Given the popularity of our weekly Market in Pictures, we thought it made sense to pick out a few and go into more detail with our PMs. In this edition, Dave and John Luke will spend a few minutes on each of the following:
- Earnings Update
- Projected Rate Cuts
- Market Breadth
- Strong Employment
Hope you enjoy, and please send a note to [email protected] if there’s a particular chart/topic you’d like to see covered next month. Time to swing it around!
For those who prefer to read, the transcript:
Derek
Good afternoon. It is actually Friday, February 2nd and we’re going into overtime here. We usually do these right around the end of the month and this week between the Fed meeting and non-farm payrolls, and everything else that was coming out, the QRA, it was just a heavy week of data and it made a lot more sense to just wait and let it all play out. So here we are Friday afternoon. I think these guys are probably brain-dead, as well, like me, but we’ve got a few exciting charts and we figured we’d go through our monthly habit of just going through a couple of charts that have hit our radar that we’ve put out and published and just give a little bit of context to them and where they fit in the market.
I’ve got Dave Wagner, who you all know and love, our equity guy, and John Luke Tyner, our fixed income guy. The opinions expressed during this call are those of the Aptus Capital Advisors Investment Committee and are subject to change without notice. This material is not financial advice or an offer to sell any product. Forward-looking statements are not guaranteed. Aptus reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. More information about Aptus’ investment advisory services can be found in its form ADV part 2, which is available upon requests.
We could do 30 minutes just on this week, but it’s earnings month, end of the year. Earnings always come out a little bit later, I think. Right, Dave? As people are wrapping up their books for the year. Do you want to give us any context? I know we had pretty much a flat year in 2023 with some dispersion, but what are you seeing so far?
Dave
Yeah, a lot of it’s really anecdotal still because we really haven’t seen a huge move in the market. As of the end of the day, February 2nd, the market ended of the day at 4960 and that’s another all time high. I think heading into this year, we stated at the market level that the burden of proof was on the bears actually, that the momentum was gargantuan for the bull, that the burden of proof was on the bears. At least in my mind, looking into a lot of the reports, specifically on the Mag 7, I think the burden of proof actually turned to the bulls.
And on Tuesday we had reports from Microsoft and Google, and those are names that have absolutely run into earnings. I think Google was up almost 30% in the three months preceding their earnings report. And Google had a great report, stock was down 6%. Microsoft, I couldn’t pick apart or show any aspect of the Microsoft report that I didn’t like, and yet the stock was down 2%.
And that’s why I say the burden of proof right now is on the bulls because the majority of the earnings growth, or insulation that we’ve had over the last year, because earnings growth over 2022 for 2023 was flat, but if you actually excluded the Magnificent 7 earnings would have actually contracted by about 11%.
But then, we fast forwarded to Thursday night when we had Meta and Apple and a few others report, and Amazon. And Amazon and Meta were very, very strong. I think Apple was actually pretty poor with everything going on in China and them fighting a war on many different fronts, whether it’s from regulation, market share loss in China from Huawei. Bringing all this together, because obviously the Magnificent 7 is going to be what drives overall earnings as it has for the last few years. Are companies being rewarded for their performance over the last quarter and over the last year?
And I would say, you know what? They’re not being rewarded because they’ve already been rewarded. If you look at the average return of those companies the day following their earnings, if they beat on the top and bottom line, they’re only up about eight tenths of a percent. That’s about half the historical average of 1.5%. So it does seem like a lot of the names on the individual basis are really priced for perfection.
I think I have been a little surprised with the earnings coming out of financials, more specifically, and industrials right now. They’re the ones that are really driving this market, but as we know and as our outlook for the entire year, as long as the propensity of the consumer remains, which we definitely saw that in the retail side in December and in January, it’s really going to be hard to really beat down the earnings expectations heading into 2024. Not from the Magnificent 7, but more so the exuberance and the potential for the remaining 493 really insulating that 10% earnings growth that we’re expected to see for 2024.
So all in all, hasn’t been a terrible earnings report. We were really focusing on this quarter because many companies didn’t get guidance last quarter and they tend not to give guidance in the first quarter of the new year. So we’re smack dab right in Q4, but everything that we’re looking for, management commentary and a lot of recent economic data that the consumer remains really, really strong.
Derek
You know what’s funny, I’m looking at your chart here and I guess you don’t necessarily notice it when it happens slowly, but comparing these earnings expectations from October to now, it looks like technology’s the only one that’s actually held its earnings growth rate, even it’s up a little bit. So pretty much the whole rest of the market has seen, I guess, earnings estimates fall throughout that period. Is that right?
