Giorgio "Joe" Vintani
Equities on the sidelines, rates mostly down, and bonds mostly up. Rotation in place with value trumping growth last week. Increasing evidence that the Fed is almost done and fears about a recession abound. Stay the course (long) on (US) Equities, neutral on Bonds, and watch the upcoming data (CPI, PPI) carefully.
Major market events 10th April - 14th April 2023
Highlights for the week
Mon: Easter Monday, US Markets Open.
Tue: CN CPI, CN PPI.
Wed: US CPI, Bank of Canada Interest Rate Decision, FOMC Meeting Minutes.
Thu: UK GDP, German CPI, US PPI, US Initial Jobless Claims.
Fri: CH PPI, US Retail Sales.
Euro Stoxx 50
Nikkei 225: April 7th
A week on the standstill for equities, rates mostly down and bonds mostly up, with three indicators (Jobless Claims, JOLTS Job Openings, ADP Payrolls) signalling weakness and increasing worries about an upcoming recession. Meanwhile 4Q22 US GDP Growth was 2.6%
Value managed to recover some ground over equities in the past week, with the Dow Jones outperforming both the S&P 500 and the Nadsaq. Without a clear leadership, equities coild only go down. So far the Nasdaq 100 is well clear of its previous top on Feb 2 (12,803.14), but more caution should be exercised should it fall below that level (a chance of a double top).
The never ending discussion on rates continues, with some people speculating that the Fed might be done, as much as I don't think so. But in the process of a transition from a monetary risk to a market risk, people have been focusing on the job market lately with a sense of increased worry, as its recent weakness portends the upcoming recession most see in 2H23. Luckily, the NFP was low enough at 236K to be below consensus (239K) but high enough in order not to factor an immediate deterioration of the economy.
The inverted curve does not bode well for the economy. Economic surprise index are taking a hit. Credit, too, seems to be forecasting a recession.
In a macro risk environment, one of the most crucial aspects is earnings, which could be under pressure. There is increasing evidence that earnings do not survive a recession (unscathed). 1Q23 should be the low point for growth, and then there should be a rebound for the rest of the year - only possible if no recession does materialize.
1Q23 earnings reports will start in earnest on Friday with the big banks, always the first to report in a 'traditional' quarter (ending in March). We shall see as we go.
Checking up on the economy: the good
The 'good' points to more sustained growth and no recession, albeit at the cost of higher rates (the 'higher for longer' moniker that is soon becoming a mantra). There does seem to be a change in the narrative though, at least according to what is being priced by the market, with rates becoming less of a concern and the economy's performance becoming more of a concern. On that note, we have an update from Atlanta Fed on its GDPNow real GDP Estimate for 1Q23, lately at 1.5%, revised downwards from 2.5% - which would be a positive result. It is worth noticing that the Blue Chip Consensus also reported here, has trickled up to a level of almost 1%. There is still some distance between the two but the direction seems the same.
Source: Blue Chip Economic Indicators and Blue Chip Financial Forecasts
Another positive indicator is the reach of peak unemployment, currently 3.5% in the US. This takes into account a very strong growth in the economy which is likely to continue.
Source: BofA Research Investment Committee, Global Financial Data, Bloomberg, Haver, NBER
Last but not least, another positive aspect is that the Fed might be either done with hikes, or be very close to the top in rates, according to the below chart that shows what is priced in the market.
Source: The Daily Shot
Checking up on the economy: the bad
Let's start with this chart with a very useful reminder: earnings do not survive recessions. So we absolutely must avoid one if we are to thrive. The pressure on earnings is one of the most concerning aspects to consider, along with an Equity Research Premium well away from its usual standard. The chart below shows that we might be on track for a significant reduction in earnings in 2H23; that would be the Morgan Stanley's scenario, whose predictions for top-down earnings stand at $195, 13% below last year's.
Source: BofA Global Investment Strategy, Bloomberg, Refinitiv Datastream
And the likelihood of getting an earnings recession - calculated from the credit managers index and the ISM - looks very much on the cards. Earnings have fallen, but they have further to go.
