March 25, 2024
Inflation data was once again hotter than expected in February with CPI, PPI, and import prices all accelerating. Fed Chairman Jay Powell, at his post-FOMC press conference, cautioned against quickly dismissing data that does not support one’s view, but then did just that by saying January and February’s hotter inflation numbers were likely a result of seasonal factors that didn’t dissuade him from his view that prices remain in a disinflationary trend towards 2% with some “bumps” along the way. At least he didn’t call it “transitory”!
The financial markets interpreted the FOMC statement, updated Summary of Economic Projections, and Powell’s comments as affirmation that they are still planning to move ahead with rate cuts beginning as soon as their June meeting. Markets are naturally euphoric about the idea of a strong economy and labor market, double-digit S&P 500 profit growth, AND the Federal Reserve beginning to ease at the same time. We continue to believe investors are likely to get one or the other this year – either double-digit profit growth or rate cuts. It is doubtful they’ll get both.
Macroeconomic data otherwise remains mixed, with some evidence of slowing activity at the same time the housing market appears to be strengthening while evidence of a deterioration in the labor market remains elusive. Outside of outright job losses, consumer headwinds continue to mount, such as slowing wages, diminished savings, and rising interest payments and gas prices.
2024 S&P 500 earnings estimates edged slightly lower over the past two weeks, but still project low double-digit year-over-year growth (with similar expectations for 2025). We continue to expect growth and inflation to moderate further, putting consensus estimates at risk.
The strong outperformance by the “Magnificent Seven” versus the broader market over the past year has been justified by strong profit growth outperformance. However, that profit outperformance appears poised to change as growth for the “Mag 7” moderates at the same time growth for everything else accelerates. This dynamic could present a catalyst for a catch-up trade by the rest of the market.
With the S&P 500 extended and overbought (especially for mega-cap technology stocks), valuation at 21x next twelve months earnings (equating to a historically low 70 bps equity risk premium), our proprietary price-to-present value estimate at a historically elevated 132%, and Investor Intelligence bulls now in excess of 60% (historically, a threshold that portends caution), we believe the preconditions are in place for a 5-10% correction at any time. More than that would likely require a recession-induced decline in corporate profits, and we simply do not have enough evidence to support that imminently.