“Remember, if there is one core teaching at the heart of this philosophy, it’s that we’re not as smart and as wise as we’d like to think we are. If we ever do want to become wise, it comes from the questioning and from humility—not, as many would like to think, from certainty, mistrust, and arrogance.”

Ryan Holiday, Stephen Hanselman – The Daily Stoic

The View from 30,000 feet

As I sat down to write this week’s note, a Bloomberg headline floated across my screen – 60,000 Headlines Show Powell’s Hawkish Pivot Has Just Begun. The article discusses the use of Bloomberg’s proprietary Economics Fed Sentiment Index driven by an AI engine that analyzes news headlines surrounding Fed speaking engagements. What struck me about the headline was the sheer volume of data that market participants are inundated with on a daily basis. With the advent of technology, the capacity to create information has grown exponentially, making it harder and harder to decipher signal from noise. The headline, beginning with “60,000 Headlines” highlights the problem of noise.

This week’s data releases offered a cross current of simultaneous positive news and negative news providing a different example of noise. For example, an unexpected downside surprise in the Q1 GDP release could be contrasted against positive news from internal components of GDP, such as Final Sales to Domestic Purchasers, and positive real-time data such as big upside earnings surprises from Google and Microsoft, as well as the first release of the Atlanta Fed GDPNow model which published the first forecast of Q2 GDP as a jaw dropping 3.9%. The mix of seemingly conflicting data is creating a whipsaw of opinions that is oscillating between good news and bad news, generating a fog of noise.

The lack of clear uniformity in the data pointing to a specific outcome means markets are subject to chop and volatility. For example, last week the S&P 500 was up +2.67%, while the week before it was down -3.05%. The coming week’s Fed meeting and employment report will likely provide some short-term decisiveness, as we get an interpretation of what the Fed sees as signal and noise, combined with the most important component of all when it comes to growth – jobs. We continue to be optimistic about risk asset prices, with an important caveat – as long as the labor market holds up and the level of rates remains contained.

• Early in the week Q1 GDP shocks the markets, which was steadied later in the week by PCE
• Earnings Season Update: Tech juggernauts lead the way
• Economic surprises and inflation surprises trending in opposite directions driving market anxiety
• Focus Point Sector Rotation Update: Oversold mean reversion signals triggered in Tech and Real Estate

Early in the week Q1 GDP shocks the markets, which was steadied later in the week by PCE

• Going into Thursday the markets were feeling confident about the first estimate of Q1 2024 Prior to the report:
  • The most recent Atlanta Fed GDPNow model forecast was 7%.
  • The Bloomberg consensus, which provides estimates from 69 economists and strategists, indicated a range of probable outcomes of 7% to 3.1%, with an average of 2.5%.
• Unfortunately, the data release indicated that the first estimate of Q1 2024 GDP was 6%, below the bottom of the range of Bloomberg estimates. The low GDP number compounded market jitters from PMI data earlier in the week that showed large negative surprises to both Manufacturing and Services PMIs.
• Compounding the problem was an upside surprise in the Quarterly Core PCE Price Index released with the GDP estimate, which served up on a platter the word “stagflation” as the markets were confronted with disappointments in both growth and inflation.
• The news Friday got a little better with only a mild upside surprise to PCE data, that alleviated concerns that inflation was about to reaccelerate, as Core PCE, the Fed’s preferred measure of inflation, continued to chug along at 8% y-o-y.
• By the end of the week a narrative was painted by the markets that market participants would be better to focus on a component of GDP known as Final Sales to Domestic Purchasers, that strips out the volatile import/export and inventory numbers that introduce noise into the headline This number was up 2.9%, which in an of itself should not be taken as any guarantee of economic strength for the remainder of the year. Investors should not be complacent. Two out of six of the of the recessions since 1980 had similar measurements of Final Sales to Domestic Purchasers the quarter before the economy slipped into a recession. That’s not to say a recession is just around the corner but should serve as a reminder that conditions can change quickly, and investors need to be constantly vigilant.

Better served to look at consumption, spending and coincident indicators for forecasting

Earnings Season Update: Tech juggernauts lead the way

Key take-aways from Q1 earning season:

• With almost half the S&P500 having reported, earnings are beating at an above average pace, but sales are beating a below average pace.
• The three strongest sectors in terms of earnings and margin expansion are Comm Services, Tech and Utilities.
• Companies sandbag earnings. In a typical quarter, by the end of the quarter actual earnings reports beat estimated earnings report by 5% to 6%. This quarter, with almost half the earnings in, on average, there has been almost zero movement from expectations at the beginning of the quarter.
• Q1 earnings are being driven by five companies – Meta, Amazon, Google, Microsoft and Nvidia. According to Factset, the total contribution to earnings of the other 495 is -6.0% for the quarter.
• Full year 2024 earnings projections have moved from 8% at the beginning of 2024 to 10.8% as of the end of last week.

Earnings and margin power are concentrated in a select few stocks

Economic surprises and inflation surprises trending in opposite directions driving market anxiety

• At the end of 2023 the Bloomberg Survey of economists, which covers 71 economists, estimated that 2024 GDP would come in at a rate of 1.2% for the calendar year 2024.
  • Fast forward to April and the current Bloomberg Survey of economists estimates that 2024 GDP will be 4%.

• The big jump in economist forecasts took place between December and During that time the Citigroup Economic Surprise Index, which measures consensus estimates for economic data versus actual reported data, jumped from 1.10 to 47.2.
• At the end of 2023 the Bloomberg Survey of economists, which covers 71 economists, estimated that 2024 Core PCE would come in at a rate of 2.5% for the calendar year 2024.
  • Fast forward to April and the current Bloomberg Survey of economists estimates that 2024 Core PCE will be 6%.

• • Move higher in economist forecasts took place over the last month. The Citigroup Inflation Surprise Index, which measures consensus estimates for economic data versus actual reported data, has been trending higher since the end of November 2023.

• Market moves are frequently caused by a mismatch in The big mismatch in expectations in 2024 has been on the growth side, and to a lesser extent surrounding inflation. This trickles through to rate expectations with the consensus view now seeing a Fed asking why they would begin a cutting cycle in the face of accelerating growth and rising inflation?

Inflation data causing a repricing of rate cuts but may not be accounting for falling growth

Focus Point Sector Rotation Update: Oversold mean reversion signals triggered in Tech and Real Estate

• The Focus Point Sector Rotation Model is a combined trend following and mean reversion model that utilizes seven factors to analyze daily price data on sectors to determine the strength of upward trends.
• The markets have had deteriorating upward trends since the beginning of April, with only Consumer Staples and Utilities, two defensive sectors, exhibiting strong upward trends.
• However, two sectors triggered deeply oversold mean reversion signals during the month and have been on a tear higher since triggering signals:
  • On 4/16 Real Estate triggered a mean reversion buy
  • On 4/19 Info Tech triggered a mean reversion buy

Putting it all together

• The past month has been a coming to terms with higher growth estimates combined with persistently strong inflation estimates, which has slashed Fed interest rate cutting The Bloomberg WIRP function, had the high number of rate cuts estimated at 6.7 on 1/12, but has since fallen to 1.3 as of 4/26.
• Indicators of economic growth have been soft since mid-April, and last week’s Q1 GDP also missed on the This combines with what is shaping up to be a soft earnings season, with the majority of upside in earnings projections concentrated in a handful of companies.
• There is a robust fear about the inflationary trends returning, which has been fueled by a series of inflation beats since November.
• The bear case is that higher growth will stoke inflationary pressures and force the Fed to not only back away from cuts but may push them towards hikes.
• When looking at the data, economic estimates have recently missed on the downside. We’re finding it difficult to see a case for an inflationary boom with growth numbers missing and anecdotal information from the labor market showing softness.
• This leads us to conclude that in the near-term softening growth numbers will placate the markets, which should be supportive of risk assets, and fears of a reacceleration in inflation should recede.

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