Giorgio "Joe" Vintani
Equities on the sidelines, rates up, and bonds down. First results for 1Q23 from US Banks were very good. US CPI and PPI better than expected, still worries about the Fed's hikes continue to persist. Japan star of the week after Warren Buffet's positive recommendation. Continue to be moderately positive on (US) Equities (but watch out for stops!) and neutral on Bonds.
Major market events 17th April - 21th April 2023
Highlights for the week
Mon: NY Empire State Manufacturing Index.
Tue: CN Industrial Production, CN GDP.
Wed: EU CPI, US Beige Book.
Thu: German PPI, US Philly Fed Manufacturing Index, US Initial Jobless Claims.
Fri: German Manufacturing PMI, UK Manufacturing PMI, US Services PMI.
Euro Stoxx 50
I'm travelling this week, and hence the Week Ahead will be a little bit shorter than usual.
A week on the standstill for equities, even though markets were mostly positive. rates up and bonds down. US CPI and PPI both signalling a moderation of inflation, still not enough to quash hawkish expectations about the Fed.
Once again the rotation was in place, with the Dow outperforming both the S&P 500 and the Nasdaq in the past week. The 1Q23 results by the US major banks on Friday were mostly positive, and that was a surprise. The Nasdaq ended the week in the black but it is taking a break as the leader, leaving the market without a clear driver at present.
Technically we are still in limbo: the Nasdaq 100 is well clear of its previous top on Feb 2 (12,803.14), but the S&P 500 hasn't managed to do that yet (4,179.76). On the positive side, if the S&P 500 manages to climb above its previous top, I can see an extension of the current rally; on the negative side, should the Nasdaq 100 fall below its previous top on Feb 2 then much more caution should be exercised (a chance of a double top and of the market re-testing recent lows).
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 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. This week's musings see the market pricing in a 25 bps hike in May, which could be the last; Goldman Sachs has removed a 25 bps hike in June from its forecast.
Although earnings are forecasted to decline in 1Q23, it could be the trough if a recession does not materialise and things could get better from here. It is important to see if bottom-up forecasts for both 2023 and 2024 continue to be cut or, at some point, manage to find their feet.
1Q23 earnings reports will continue this week with some notable companies reporting. Obviously, these reports could tilt the market either way. 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. A study of 16 bear markets in the last 150 years always ended with the market being higher after a while. While this is encouraging, remember J.M. Keynes' old quote 'The market can stay irrational longer than you can stay solvent'.
Source: BofA Research Investment Committee, Global Financial Data
Another positive indicator is the very strong demand from corporates via buybacks. In little more than the first 3 months of the year, we have reached a level which topped the entire last year's demand.
Source: BofA Research Investment Committee, Global Financial Data, Bloomberg, Haver, NBER
Finally, Macro variables point to a decrease in rates' volatility, which would be highly beneficial not just for that market.
Source: Haver Analytics, Consensus Economics, Goldman Sachs, Goldman Sachs GIR
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. And the pressure on the stock market happens during the recession and not in the 12 months before, as shown by the below chart.
Source: BofA Global Research, Global Equity Derivatives Strategy Team
One of the other aspects that I have spoken of at length is the inverted yield curve. When the percentage of inverted curves reaches 100% the recession inevitably follows - and we are getting dangerously close to that. This time is different?
Source: Real Investment Advice
Checking up on the economy: the ugly
We are back with an old 'friend' - the US Debt Ceiling, which could bring (it usually does!) higher volatility in all markets. The main issue is that the solution is political, not market-driven, and it usually brings extensive political brinkmanship. J.P. Morgan's CEO Jamie Dimon has said that as long as he is alive, the US will never default. Join me in wishing him the longest and happiest life ever; as per the debt ceiling, I expect nothing good, considering a split house and previous negotiations. Darkest before dawn.
Source: Bloomberg, Goldman Sachs GIR
Sentiment and what the market is telling us
The Fear and Greed Index is still in Greed territory, ending the week with a reading of 65, revised upwards from last week's reading of 57. It seems to lift in synch with the market's recent upward moves.
Source: CNN Business
What are the Flows telling us?
It should be no surprise that there are positive flows to treasuries, even with a distinct choppiness in performance in the last few weeks. The current yields offered are attractive, and with the peak in rates coming soon, a very strong performance is within its sights.
Source: BofA Global Investment Strategy, EPFR
At the same time, there were notable outflows in tech recently. It looks like investors are fading the rally, as advised by some of the brokers (Bank of America for one). Let's see if 1Q23 earnings can change investors' minds.
Source: BofA Global Investment Strategy, EPFR
The forward 12-month P/E ratio for the S&P 500 is 18.3x, up from last week's reading of 17.8x, 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 ($220.21) 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 -6.5%. If correct, it will mark the biggest decline since 2Q20, when such a decline was -31.6%. The revision to 1Q23 earnings growth, -6.5%, has been positive if compared to 31 Mar's -6.7%, but it is still very early days. 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 0.9% year on year, revised downwards from 1.5% last week, versus 1.4% on Mar 31, while revenue is forecasted to grow by 2.1% vs 3.2% on Dec 31.
With estimates now measured against the forecasts as of Mar 31st, there are very few differences yet. Of note, Information Technology growth is negative -0.4%. We will see if this is confirmed by the upcoming reports.
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. Information Technology revenue growth has been cut to 1.3% from 3.7% three 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.
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 $220.21 from last week's reading of $221.50; while 2024 is currently forecasted to be $246.68, compared to last week's reading of 248.16. I look with much interest at further revisions as the 1Q23 report season gets underway in April.
This is the detail for 2Q23. 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: Bank of America (Tuesday, Before Open), Johnson & Johnson (Tuesday, Before Open), Netflix (Tuesday, After Close), Morgan Stanley (Wednesday, Before Open), Tesla (Wednesday, After Close), IBM (Wednesday, After Close), American Express (Thursday, Before Open), Procter & Gamble (Friday, Before Open).
Source: Earnings Whispers
Revenue growth estimates for 2024 are forecasted to grow by 5.1% (5.1% on Dec 31st) and earnings growth estimates for 2024 are predicted to grow by 12.1% (12.1% on Mar 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). Despite being several pressures against Equities, tactically continue to suggest staying long on (US) Equities, as long as the Nasdaq 100 stays above the Feb 2nd peak. 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.
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. They got a boost given the recent buy recommendation by Warren Buffett, and the oracle is very rarely wrong. So Japanese Equities are now investable regardless of the lower volatility derived by being the only nation in G7 not to raise rates in the current environment.
Happy trading and see you next week!
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