Source: BofA Research Investment Committee, Refinitiv, Bloomberg
And we have to consider the US 2yr Government Bond Yield and how its yield crumbled last week after each of the three important economic indicators were showing a softer activity. The Citi Economic Surprise Index took a beating as well. We will see next week if there will be a rebalancing following a more encouraging (=less recessional) NFP.
Source: The Daily Shot
Checking up on the economy: the ugly
According to the below chart, it looks we have some hard times in front of us if the recession does indeed materialize. One of the biggest questions concerns the EPS trough - which should happen with 1Q23. But will the economy find some strenght in order to climb out from the (earnings) hole it has fallen into? After getting to the top in rates, that will be one of the major questions to face.
Source: BofA Research Investment Committee, Global Financial Data, Bloomberg
Source: Goldman Sachs Global Investment Research
Unfortunately, there is evidence that rate cuts do not benefit much the S&P 500, as significant drawdowns have occurred over time when the Fed was cutting. The other issue is that the market does see 84 bps of cuts before the Fed meeting on 31 January 2024, while Governor Powell has said time and again that he does not see rate cuts this year. In the end, that might even benefit the stock market.
Source: Real Investment Advice
Adding to worries, it looks as though some of the more recent rounds of layoffs have been promted by lack of demand, rather than by cost cutting initiatives (which often go in synch). This is not a positive sign and one which could indeed lead to a recession in the back half of the year.
Source: LPL Research, Challenger, Gray & Christmas
Finally, the leadership has been so narrow that has almost been restricted to a very select number of US Stocks. This will definitely have to broaden if the market is go to meaningfully higher. A leadership is important, but no company is able to outperform the market all the time.
Source: Truist IAG, FactSet
Sentiment and what the market is telling us
The Fear and Greed Index has improved from Neutral to Greed, ending the week with a reading of 57, revised upwards from last week's reading of 49. It seems to lift in synch with the market's recent upward moves.
Source: CNN Business
A slightly different picture is offered by the AAII Sentiment Survey, which for me is a lagging indicator. Bulls have finally increased, and Bears have decreased meaningfully this time. The balance of control is very much in neutral position at the moment, with the two sides tugging in order to get the upper hand.
Source: AAII Sentiment Survey
What are the Flows telling us?
While cash is still strong in an environment that pays some great nominal rates, it looks as though some investors are taking notice at equities' performance this year, with some 37% planning to increase equity exposure during the course of the year.
Source: J.P. Morgan
The latest report available is still that of March 31st so this section hasn't been updated this week.
The forward 12-month P/E ratio for the S&P 500 is 17.8x, up from last week's reading of 17.1x, which is below the 5-year average at 18.5x but above the 10-year average at 17.3x. Reporting for 2022 is now complete, and we are looking forward to 2023. The present, bottom-up level ($221.5) is beginning to slip from Goldman Sachs' top-down $224 forecast. As we have been going down steadily for a while, I just wonder if at some point down the year the US Corporates will find in them what it takes to reverse this trend, as forecasted to happen in the back half of the year.
For 1Q23 the forecasted EPS decline for the S&P500 on aggregate is -6.6%. If correct, it will mark the biggest decline since 2Q20, when such a decline was -31.8%. The revision to 1Q23 earnings growth has been brutal as it was only -0.3% on Dec 31. Despite the concern about a possible recession next year, analysts still forecast a positive growth in earnings for the overall market in CY 2023 of 1.5% year on year, revised downwards from 1.9% last week, versus 4.5% on Dec 31, while revenue is forecasted to grow by 2.0% vs 3.2% on Dec 31. The cuts on the S&P 500's earnings growth are getting significant: earnings growth has been reduced to a third of what it was just 12 weeks ago. Ouch!
Very few sectors are holding up estimates relative to 31 December. The only sector not to have its estimates cut further is Utilities and - perhaps surprisingly - Communication Services; all the others are facing cuts. After a few disappointing earnings reports Technology has seen its earnings estimates reduced to -0.5% from 2.6% a little more than three months ago.
The S&P 500 has its revenue growth estimates stable from last week at 2.1%. Financials are still leading the pack in terms of revenue forecasts, but the only sectors with higher revenue growth than on 31 Dec 22 are Real Estate and Consumer Staples, with all others being down. Information Technology revenue growth has been cut to 1.9% from 3.7% two months ago. The sector seems to be doing better on the top than on the bottom line, perhaps signaling the reason for some of the layoffs; Meta has continued with another round of 'thousands' after the reductions in November.
Let's take a look at EPS for 2023 and 2024, which last week has the first upward revision in quite a while. The forecast for 2023 has now been updated to $221.50 from last week's reading of $222.75; while 2024 is currently forecasted to be $248.16, compared to last week's reading of 248.74. I look with much interest at further revisions as the 1Q23 report season gets underway in April.
This is the detail for 1Q23. While the market might be more concerned about rates and recession than earnings at this point, the latter's deterioration is continuing to get me worried as the downward revisions have been relentless and guidance very muted. It seems almost a miracle that the market managed to stay afloat with these shrinking earnings. 4Q22 is over, but 1Q23 looks to start much in the same fashion, with a significant earnings decline. April will see the beginning of the reporting for 1Q23, and I will be looking at it with much interest.
Earnings, What's Next?
The earnings season is now entering its early 1Q23 reports. Here's a list of companies reporting this week. Highlights include: LVMH (Wednesday, Before Open), Delta (Thursday, Before Open), J.P. Morgan Chase (Friday, Before Open), Citigroup (Friday, Before Open), Blackrock (Friday, Before Open), and Unitedhealth (Friday, Before Open).
Source: Earnings Whispers
Revenue growth estimates for 2024 are forecasted to grow by 5.0% (4.6% on Dec 31st) and earnings growth estimates for 2024 are predicted to grow by 12.1% (10.2% on Dec 31st), so the future looks to be bright. While we continue to debate whether the US economy will fall into a recession or not and what will be the peak rates for Fed Funds, we should take note that almost every strategy has seen a more defensive positioning in the last month.
We are probably shifting from a monetary risk to a macro risk, where the performance of the economy is more important than what the Fed does. We should be mindful that the economy is probably just doing ok, even though passing the peak in rates will remove the overhang present on the market. If and when rates will diminish in importance, earnings (and top-line growth) will hopefully pick up their pace.
The Nasdaq has been able to climb above its peak of 12,803.14 on 2nd February, and now it's time for the S&P 500 to follow through (its peak is 4,179.76 on the same day). Tactically continue to suggest staying long on (US) Equities, keeping in mind the S&P 500's 5th January bottom of 3,808.10 as a level which - if broken - would prompt me to cover the trade. Either the S&P will be able to climb above its previous peak, which would open a new leg up for equities and for the market, or it doesn't, and we fall in double top territory with the markets possibly revisiting their recent lows. European Equities seem to be ok, too - avoid the UK as it is a chronic underperformer. Regarding bonds, the trajectory is that yields will eventually fall, albeit with a few bumps on the road. As we are still gathering data in that respect I prefer to stay on the sidelines for the time being, looking at the next Fed Minutes to see if they report a change in the committee's stance (I think it's too early for that).
For the less volatility prone of you, it may make sense to take all opportunities to alter the weights of your asset allocation by increasing the weights of safety assets at the expense of more risky assets by lightening up in equities and reinvesting in bonds at attractive (approx 4%) yields. For those willing to look besides US treasuries, investment grade bonds (LQD ETF) could also be a valid compromise: 1.2% pickup over government bonds for the safest part of the credit complex may still be compelling. 10-Year yields were turbulent last week, both in the US and Europe, though the ceiling should be near for both. For those wishing to keep their money in Equities with lower volatility, suggest switching to Japan as the company with the most stable outlook (the country with the more precise picture of rates at the moment) until rate perspectives become clearer in the US and Europe.
Happy trading and see you next week!
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.