February 26, 2024

After several months of stronger economic data and cooler inflation, we saw a notable reversal in January with weaker economic readings and hotter inflation.  January retail sales, industrial production, housing starts, and LEIs were all weaker than expected, although severe winter weather likely had an impact, which means February data will carry added significance.  Jobless claims and credit spreads, however, still point to a strong economy.

While goods deflation continues, January’s CPI core services – both housing inflation and services excluding housing – surprisingly reaccelerated.  A case can be made that a combination of base effects, rising gas prices, and continued stubborn housing prices may result in less near-term headway on the prior disinflationary track, which means the “last mile” debate is likely to remain front and center.  Not surprisingly, FOMC minutes from the January meeting showed that members are in no rush to begin cutting rates, thereby forcing investors to reassess both the timing and magnitude of cuts in 2024.  Despite that, the S&P 500 index still rose to new highs, primarily on enthusiasm about AI-driven tech earnings.  The market’s concentrated returns continue for now.

We are now at the tail-end of the fourth quarter earnings season.  We’ve witnessed the typical beats against lowered expectations, resulting in better than expected fourth quarter profit growth.  However, that growth has been primarily concentrated in the big mega cap technology stocks.  We’ve seen very little change to 2024 S&P 500 earnings per share estimates over the past couple of weeks.  2024 profits remain at risk in our view as growth and inflation likely slows.  Investor sentiment remains bullish with bull/bear ratios at historically high levels, and the CBOE Volatility Index (VIX) at less than 14 continues to reflect a high level of investor complacency at a time of elevated geopolitical concerns, questionable leadership, and compromised fiscal health due to large debts and deficits.

Consensus continues to assume a soft landing and rate cuts in 2024.  The S&P 500, now trading at 20.5x next twelve months earnings and reflecting a historically low +50 bps equity risk premium, appears priced for perfection and therefore vulnerable to any bad news on the economic or interest rate front.  In our view market risks remain: (1) full valuations, (2) overly optimistic 2024 earnings per share estimates, (3) rising geopolitical tensions, (4) Presidential Cycle/election uncertainty, and (5) too much investor complacency.