as Charles Dow said, ‘the trend is your friend’. This 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. 

Portfolios

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!

No changes last week, although Tom is looking for the right moment to trim equities and load up on even very long (30-year) bonds. No changes in the Equity portfolio as well, although we might revisit Shopify after the results. Finally, we have decided to leave out Nvidia, Meta, and Tesla, to better balance the portfolio, while not necessarily being negative on the prospects for these companies.

https://www.wikifolio.com/en/int/w/wf00inf8ig

https://www.wikifolio.com/en/int/w/wf000ipggi

Happy trading and see you next week!

InflectionPoint

Disclaimer

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