Market Snapshot
briefing.com
| Dow | 34127.25 | +177.89 | (0.52%) | | Nasdaq | 11671.91 | +159.49 | (1.39%) | | SP 500 | 4088.76 | +28.33 | (0.70%) | | 10-yr Note | -24/32 | 3.52 |
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| | NYSE | Adv 1741 | Dec 1235 | Vol 766 mln | | Nasdaq | Adv 2540 | Dec 1942 | Vol 6.2 bln |
Industry Watch
| Strong: Consumer Discretionary, Communication Services, Industrials |
| | Weak: Energy, Health Care, Materials |
Moving the Market
-- Mixed reactions to earnings reports from the likes of American Express (AXP), Visa (V), Intel (INTC), and KLA Corp. (KLAC)
-- Digesting the Personal Income and Spending report, PCE-Price Index and core-PCE Price Index that showed a moderation inflation, but still too high for the Fed's liking
-- Continued rebound effort in the mega cap space
| Closing Summary
27-Jan-23 16:25 ET
Dow +28.67 at 33978.03, Nasdaq +109.30 at 11621.72, S&P +10.13 at 4070.56
[BRIEFING.COM] The stock market closed out the week on an upbeat note, notwithstanding some late day selling that cut into today's gains. Some early weakness was precipitated by an ugly earnings report and outlook from Intel (INTC 28.16, -1.93, -6.4%), disappointing guidance from KLA Corp. (KLAC 399.37, -29.39, -6.9%), an earnings miss by Chevron (CVX 179.45, -8.34, -4.4%), and a Q4 profit warning from Hasbro (HAS 58.61, -5.17, -8.1%).
Nonetheless, buyers again stepped in to buy the dip today supported by a continued rebound effort in the mega cap space. The Vanguard Mega Cap Growth ETF (MGK) closed with a gain of 1.0% versus a 0.2% gain in the Invesco S&P 500 Equal Weight ETF (RSP). The main indices spent most of the afternoon on a steady climb that had the S&P 500 nearly brush up against the 4,100 level.
Encouraging earnings results and/or guidance from the likes of American Express (AXP 172.31, +16.43, +10.5%), Visa (V 231.44, +6.73, +3.0%), and L3Harris Technologies (LHX 212.10, +15.56, +7.9%) helped offset the disappointing corporate news, along with some relatively pleasing inflation data in the December Personal Income and Spending Report.
Briefly, the PCE Price Index was up 0.1% month-over-month (Briefing.com consensus 0.0%) while the core-PCE Price Index, which excludes food and energy, was up 0.3%, as expected. That left the year-over-year changes at 5.0% and 4.4%, respectively, versus 5.5% and 4.7% in November.
Treasury yields initially spiked following the data release, likely driven by the understanding that inflation rates are still too high for the Fed's liking. Yields pulled back, however, to settle off their highs. The 10-yr note yield hit 3.55% shortly after the release, but settled the session at 3.52%. The 2-yr note yield, which is most sensitive to changes in the Fed funds rate, hit 4.24% after the release before pulling back to 4.21%.
Today's rally effort ran out of steam as the main indices took a sharp turn lower with about 15 minutes left in the session. There was no specific news catalyst for the selling. Market participants most likely wanted to take some money off the table following a big run and ahead of a big week of market moving catalyst next week that will include, among other things, the FOMC decision, earnings reports from more mega cap companies, and the January Employment Report.
Roughly half of the 11 S&P 500 sectors logged a gain led by the consumer discretionary (+2.3%) sector. The energy sector (-2.0%) was the worst performer by a wide margin due to falling oil prices and weakness in Chevron. WTI crude oil futures fell 2.0% to $79.45/bbl.
