Everyone was a winner last week with the S&P 500 gaining +1.85%, the Nasdaq Composite +1.14%, Russell 2000 +2.21%, MSCI EAFE +1.80%, and Europe +3.43%, while bonds and Emerging Market equities were flat to slightly positive.  Gold rallied +2.7% and silver surged over 6% as confidence grows that a Fed cutting cycle is a matter of when and not if.  These expectations got a bump from weaker economic data last week with a surprising rise in jobless claims and weak readings coming out of the University of Michigan Consumer Sentiment survey.  It’s been a bit of a rollercoaster ride over the last six weeks where the S&P 500 surged over +10% in the first quarter to then endure a nasty 6% correction in April, but has since rallied to be within 1% of its all-time highs. 

Though, I must say that I expect the path to additional gains in the stock market throughout the balance of the year will be more muted and harder to come by.  For starters, valuations remain rich with the S&P 500 trading at a P/E north of 20x. First quarter earnings illustrated how high valuations are acting as a headwind to additional gains.  Even with year-over-year EPS growth looking like it will come in at a two year high of +5.5% for Q1 (estimates were for +3.5% at the end of March), the shares of companies that beat estimates have rallied less than +1.0% while those that missed have declined by nearly -3.0% - classic case of a lot of good news already being in the price.  Not to mention that the aggregate profit picture is heavily skewed by a ridiculous +48% earnings growth out of the “Magnificent 7” while the rest of the index is posting a decline of -2.4%.  While this disparity should shrink in coming quarters (Mag7 EPS growth slows and the other 493 companies see EPS growth accelerate), as an investor you just cannot afford to not have exposure to these high cashflow Tech monopolies.

What has been interesting to observe lately is the dramatic move in the Utilities sector which has rallied nearly +20% in the past three months.  A couple narratives are at play here; 1) catch up trade as utilities had been drastic underperformers, 2) investors weaving utilities in with the A.I. revolution given the power demands required to fulfill it, 3) equity investors gaining confidence that the Fed is done hiking and interest rates are capped going forward, 4) investors are starting to slowly position for recession risks to rise (this is one of the sectors to own in such an environment.  All of these explanations have some plausibility, but the latter seems a bit too early to put on in my opinion with growth (while decelerating) still solid. 

Two other positive tailwinds supporting asset prices at the moment are the Fed and CEO confidence.  First on the Fed, the “Fed Put” is real and its back in play with the futures market having all but priced out any Fed easing this year.  This is a big change from the 6-7 cuts for 2024 being priced in at the start of the year.  It’s impressive that asset markets have digested such a drastic repricing with just a mild 6% correction in the S&P 500.  This gives the Fed a lot of ammunition to ease should growth or the labor market slow dramatically.  Meanwhile you have other central banks around the globe no longer waiting for the Fed to move as the ECB, BoE, and the BoC looking like they will start cutting their policy rates in the next month or two.  This puts a bullseye on the U.S. dollar which looks toppy, but theoretically should strengthen on supportive interest rate differentials.  Nevertheless, I think the bigger theme investors should be focused on as it pertains to the U.S. dollar and U.S. policy (both monetary and fiscal) is that a true Fed pivot and a weaker dollar further fuels a cyclical upturn in the rest of the world which over the last several months has showed signs of getting underway. 

As for CEO confidence, it’s improving and without question stronger profits have something to do with it.  Analysts have been taking up their numbers for Q2 EPS growth to +9.8% from +9.0%, and this represents the first time they have moved profits up instead of down at this point of the reporting cycle (first month of the quarter) since Q4 2021.  Below is an excerpt from an article penned last week in the WSJ by Justin Lahart, Profits Are Booming - and That's Shielding the Economy:

“Among companies in the S&P 500, the term “recession” showed up in just 100 transcripts of earnings calls, investor events and conferences recorded in the first quarter, according to FactSet.  That was down from 302 in the first quarter of 2023, and the fewest in two years.  Survey-based measures of corporate sentiment have picked up. The Business Roundtable’s index of chief executive officers’ economic outlook rose to the highest level in the first quarter since the second quarter of 2022.  Indexes of CEOs’ hiring and capital-spending expectations have gained ground. A survey of chief financial officers conducted by Duke University’s Fuqua School of Business with the Federal Reserve banks of Atlanta and Richmond showed a similar increase in optimism.”

The following chart from Apollo’s Torsten Slok highlights the rebound underway in CEO confidence which is approaching levels it was at before the Fed started its rate hiking cycle. 

It’s worth pointing out that the above chart could double as a chart of the S&P 500 and is yet another example of how financialized the U.S. economy has become.  CEO’s have never been more incentivized to manage their organizations to their stock price than they are today.  Stock price up; roll out the hiring and expansion plans.  Stock price down; roll out the pink slips, efficiency, and cost reduction plans.  You may not like it, and you may not agree with it, but it is the reality we are operating in.

This upcoming week is loaded with U.S. economic data as inflation is sure to take centerstage.  On Tuesday we get PPI for April while Wednesday brings both CPI and retail sales.  Consensus estimates for the CPI print are for +0.4% on the headline and +0.3% for core CPI.  CPI has come in above consensus estimates for five straight months and as a result rate cut expectations have gone from 7 to 1.  Another print above expectations will add fuel to the fire of those in the ‘sticky inflation’ camp and really undermine those in the ‘bumpy but progressing towards target’ camp.  Adding to the intrigue will be Wednesday’s retail sales report where a weak number coupled with a hot CPI print would be a perfect recipe to reinvigorate the 2022 ‘stagflation’ backdrop – yields rise, bonds sell-off, stocks sell-off, commodities are mixed, while the U.S. dollar and gold rally.  I remain in the ‘bumpy but progressing towards target’ camp but have to admit that a sixth straight month of hotter than expected inflation would require a new definition for the word ‘bumpy’ because that looks more like a trend if we’re being honest.   

I’m going to keep this week’s note short and sweet as I really don’t have much to opine on.  What’s most interesting to me at the moment, is the broad weakness we’ve been seeing in the U.S. data over the past month.  Right now, I’m not making too much of it as it’s not enough information to draw much of an inference from. But it’s definitely something to be monitored and should it be repeated next month then we’ll have something to talk about.  Otherwise, I’m firmly back in the ‘indifferent’ camp where stocks look reasonable (some more constructive than others), bonds at current yield levels offer a favorable risk/reward, and money markets yielding near 5% with zero risk is a no-brainer for idle capital.  Gold looks like it’s still in consolidation mode after a big run, but I think there is more upside for it over the next six to twelve months.  And I think foreign equities and commodities are back to being positive diversifiers to a portfolio rather than performance drags which has been the case for the last 18 months coming into the end of January. 

As always, be patient, disciplined, and prudent with how you deploy your capital at this juncture.  I continue to turn over a lot of rocks in my research but have little to show for it in the way of new opportunities that look enticing.  As a result, outside of some tweaks to positions here and there, I find myself doing a lot of nothing, but sitting on my hands. 

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