“I’m From The Government And I’m Here To Help” …
The S&P 500 advanced 1% last week making it 16 of the past 18 weeks in which it has registered gains. The Nasdaq Composite was up 1.76%, joining the S&P 500 on this torrid ride with both indices making new all-time highs. While market concentration is a concern, there has been a broadening out of the equity market of late with the S&P 500 equal-weighted index flirting with breaking out to new all-time highs. Though it is worth pointing out the breakdown in the share prices of Apple and Alphabet of late. The Mag7 has been downgraded to the Fab4 with Nvidia, Microsoft, Meta, and Amazon the only ones deserving of such prowess. The big winner last week was the Russell 2000 small cap index which surged +3.0% while the Dow finished flat (weighted down by a cyber attack on UNH). The S&P 500 is now up more than +7% on the year and recent price action wreaks of FOMO as lagging investors can no longer stomach the agony of seeing their friends and neighbors counting their stacks.
The earnings picture has helped to support the runup (although I’d argue earnings haven’t kept pace with the advance in price) with over 90% of companies having reported Q4 results and 78% beating estimates. In aggregate Q4 earnings results are on track for +8% year-over-year growth – handsomely outpacing expectations for growth of +1% y/y when the quarter began. Keep in mind those results are now behind us and what lies ahead is more important for the future direction of equity prices. We are already seeing 2024 profit estimates being trimmed, but that is not all that unusual as the Wall St. game of lowering the bar to a level that can be exceeded has become the norm. Stock buybacks have been a major positive contributor from a flow-of-funds perspective as C-suite executives are using retained earnings to buy back stock at a rapid pace. Share buybacks tallied more than $200 billion in Q4 which is up +20% from Q3 and more than +8% above year-ago levels.
The broadening in asset price appreciation hasn’t been relegated to just stocks. Bitcoin has been on a tear and is up 23% over the past seven days. Not to mention its up almost +50% on the year and roughly 5% shy of its all-time high. Without question Bitcoin has stolen some of gold’s luster, but it too is making new all-time highs with the yellow metal pushing above the $2,100/oz level.
Few would have imagined that gold would be performing as well as it has with interest rates and the dollar up for the year and the Fed backing off rate cuts. But here we are, and it makes you wonder if the unsustainable path of government debts and deficits are causing more investors to question how much capital they are willing to park in sovereign debt. I had a discussion with a very sharp client about this last week; Why hold gold with yields on Treasuries and Treasury Inflation Protected Securities (TIPS) at their highest levels in more than a decade? Tim, my answer remains the same, because gold remains one of the best non-correlated asset exposures to both equities and bonds that a client can hold in their portfolio. Furthermore, it’s a viable hedge against fiscal ignorance.
Speaking of fiscal policy, it seems as though investors have become detached from acknowledging the contribution of massive government spending on economic activity. From 2019 to the end of 2023 gross federal debt rose by $12.5 trillion while U.S. GDP rose from $21 trillion to $28 trillion, an increase of $7 trillion. Think about that, a nearly $2 increase in federal debt for every $1 increase in economic output – that’s a negative multiplier if I’ve ever seen one. Nothing new here, but the widening gap is concerning. I know, I know – tell me when it will matter Corey, until then carry on. I’m guilty of this short-sited thinking as well, but it’s this kind of thinking that perpetuates the abuse.
This level of debt growth would have never been possible without the cooperation of the Federal Reserve. Quantitative Easing didn’t exist in the post-WWII era until Bernanke pulled it off the shelf to bail out the financial system in 2008. It started as an emergence measure that took the Fed’s balance sheet from $800 billion pre-GFC to $4.5 trillion by 2014. Then in 2018 Jay Powell began the “tapering” process but that got short-circuited in 2019 with Powell only able to the get the balance down to $3.8 trillion. Then Covid hit and the balance sheet resumed growing and ballooned out to nearly $9 trillion. Today the balance sheet stands at nearly $7.5 trillion – roughly 10x the pre-GFC level. Where would the economy and stock market be without the relentless support from both the fiscal and monetary levels? I guess that’s a question best left for nerdy cocktail parties because it’s hypothetical and not the reality. The reality is that these levers have been proven to be go to support structures for the financial system and economy when policy makers deem them necessary.
Here's a video that gave me a good laugh over the weekend, hopefully it does the same for you: “9-Year-Old Ask’s His Dad What Is Politics”
Shifting gears, what we are seeing playing out in equity markets around the world are a perfect illustration of the Wall St. adage, “the stock market is not the economy”. Germany is in a technical recession and yet the DAX is at an all-time high. Japan’s equity market just took out its highs from 35 years ago and yet its economic data indicates it could be in a technical recession. Canada and the U.K., two other developed economies, remain weak and fighting to remain on the positive side of the growth curve yet their equity markets while not lighting the world on fire continue to hold up well relative to underlying data. I can’t say I have a clear grasp of what is driving this fundamental mismatch to the degree we’re seeing, but my guess is the massive amount of global liquidity sloshing around and passive investing are material contributors.
Similar dynamics are at play in U.S. markets were even a very weak print like we got last week from the ISM manufacturing index slipping to 47.8 in February from 49.1 was treated by investors as good news in that it triggers the possibility of the ‘Fed put’ being back in play. The narrative of U.S. economic resilience remains so entrenched that even when concerning data gets printed the equity market manages to close at new highs. Makes you wonder if we’ve reached the stage of the rally where it doesn’t matter what the economic data does as long as it’s not cratering. Oh well, it will matter when it matters, but that doesn’t mean that investors should stop doing the work on measuring and mapping that data on an ongoing basis.
Afterall, U.S. equities are far from cheap and a forward P/E of 21x does not offer much of a margin of safety if bad news become bad news. At some point, prices will have to pause or give way to allow the “E” to catch up to the “P”. We’re talking about a broad equity market today that trades 5 points higher than the long-term mean of 16x.
Same goes for the corporate bond market with investment grade spreads closing on 90 basis points (have been tighter just 4% of the time in the post GFC era) and high yield spreads down to roughly 320 basis points (tighter just 3% of the time over the past 16 years).
As for U.S. Treasuries it looks as though fixed income investors are now aligned with the Fed’s latest dot-plots of three cuts in 2024. The swaps market has re-priced to a 4.61% year-end funds rate which is 78 basis points below the 1-month T-bill.
As for the week ahead, there is a lot going on with Jay Powell set to deliver his semi-annual testimony to Capital Hill on Wednesday. Also, on Wednesday we get the JOLTS data and the ADP employment report. The ECB is concluding its policy meeting on Thursday where, like the Fed, concerns over the slow progress on disinflation will likely keep them leaning in the hawkish direction for as long as they can hold out. China holds its National People’s Congress this week where they will put out fresh growth targets, and at the end of the week we get the February jobs report where the consensus is looking for +200k in job gains. Such a number will be far too strong for the Fed to do anything but stay on the sidelines and stick to the ‘higher for longer’ script as it pertains to policy rates.
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