- Nasdaq Composite: +11.0% YTD
- Russell 2000: +8.5% YTD
- S&P Midcap 400: +7.8% YTD
- S&P 500: +6.0% YTD
- Dow Jones Industrial Average: +2.5% YTD
Reviewing today's economic data:
- December Personal Income 0.2% (Briefing.com consensus 0.2%); Prior was revised to 0.3% from 0.4%; December Personal Spending -0.2% (Briefing.com consensus -0.1%); Prior was revised to -0.1% from 0.1%;
- December PCE Prices 0.1% (Briefing.com consensus 0.0%); Prior 0.1%; December PCE Prices - Core 0.3% (Briefing.com consensus 0.3%); Prior 0.2%
- The key takeaway from the report is that it showed a continued moderation of inflation pressures, although the inflation rates are still too high for the Fed's liking -- particularly services inflation which was up 0.5% month-over-month following a 0.3% increase in November -- and will keep the Fed in a vigilant, inflation-fighting mode.
- December Pending Home Sales 2.5% (Briefing.com consensus -1.0%); Prior was revised to -2.6% from -4.0%
- January Univ. of Michigan Consumer Sentiment - Final 64.9 (Briefing.com consensus 64.6); Prior 64.6
- The key takeaway from the report is that consumer sentiment picked up in January on better feelings about personal finances that stemmed from higher incomes and easing inflation, although it is also worth noting that two-thirds of consumers expect an economic downturn during the next year.
GE HealthCare (GEHC) will headline the earnings reports ahead of Monday's open.
There is no U.S. economic data of note on Monday.
S&P 500 pulls back after nearly reaching 4,100
27-Jan-23 15:25 ET
Dow +151.65 at 34101.01, Nasdaq +160.46 at 11672.88, S&P +26.87 at 4087.30
[BRIEFING.COM] The S&P 500 trade just below its high of the day after getting rejected near the 4,100 level.
The 2-yr Treasury note yield rose four basis points today, and one basis point this week, to 4.21%. The 10-yr note yield rose three basis points today, and four basis points this week, to 3.52%.
GE HealthCare (GEHC) will headline the earnings reports ahead of Monday's open.
There is no U.S. economic data of note on Monday.
Energy complex futures fall
27-Jan-23 15:00 ET
Dow +177.89 at 34127.25, Nasdaq +159.49 at 11671.91, S&P +28.33 at 4088.76
[BRIEFING.COM] The S&P 500 is pushing towards the 4,100 level, continuing its rebound into the late afternoon trade.
Market breadth skews decidedly positive. Advancers lead decliners by a 2-to-1 margin at the NYSE and a 3-to-2 margin at the Nasdaq.
Energy complex futures settled the session lower. WTI crude oil futures fell 2.0% to $79.45/bbl and natural gas futures fell 0.3% to $2.84/mmbtu.
On a related note, the S&P 500 energy sector (-1.6%) remains buried in last place by a wide margin, driven lower by Chevron (CVX 180.41, -7.36, -3.9%).
S&P 500 stepping to highs
27-Jan-23 14:30 ET
Dow +132.27 at 34081.63, Nasdaq +145.75 at 11658.17, S&P +22.69 at 4083.12
[BRIEFING.COM] The S&P 500 (+0.56%) is firmly in second place to this point on Friday afternoon, trading now near session highs.
S&P 500 constituents Tesla (TSLA 179.97, +19.70, +12.29%), L3Harris Tech (LHX 211.36, +14.82, +7.54%), and Generac (GNRC 118.60, +5.63, +4.98%) are among today's top performers. TSLA moves higher today despite a dearth of corporate news, while LHX gains after last night's earnings, and GNRC moves higher with a winter storm cruising across the country.
Meanwhile, O'Reilly Auto (ORLY 769.51, -31.12, -3.89%) is among the top five laggards today.
Gold scrapes by with slight weekly gains
27-Jan-23 14:00 ET
Dow +68.09 at 34017.45, Nasdaq +132.92 at 11645.34, S&P +15.26 at 4075.69
[BRIEFING.COM] With about two hours to go on Friday the tech-heavy Nasdaq Composite (+1.15%) holds a commanding lead among the major averages.