Dave
Yeah, that’s right. On average from I think from the end of Q3 to the end of the year, the average earnings per share expectations for the fourth quarter tends to come down about 3%. The market actually saw degradations of earnings per share during that time period of 6%. So two times greater than what you normally tend to see. But if you aggregate all of the companies that have reported now as of end of today, which is about 70% of the S&P 500, you’ve actually seen holistic overall ETF expectations increase by 5% since its January 1st expectations.
John Luke
Yeah. And just to parlay a little bit, if you think about the companies like a Meta or an Amazon where it’s focused on a lot of advertising revenue, what that tells me with the strong reports is a lot of companies are making investments to increase ad spend, and I think that comes on the back of price increases that we’ve seen where they’re trying to keep that volume, or increase that volume, by more ad spend.
And so I think that a lot of it too for other companies besides technology is generally positive, might not be directly reflected in the numbers today, but if they’re confident in spending on ads to help improve volumes for their products, maybe that has more potential for some broadening in the back half of the year. Not to get ahead of a couple other charts we have.
Derek
Okay. So I mean I guess based on this, I guess technology being the leadership group probably is somewhat warranted. They’ve continued to hold up as far as growth. I was going to say, what do you got from a macro standpoint? A lot of earning season is always micro, what companies, what sectors are doing well, but obviously interest rates have been the driver of a lot these past couple of years and we’ve had kind of a wild week.
John Luke
It’s been pretty choppy to start the year with rates trending up and then the past couple of weeks have been trending lower, but Fed came out on Wednesday generally in line with I think what we had been spouting. There’s just not enough time for enough bad data for the Fed to really cut rates as soon as what markets were expecting and pricing in to some extent. And so, you’ve generally seen with obviously the Fed kept rates at five and a quarter to five and a half, but Chairman Powell pushed back on the thought for March cuts and thought that might be a little bit premature.
And we’ve seen six months of what he referred to as good data, six month annualized inflation is around target, but if you look at one year numbers, it’s still pretty substantially above target. And so, I think really his commentary is to focus on they don’t want to keep rates too high for too long and keep real rates in overly restrictive territory. They probably are getting to a place where they can cut back and level the playing field where you get in an environment where real rates are moving up because inflation is moving down. And so, I think they’re going to have a close eye on that.
Really the biggest question in my mind is if you keep real rates too high, if they don’t cut in time, then you put substantial pressure on the economy to create recession risk. But on the other side of the coin, if they cut too quickly and they ease the economy, they do risk a potential re-ignition of inflation while we’re still above target. I think that’s really one of the biggest fears.
So what we’ve seen is markets basically pricing out the March cut and bumping it into May. So it looks like May’s not a lock for a cut, but it’s certainly more likely to be May than March, in my opinion.
Derek
So just to clarify on this chart, because the font’s kind of small, but now I know where we’re going here. So this isn’t like a progression of interest rates. This is the odds on a 0 to 100 scale, the percentage odds that we were going to see a cut in March and in May and it’s fallen off of a cliff, I guess, the March.
John Luke
Yeah. The red there at the bottom is the March probability for a cut and it’s fallen to 20% or so, and I think it got up as high as 80 or 90% at the beginning of the year. It’s drifted lower in general as we’ve continued to get relatively good data, which I think that’s what Chairman Powell was saying is you haven’t seen a degradation in data. If anything, like you saw ISM manufacturing data come out this week, which is still below 50, but it’s bottoming and arguably inflecting higher. Basically what this graphic is telling you is how aggressive the market’s pricing in these cuts.
Dave
What this chart’s telling me in my mind is that monetary policy just isn’t at equilibrium. And what do I mean by that? I think that’s defined as the Fed behaving in a way that the market expects, as well as the market behaving the exact way the Fed expects. And I think you could get a better monetary policy equilibrium, so more of a confluence of these two lines closer together, when the Fed dot forecast and market expectations converge. And until you have that monetary policy equilibrium, that just tells me that there’s going to be continued volatility in the rate markets.
Because I think a lot of people would probably be asking themselves right now, how are rates? You ended the week here with the tenure at 4.02%, how are rates not much higher, like what they were back in August, September and October of last year? Because we’ve just seen such continued strong macroeconomic data really across the board.
John Luke
Yeah. The 10-year treasury was down 25 basis points coming into today, finished up about 10 basis points higher, so in a week still trending lower with general treasury yields, but man, it’s volatile out there.
