Higher-than-expected US CPI and PPI stopped the raging bull. Earnings in 4Q23 continue to rebound, following a very positive 3Q23. Europe outperformed the US on a YTD basis; 10-year Treasuries and other long bonds lost further ground 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. Watch out for interesting EU CPI on Thursday, a possible game-changer. 

Major market events 19th – 23th February 2024 

Highlights for the week

Mon: US Markets Closed (Washington’s Birthday) 

Tue: CN PBOC Loan Prime Rate, CA CPI, JP Trade Balance 

Wed: EU Consumer Confidence, US FOMC Meeting Minutes 

Thu: JP Services PMI, FR Services PMI, DE Services PMI, FR Manufacturing PMI, DE Manufacturing PMI, EU Services PMI, EU Manufacturing PMI, UK Services PMI, UK Manufacturing PMI, EU CPI, US Jobless Claims, US Services PMI, US Manufacturing PMI  

Fri: JP Markets Closed (Emperor’s Birthday), DE GDP

Performance Review

Index	9/2/2024	16/2/2024	WTD	YTD
Dow Jones	38,871.39	38,627.99	-0.11%	2.42%
S&P 500	5,026.61	5,005.57	-0.42%	5.54%
Nasdaq 100	17,962.40	17,685.98	-1.54%	6.91%
Euro Stoxx 50	4,715.87	4,765.65	1.06%	5.60%
Nikkei 225	36,897.42	38,487.24	4.31%	15.62%

Source: Google

InflectionPoint reports:

* Eventually the unstoppable rally had to give – I’m speaking of the US of course – pushed back by ever-rising yields and a ‘negative’ CPI. Inflation is apparently getting its second winds and will be here for a while, which will push a cut in the Fed Funds rate further out. As for the rest, long bonds are down, and we are going back to yields seen last in December, while the US Economy is still powering ahead, albeit a bit more slowly, and while earnings are indeed making their mark, unfortunately, the fat multiple does not retreat. Another busy reporting week with solid earnings, Europe overtook the US on a YTD basis, and Japan was the star of the week, getting closer to both its Feb 9 high (38,865.06), and its Dec 1989 all-time high (39,915.87). Now things get interesting: this week we have the EU CPI on Thursday. I think it is more likely than not that it will be in line (base case) or better. If this does indeed happen, Tom (who is a fixed-income specialist) is right and I am wrong in forecasting that the ECB will cut after the Fed. Of course, one swallow doesn’t make a summer, but it would be a step in the right direction. Inflation in the EU has come down to 2.8% (consensus), and will is still some way to the ECB’s desired measure of close, but below 2%, we are not far off from it. If it happens, it will all likely mean that European markets can outperform US peers while the Fed is still keeping its policy restrictive enough to bring inflation down. Early days still. Japan did surprise once again; it will be important to see when it will test the Feb 9 high and all-time high.  Personally, I would expect the market to take a breather, but … the trend is still your friend. Before I forget, we should wait for the 1,800 pounds gorilla, Nvidia, which reports this week and is known to blow forecasts away. While the stock usually falls even on a good report, it will send a powerful message. 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 20.4x, a recent record.  Still long equities (but it may make sense to take some profits here), if the ECB does eventually cut before the Fed then stay long USD, 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 (now on key support levels against all major currencies). 

* And then – like Terminator – value is back massively – down but not out. Europe not only performed better than the US last week but recovered all the YTD gap and then more. Japan had a staggering performance while losing 3rd place in the largest economies to Germany – the weakness of the JPY will have had a major impact on that. At the same time, valuations seem easier to digest and earnings and GDP growth – fuelled by an ultra-supportive BOJ could well propel the Nikkei 225 and the Topix higher. The US CPI was not a nice surprise and that had its impact on when the Fed might ease – what is now June could become July, or later, if data does not get better. Remember higher for longer? At the same time, the UK was in a recession in 4Q23, and that is putting additional pressure on the BOE ahead of heavily contested general elections likely happening in autumn. 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 while Corporate America continues to surprise on the upside, this is doing very little to moderate the current expensive multiple (even in a down week). 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). 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).

*  We now know that the US CPI (and the US PPI) did disappoint. Other than pushing forward the first cut to a later date (which might well happen in 2H24), it can also reduce the number of cuts to be done in the year. March, once touted as the first possible month for the Fed to ease, according to the CME FedWatch Tool, now is a no-brainer as the chances of a cut are down to just 10%. The real call now is in May, and the CPI changed the perspective as now the likelihood of no change is dominating with a 61.6% probability. My own bet is still in June, in which chances of a cut are a dominant 81.6%, 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). Watch out for the uber-hyped Nvidia, which reports on Wednesday, after the close. 

* Yields on US 10-year Treasuries have now reached 4.28%, 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 3.2%, up from 2.9% last week and from -1.4% (!) three 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 20.4x – and while it is higher both than the 5-year (19.0x) 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 243.29 little changed from 243.42 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 275.35.

* Growth is still plentiful according to Atlanta and New York Federal Reserve Banks, although we had a negative revision from both last week. Looking at 1Q24, the former’s GDPNow model is forecasting growth of 2.9%, revised down from last week’s 3.4%, with the Blue Chips consensus around 1.8%. The latter’s Nowcast, which produces an annual forecast that is less volatile, also saw a trim last week and now sees annual growth at 2.80%, down 0.53% 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 3.2% in 4Q23, revised upwards from 2.9% last week, and compared with an estimate of 1.5% as of Dec 31st.  Revenue growth is faring better, at 4.0% 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 2.4%, 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 (January 2025) 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 79% of S&P 500 companies having reported – is about to enter another very busy week. Highlights include 1,800 pound gorilla Nvidia (usually the top contributor in earnings for the S&P 500) on Wednesday, After Close.

Source: Earnings Whispers

Market Considerations

Source: Goldman Sachs, 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% (11.5% on Dec 31st), so the future looks bright. Introducing estimates for 2025, which sound again very positive, with revenue to grow by 5.8% (5.6% on Dec 31st) and earnings to grow by 13.1% (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, June, or July. 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. Goldman Sachs is more optimistic than consensus (and so far the data has proved them right) on US GDP growth in 2024. I wonder if stronger (top-line) growth will eventually turn out in better earnings (and lower multiples). This shows that the strength of the US Economy is here to stay, and people should focus more on growth and earnings and less on rate cuts in building their investment scenarios. Speaking of Goldman Sachs, I believe it is timely to remember a trade suggested by their esteemed Chief US Equity Strategist David Kostin: a shift from growth stocks to those that have been neglected so fat (essentially a shift out of growth and into value), which is particularly likely to happen in the US Economy is strong (and growth plentiful). 

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). 

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. 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

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.