Gold futures settled less than $1 lower (flat) to $1,929.40/oz, trimming overnight losses to end the week up just under +0.1%; the yellow metal started the week on a down note, evidenced by the +0.88% weekly finish off Monday morning lows.
Meanwhile, the U.S. Dollar Index is up about +0.1% to $101.98.
Setting up for more chop
This January has been terrific so far for the stock market and it isn't over yet. Entering today, the Nasdaq Composite is up 10.0%, the Russell 2000 is up 8.1%, the S&P Midcap 400 is up 7.4%, and the S&P 500 is up 5.8%. The straggler is the Dow Jones Industrial Average, which is up "only" 2.4%.
These moves have come against a weakening earnings backdrop, something Page One readers have heard us mention all month. Be that as it may, there has been a clear, bullish bias.
The market has wanted to trade higher, clinging to the belief that the economy will achieve a soft landing, the Fed will pause its rate hikes soon, and that the earnings growth deceleration in 2023 won't be as bad as feared.
That thinking has triggered some bargain-hunting interest, a wave of short-covering activity, and even some fear of missing out on a sustained rally effort that has manifested itself in robust gains for the major indices.
It has also raised its share of questions about whether the good times can last. A nagging sense that the market is getting ahead of itself has led to some more choppy trading action of late, but to be fair, most days have settled nonetheless with an upside bias.
We will presumably see more of that chop today. The earnings news since yesterday's close has been mixed at best and the December Personal Income and Spending Report released at 8:30 a.m. ET was also mixed.
In terms of earnings reactions, American Express (AXP), L3Harris Technologies (LHX), and Visa (V) stand out on the good side. They are up 5.3%, 4.1%, and 1.3%, respectively. Intel (INTC), Hasbro (HAS), KLA Corp. (KLAC), and Eastman Chemical (EMN) stand out on the bad side. They are down 9.9%, 6.0%, 4.7%, and 3.0%, respectively.
Hasbro for its part didn't report earnings. Instead, it issued a Q4 EPS warning that it attributed to a challenging holiday consumer environment and also announced a plan to cut approximately 15% of its global workforce.
Last week's Retail Sales Report made it clear that retail spending was weak in December and the same was seen in the December Personal Income and Spending Report today.
Briefly, personal income was up 0.2% month-over-month, as expected, and personal spending was down 0.2% month-over-month (Briefing.com consensus -0.1%) following a downwardly revised 0.1% decline (from +0.1%) in November. Real personal spending declined 0.3% month-over-month in December.
The PCE Price Index was up 0.1% month-over-month (Briefing.com consensus 0.0%) and the core-PCE Price Index, which excludes food and energy, was up 0.3%, as expected. That left the year-over-year changes at 5.0% and 4.4%, respectively, versus 5.5% and 4.7% in November.
The key takeaway from the report is that it showed a continued moderation of inflation pressures, although the inflation rates are still too high for the Fed's liking -- particularly services inflation which was up 0.5% month-over-month following a 0.3% increase in November -- and will keep the Fed in a vigilant, inflation-fighting mode.
Currently, the S&P 500 futures are down 11 points and are trading 0.3% below fair value, the Nasdaq 100 futures are down 60 points and are trading 0.5% below fair value, and the Dow Jones Industrial Average futures are down 11 points and are trading roughly in-line with fair value.
That's a setup for a mixed open, which is fitting for a market that has turned more choppy of late knowing that stock prices have risen as earnings estimates have fallen. In other words, the market's technical posture has been straighter than its fundamental posture.
-- Patrick J. O'Hare, Briefing.com
American Express misses Q4 estimates, but dividend hike and upside outlook provide comfort (AXP)
Despite missing 4Q22 EPS and revenue estimates, credit card company American Express (AXP) is charging higher and is providing the DJIA with a meaningful boost. Participants are looking past the downside results, instead focusing on AXP's bullish FY23 outlook and its sizable 15% quarterly dividend increase to $0.60/share, which pencils out to an annualized yield of about 1.4%. Perhaps most importantly, the enhanced dividend represents a vote of confidence regarding the economy, indicating that AXP isn't anticipating a severe recession this year.
- However, the increased dividend and AXP's upside FY23 EPS and revenue guidance, which calls for top-line growth of 15-17%, doesn't mean that the company only sees clear skies ahead. Like many other financial companies, AXP built up its reserves for credit losses in Q4, partly explaining why it missed EPE estimates. Specifically, reserves for credit losses totaled $492 mln compared to a reserve release of $168 mln in the year-earlier quarter.
- The protective measure to increase reserves comes as AXP's delinquency rate edges higher. In Q4, loans that are 30+ days past due as a percentage of total hit 1.0%, compared to 0.9% last quarter, and 0.7% in the year-earlier quarter. It's important to note that the delinquency rate is still below the 1.5% rate that was seen in the pre-pandemic quarter of 4Q19.
- The other factor that pressured AXP's earnings in Q4 was the 15% yr/yr increase in expenses. While robust travel demand has been a major catalyst for network volume growth (+12% in Q4), it has also driven travel-related benefits higher as customer redeem their rewards.
- Additionally, AXP has ramped up its marketing efforts in support of its strategy to grow its younger customer base. Those investments are paying off, though, with CEO Stephen Squeri noting during the earnings call that Millennial and Gen Z customers continue to be the largest drivers of growth. For some context, Millennials and Gen Z customers accounted for 30% of AXP's total billed business in 4Q22, compared to 20% in 4Q19.
- It's not only younger customers that are boosting their spending on Travel & Entertainment (T&E). The T&E category was up 28% in Q4 and AXP is clearly expecting the spending momentum to continue in FY23. The company's upbeat outlook and upside guidance dovetails with the bullish FY23 forecasts provided by the major airlines.
As layoffs continue to pile up and as corporations pull back on travel spending, there's some concern that travel demand will eventually soften. For the time being, though, AXP and its more affluent customer base are exhibiting resilience in the face of stiff macroeconomic headwinds.
Colgate-Palmolive investors not smiling at its decelerating FY23 organic sales growth outlook (CL)
Investors are not brushing Colgate-Palmolive's (CL -3%) somewhat concerning FY23 organic growth guidance aside today, sending shares to intra-day lows of roughly $71.00, levels not seen since October. CL, a consumer-defensive organization that owns familiar brands like Colgate and Speed Stick, does expect positive earnings and sales growth yr/yr this year. However, the company predicted organic sales to climb toward the higher end of its long-term targeted range of +3-5%, a slight decline from the +7% delivered in FY22.
On the plus side, CL shares have begun recovering from earlier losses, a sign that perhaps the initial sell-off was a bit of an overreaction. However, there were a few areas of minor concern worth noting in Q4.
- Organic volume contracted yr/yr for the second-straight quarter, slipping 4.0% with declines in each division outside of pet nutrition (CL's Hill's banner). A malefactor was pricing, which jumped 12.5% yr/yr in the quarter.
- However, private labels are also taking a bite out of volumes, although CL did not express much concern surrounding private label penetration. CL stated that it has seen a bit of growth in certain regions. For example, in Europe, the biggest jump was just 1 pt in home care products (cleaners, fabric softeners, etc.). This was also consistent with what CL expected.
- Gross margins were also knocked down by 250 bps to 55.6%, including an unfavorable 90 bp hit from private label sales resulting from some of CL's pet food acquisitions.
These blemishes certainly feel like nit-picking, however. CL remains a giant in its respective markets. For example, it commands a 39.8% global market share in toothpaste and a 31.7% share in toothbrushes. Additionally, its pet food banner, Hill's, continues to exhibit strength, being the only division to post positive organic volume in Q4, growing 0.5% yr/yr. