“Another concept used to cope with uncontrollable events is known as amor fati which is Latin for ‘love of fate’. The exact term can be traced back to the nineteenth-century German philosopher Friedrich Nietzsche who describes it as, ‘My formula for greatness in a human being is amor fati: that one wants nothing to be different, not forward, not backward, not in all eternity. Not merely bear what is necessary, still less conceal it … but love it.’”
The Art of Resilience
The View from 30,000 feet
Last week was Super Bowl week for economists, with fresh guidance from the Fed, ECB, BoJ, as well as data releases on GDP and inflation. The economic data fireworks show was set against a busy week of earnings data, which acted as garnishes to the main course of economic data. The Fed was the first dish served, which could aptly be described as a nothing-burger, served with a side of data dependency. The ECB followed suit with a similar message, but against and wildly different economic backdrop for the Eurozone, which suffers from similar inflationary concerns, but a dramatically different growth landscape. As expected, the BoJ, provided hints that the days of yield curve control pinned at the zero-bound are numbered, setting the stage for the largest change in Japanese markets in three decades. Meanwhile, the news was filled with daily speculations that China would act more decisively to head off deflationary pressures threatening to push the country’s economy into a cold dark economic winter.
- The Focus Point Leading Market Indicator continues to trend higher, moving further into Neutral Conditions
- Better than expected inflation and growth data, and a Fed that is getting everything they want for the moment
- Earnings Season – Steady as she goes
- The most Frequently Asked Question from clients this week: What keeps you up at night?
The Focus Point Leading Market Indicator trends higher, moving further into Neutral Conditions
- The Focus Point Leading Market Indicator continue the recent trend higher, with positive changes in the following indicators within the model:
- Financial Conditions
- Margin Debt
- University of Michigan Consumer Sentiment
- However, not all the news was good. Indicators within the model that turned negative included:
• Earnings Momentum
• Consumers and business are feeling better about the economy and the prospects of vanquishing inflation. Better attitudes matched with falling volatility is a formula for institutional investors to leverage the portfolios and is adding to net flows into risk assets. Stronger than expected economy paired with disinflationary data and more accommodative Fed is creating a continued runway risk assets to rally. Investors should be careful not to become complacent, with the Fed fixated on data dependency, the markets are only one or two data prints away from a different environment.
The accumulation of economic strength signaling growing stability for the rally in risk assets
Better than expected inflation and growth data, and a Fed that is getting everything they want
- Wouldn’t it be nice to get everything you want for your birthday? Jerome Powell’s birthday is February 4th and his birthday wish was for lower inflation and better economic growth. All his birthday wishes have come true.
- The drivers impacting the markets in 2023 include:
- Labor market strength and wage increases boosting spending
- Pandemic related cash balances fortifying consumers and company increased spending
- Consistent dissipation of headline inflationary pressures due to falling commodity costs and goods demand normalizing
- Less hawkish monetary policy as central banks around the world approached the terminal level of rates
- Corporate earnings holding up better than expected due to nominal spending and pricing power
- The housing markets showing signs of resiliency despite crippling affordability
- A frenzy around AI stocks reminiscent of the dotcom boom and FOMO as a driver of retail buying and institutional catch up
The first reading on Q2 GDP supported the picture of better growth, with the GDP accelerating from 2.0% to 2.4% in Q2, surprising against an expectation for GDP to fall to 1.8%. Durable Goods Orders similarly surprised, jumping 4.7%, compared to an expectation of 1.3%. While Personal Spending, also came in above expectations, with revisions higher to prior numbers.
PCE printed 3.0%, the lowest level since March of 2021. Core PCI, which is less heavily impacted by the 30% fall in oil prices in the last year, came in at 4.1%, below expectations of 4.2%. The Fed’s highlighted Super Core (Services Less Housing), continued a trend lower to 4.1% as well.
Life is good for Jay until this trend is interrupted
Earnings Season – Steady as she goes
- With 51% of the S&P500 having reported earnings some key figures:
- 80% of the S&P500 have reported positive EPS surprises with earnings surprises are above the respective 5 and 10-year averages of 77% and 73%. At the sector level, Information Technology and Communication Services have been particularly strong with over 90% of the companies in each sector beating EPS projections.
- The Consumer Discretionary sector is reporting the highest year over year earnings growth, with an annual increase of 36.1%, and Energy reporting the lowest year over year earning growth with an annual decrease of -52.0%.
- Overall, companies have reported earnings that are 5.9% above estimates, which compares to respective 5 and 10-year averages of 8.4% and 6.4%.
- Companies that have beat earnings estimates are not being rewarded this quarter, with the average gain from two days before to two days after reporting earnings, of companies who beat earnings estimates to be -0.2%.
- Current blended year-over-year S&P500 earnings are expected to be -7.3%, which is slightly lower than the beginning of earnings season, June 30, when the expectation was -7.0%. Much of the lower revision has been driven by Merck having their earnings estimates lowered due to a charge related to their Prometheus acquisition.
- The 12-month Forward Price-to-Earnings Ratio is 19.4x, which compares to respective 5 and 10-year averages of 18.6x and 17.4x. Source: Factset
- Bottom Line
- There is a broader range of companies beating earnings estimates by a lower-than-average amount. This is a good sign for a breadth, but a sign that expectations are coming more in line with company performance than in the recent past.
- The markets are expensive versus historical comparison, but investors should be careful to consider that high valuations have little relationship to near-term performance other than acting as a momentum indicator, meaning high valuations, tend to beget high valuations in the short-term.
- Analysts are projecting earnings to grow 12.6% in 2024, which is significantly above the long-term average of 6% to 8%.
- Investors should be wary of 2024 expectations, when paired with restrictive Fed policy targeting below potential growth.
Uneven sector surprises drive strength with valuations particularly elevated in Technology
FAQ: What keeps you up at night?
- As Powell alluded to in last week’s pressor, the disinflationary / growth story (immaculate disinflation) is largely tied to three drivers the Fed has little control over:
- Commodity Prices
- Supply Chains
- Government Sponsored Pandemic Savings
- Much of the juice has been squeezed out of these drivers.
- Commodity appear to have bottomed and have begun moving higher, with oil up over 20% from it’s lows in June.
- According to the Fed’s measure of supply chains (Federal Reserve Bank of New York Supply Chain Stress Indicator), friction in supplychannels is now lower than before the pandemic.
- According to the Federal Reserve Bank of San Francisco, of the $2.1t in pandemic savings created by government programs, as of Maythere was about $500b left. However, the two lowest groups in income distributions groups have had nearly all their savings return to normal.
- The facets of the economy that are supposed to be impacted by higher rates (housing and manufacturing) are showing signs of resilience, which means if the Fed is looking to impact the economy with their tools, they may need to be more aggressive.
- There is a disconnect between market expectations for higher growth and lower rates. If growth continues to surprise on the upside the logical conclusion would be higher rates, not lower rates. This creates a – good news is bad news – dynamic, that has yet to be reflected in risk asset prices.
Much of the Fed’s success in fighting inflation is tied to two drivers with little potential for more help
Putting it all together
- The recent resurgence in economic momentum and sentiment reduces the probability of a recession in the next two quarters.
- However, investors would be wise to not go all in on the “immaculate disinflationary” story (lower inflation and continued strong employment) and should consider assigning some of the probability of outcomes to a resurgence of inflation tied to factors out of the Fed’s control.
- Forced to confront the continual fall in inflation, paired with better-than-expected economic data and a strong equity market, the bears have shifted their narrative that the downturn is still coming but will now be postponed to 2024. This does not match earnings expectations for 2024, which are projected to grow at near 2x the historic average in 2024.
- Fear of the bearish proclamations of the past six months is keeping many investors sidelined. In fact, JPMorgan’s Institutional Survey found that 63% of institutional investors still have equity position expressed for a bearish outcome.
- The dynamic of underinvested institutions not fearful of a downturn in the near-term, playing catch up in a low volatility environment, creates a situation where pullbacks will likely be met with buying, putting a floor under selloffs.
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