04/22/2024 Market Strategy
When the Rubber Hits the Road
Unrealistic rate expectations meet reality of sticky inflation
Key Takeaways
- With only 70 or 14% of the firms in the S&P 500 index having reported it’s still too early to make any definitive statements about the season so far. That said, earnings so far are up 9.4% from a year earlier on 4.5% revenue growth; and 80% of firms that have reported so far have beaten expectations.
- Several cyclical sectors including technology, communications and consumer discretionary are showing double digit earnings growth for the sample of companies that have reported.
- Last week’s retail sales report surprised to the upside. Results over the three months of Q1 suggest that consumption expenditures likely drove a solid expansion in the Q1 GDP data due this week.
Stock and bond prices pulled back last week as expectations for rate cuts sooner than later by the Fed that have been held by many market participants were further dashed by economic data and comments from Fed officials that showed inflation remained too sticky to justify rate cuts for now.
In our view last week was not so much a market tantrum as a repricing of risk by those who had bet heavily (and obstinately since the start of the year) that inflation would have fallen sufficiently so that the Fed could pivot its policy.
Equity prices fell stateside and indeed around the world last week as the repricing of risk caused stocks that may have gotten ahead of themselves in the bull run to fall sharply. Bond prices tumbled and yields rose as bond market participants adjusted yields as official rates appear likely to remain high for longer.
The Dow Jones Industrials ended the week essentially flat countering the direction of other major US indices which declined. The S&P 500, the NASDAQ Composite, S&P 400 (mid-caps), the S&P 600 (small-caps) and the Russell 2000 (small-caps) declined on the week ended last Friday by -3.05%, -5.52%, -2.17%, -1.28% and -3.05%, respectively.
While last week’s declines captured headlines a sense of context suggests to us that based on where the aforementioned stock indices had come from since the lows of October last year through the end of last week the recent selling looks more like bears, skeptics and nervous investors taking profits without FOMO (fear of missing out) based on near-term asset class re-repricing on a catalyst that shows inflation is stickier than expected for now.
It’s worth noting that from their respective lows of last October through last Friday’s close: the Dow Jones Industrial Average, The S&P 500, the NASDAQ Composite, S&P 400 (mid-caps), the S&P 600 (smallcaps) and the Russell 2000 (small-caps) were up 17.8%, 20.64%, 20.87%, 17.31% and 20.9%, respectively.
Considering the degree of success the Federal Reserve has had since the inception of the current rate hike cycle in March of 2022 in bringing down inflation from nearly 10% to around a 3% level—as well as the difficulty that Federal Reserve policy makers have had in prior cycles when they’ve had to battle inflation—the effect of the Fed’s current hike cycle regime of 11 hikes and six pauses may yet prove effective.
For all the discomfort and concern higher interest rates have caused since the Fed began raising rates the end of free money has brought about the return of a period in which bond issuers pay for the privilege of borrowing money and bond buyers get something in return in the form of a meaningful coupon offering opportunity for portfolio diversification and current income.
While the cost of borrowing today is much higher than it was just two years ago before the Fed began hiking its benchmark rate, interest rates today appear to be normalizing in a post-GFC (Great Financial Crisis) and post-COVID pandemic landscape to acknowledge the sustainable economic expansion under way.
Earnings Season Continues
This week Q1 earnings season has 159 S&P 500 member companies slated to report results. Among the companies reporting are some of the most widely followed names in information technology, communications services, health care, industrials, financials, consumer discretionary and consumer staples.
So far earnings have been strong with nine sectors having reported showing positive earnings growth and just one sector showing negative earnings growth. One sector, utilities, has yet to report any results. While it’s still too early to predict the outcome of this earnings season—so far so good. (See page 7 of this report for details in our Earnings Scorecard).
The Stateside economic calendar is packed this week with a brace of data tied to home sales, regional manufacturing and services, GDP, Core PCE, durable goods and capital goods.
We remain positive on equities and continue to see fixed income securities as complimentary to stocks in providing portfolio diversification.
Some near-term profit-taking in the day to day action of the market, particularly in growth segments that have had exceptional run-ups since last year into this year, continues to appear to us quite normal. Such activity combined with a process of rebalancing and rotation into other segments of the stock market in our view can be healthy and contribute to the broadening of the markets’ progress from last year through this year.
Near-term volatility could in our view continue to present opportunity for investors to “catch babies that get thrown out with the bath water” in periods of market down drafts as the market digests levels of uncertainty that are not uncommon to times of transition like these and in periods of rising geopolitical risk.
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