Dave
John Luke, if I had to ask you, obviously QRA was out this week, Fed was out this week. From a macroeconomic standpoint, what is one big thing that maybe surprised you this week or you really would just really think this is the thing we need to be focusing on?
John Luke
Yeah, so QRA came out and I think and led to a bit of the rally in rates where the borrowing amount that the treasury is expecting was less than expected. And I think typically in the first quarter they tend to undershoot as far as how much they will actually need to borrow. And if you think about it from a couple perspectives, number one, asset prices were substantially higher last year, so I’m guessing they’re banking on decent tax receipts from that. Some of the policies with corporate income taxes are rolling off, so tax receipts at the corporate level should be higher and then just general tax season.
So I think that that will probably come back out. I know we’ve talked about this a lot, JD’s hammered on it on a number of his notes, but we’ve got 9 trillion rolling off of treasuries that have to be refinanced at higher rates, and you’ve got another 2 trillion plus of likely deficits that have to be financed. And in my opinion, the long end of the curve is just not pricing in that risk. So I think that’s really the biggest thing. It’s just something that doesn’t matter until it does. Kind of like what we saw in October of last year.
Dave
Yeah, I do think ULC and the productivity numbers were swept under the rug and they’re very strong.
John Luke
Yeah.
Dave
We saw unit labor costs substantially come down. Obviously, the wage inflation data today out of the non-farm payrolls fed something a little bit different. But I think the Fed really does focus on the ULC aspect a little bit more. And alongside that ELT report was the productivity numbers. Basically said ULCs were down more than expected and productivity was up. So I think that actually gives them even more firepower really to remain course at the Fed.
John Luke
Yeah, it’s a great point. The real rate question I think is huge. What’s the neutral rate going to be in this cycle? And we really don’t have a great answer on that yet.
Dave
That’s the one question we need an answer to right now, out of any other questions. It’s not, is the consumer going to spend or is it not all the other main things. It’s what is the neutral rate?
I was reading something, John Luke, David Lee with Goldman Sachs came out and said this. Everyone’s talking about we have to keep rate policy where it is until wage inflation comes down. As long as wage inflation continues to remain high spending is going to continue to remain high, always having the overhang of a looming second inflationary run occur. What is the right wage growth number for us to be looking at for the Feds to become more comfortable? And he stated it needs to be historical as ULC growth, which is 1.5%, plus the average inflation number over a longer period of time. So 2, 2 and a half percent, but let’s just call it 2. Let’s just put that rate in the middle. All right, so 1.5 plus the 2.25, you get three spot 7.5%, and yet we’re still seeing wage inflation be 4.5, 4.6% this morning.
So wage inflation still really does have to come down for the Fed to really feel even more comfortable in the last leg of their dual policy to lower rate.
John Luke
Yeah, no, I certainly agree. And the media and the headlines are chock-full of layoffs and data like that, but maybe it’s isolated to some tech parts of the economy, but middle America is the people that are reaping the benefits of that wage growth and continues to show and they’ve got money to spend and they’re spending it.
Derek
It’s funny, Dave, you always joke about how the bond market’s supposed to be the smart guys. It feels like they’ve been continually wrong the past couple of years, other than John Luke who’s been way ahead of the game, but how many times have they been banking on cuts and the cuts just disappear? It seems like the stock market has been a little bit closer to reality.
Dave
Derek, I love that you said that. I was thinking about that this week. My first ever CMB peak appearance with Becky Quick in January 21, I legitimately said, I was like, “I’m just an equity guy, follow what the bond guys are doing because they tend to be more right than wrong.” So I could actually probably put a date on when the equity guys, Derek, became the smartest guys in the room. But that probably comment needs to be lightly said because the smartest guys in the room, obviously from the book, the movie, is not the best ending for that group of people, but chalk it up for the equity guys. I like it.
John Luke
Just ride the wave.
Dave
Momentum.
John Luke
I think that flows perfectly into this one where continue to see the market breadth remain pretty narrow and you’re in an environment where the seven stocks maybe, I guess Tesla lost its seat on the train, but other than that, the Mag 7 and the big growth oriented stocks continue to lead charge forward and it’s been a bit of a surprise that continued. You saw a little glimpse of some narrowness at the end of last year and towards the latter part of Q4, but it seemed to flip right back.
Derek
What’s interesting here with this chart, because we’ve showed this in 38 different ways, the 7 versus 493 and everything else, this one is different because it’s showing the 10 and then the 11 through 50, which are not small caps. That’s a wild divergence between the top 10 and this 11 to 50. Didn’t even happen in the tech bubble. It looks like this is tracked pretty closely all along until these past couple of years. Am I reading that right?
