April 22, 2024
Stocks have finally succumbed to hotter inflation, higher bond yields, a more cautious Federal Reserve (“Fed”), and rising Middle East tensions. A bout of profit taking in technology stocks on fears that the big AI-driven earnings upside is possibly coming to a premature end, also weighed heavily on the market this past Friday.
Key macro-economic data from the past two weeks continued to signal an economy that is strengthening, highlighted by (a) another month of strong retail sales, (b) rising manufacturing production, and (c) benign jobless claims, which caused the Atlanta Fed’s GDPNow estimate of first quarter real GDP growth to rise from +2.5% to +2.9%. Stronger growth and hotter inflation forced Jay Powell to acknowledge the Fed may need to stay higher for even longer, pushing out rate cut expectations. Powell’s “hawkish reset” may also be an attempt at getting financial conditions to reverse course. Easing financial conditions have been a significant factor contributing to the renewed strength of the economy and higher inflation.
Despite stronger earnings beats in the early innings of 1Q earnings season, 2024 calendar year earnings estimates for the S&P 500 actually edged slightly lower over the past two weeks. We are now heading into the thick of earnings season, including a big week for technology earnings, with likely additional upside surprises. However, we continue to expect growth and inflation to moderate as the year progresses, leading to downward earnings per share revisions, assuming the Fed is successful in tempering animal spirits.
We suggested at the beginning of the quarter that pre-conditions were in place for a 5-10% pullback in the S&P 500. We’ve now hit the low-end of that range, and valuation and sentiment have marginally improved. The S&P 500 now trades at 19.5x next twelve months earnings, down from 21x. The percent bulls in the Investor’s Intelligence weekly survey decreased to 57% from a “euphoric” high 63% reading. Lastly, the CBOE Volatility Index (VIX) jumped to 19 from 13, indicating that some fear is re-entering the market, which is a good thing. Whether we get additional follow-thru to the downside for the market will likely hinge on the strength, or lack thereof, of earnings over the coming weeks, and more importantly, the profit outlook for the rest of the year.