John Luke
Yeah. It’s a large divergence. I saw an article this week that was poking fun at the Treasury versus Apple and basically it was saying that back when rates were at 0, the CFO of Apple was issuing as much 30 and 40 year bond paper as he could at 2 or 3% types of levels and the government was shortening the duration of their issuance. And so, I think it just points to so many of these companies, you look at the GDP of these large companies, they’re as big if not bigger than a lot of the developed countries entire GDPs are. And the financial position of many of these companies just continues to be a shiny spot. It’s hard to poke many holes in them from a financial analysis perspective. Obviously, the multiples are expensive but it seems like the market doesn’t care.
Dave
I think John Luke just threw that fact in there just to get my blood going because he knows those are my favorite types of statistics. Company XYZ has a greater revenue stream and this country’s GDP, like correlation, not causation. I hate those statistics and John Luke knows that.
But to put it to your point, Derek, it’s still the largest 11 through 50th companies. And if you look at the S&P 500, they’re names we all know. It’s going to be like JP Morgan, UNH, Visa, MasterCard, ExxonMobil, Proctor and Gamble, Johnson and Johnson. Very, very, very big companies still and you’re still getting this divergence.
Derek
Yeah, pretty wild. I know you wouldn’t mind seeing that divergence close a little bit, being a small cap guy.
John Luke
We would all like to see that, I think.
Derek
All right. We got a bonus. We’re going overtime on Friday afternoon here.
Dave
OT.
Derek
But it was a wild week, so we’ll go for one more.
John Luke
Yeah, I’ll be quick on this. I think it was worth including in just given what the Fed said earlier this week on wanting to see more data before going ahead with the rate cuts, and then you get a out of the park jobs number beat this morning with over 350,000 jobs added for the month. And I think what that continues to point to is many of the things that we’ve already stated, is for the most part, there’s a lot of good things to look at the economy and see as super positive, as very solid growth continues to happen and I think helps aid asset prices. Because people again have jobs, they have the propensity to spend, you’ve got the unemployment rate at 3.7%, you’ve got housing prices and stock prices at or near all time highs. It’s just hard to see the Fed cutting super aggressive given the backdrop that we’re looking at.
Dave
It was definitely not a report that they wanted to see. They obviously got the report yesterday and that was after their Wednesday meeting, after their Tuesday, Wednesday meeting. The strength continued. That’s all you can say. And I think what I would end here is this statistic here on the labor side, everyone I’ve talked to is just very pessimistic overall on the market. But we know that the market and the economy are two different things. People are more pessimistic on the market solely because the S&P 500 was up 26% last year and everyone’s very optimistic.
But if you look underneath the hood of the economy, it’s strong. It might be decelerating and that’s been the news for quite some time. Everything from a nominal perspective is decelerating, but it’s from substantially higher levels and they’re not even back to historical norms. And not only that, they’re decelerating really, really slowly. And that’s not something that you could say for any other country in the world. If you look at Europe, look at China. China’s back to the pre-stimulus rates right now even after they decreased their Triple R.
The USA has been so much of a healthier position than any other country out there right now that I could find, minus maybe Japan just because they got some pretty good, some positive sentiment, but that doesn’t mean their macroeconomics are strong like ours.
John Luke
Yeah. And to top it all off, Atlanta Fed now cast for real GDP for Q1 bumped up to 4.2%. That’s not low.
Derek
Just in time for the season 11 of Curb. Right? It’s coming up. I think they’re launching this weekend.
Dave
I knew you’d get it.
Derek
All right. Well, I know you guys have conviction in your individual ideas on different businesses and different fixed income opportunities, but I think I’m thankful that at a firm level in both the way you guys implement, probably conviction number one is asset allocation is what matters first. And if you close your eyes and look out 30 years, stocks probably better than bonds. So I think a lot of people have gotten led astray thinking about a lot of this macro stuff, and you guys have done a good job of balancing your opinions and convictions with the knowledge that at the bigger level we got to hit the allocation right.
John Luke
Yep.
Dave
100%.
Derek
So yeah, that’s good. I appreciate you guys making time on Friday afternoon. I know it’s been a long week. Some travel, some more travel coming up next week and a wild week in the market. But we do enjoy, and I know advisors like just seeing what y’all are thinking about. So appreciate it and have yourself a great weekend.
John Luke
Yeah. Thanks, guys.
Dave
God bless, y’all.
Disclosures
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The opinions expressed are those of the Aptus Capital Advisors Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward-looking statements cannot be guaranteed.
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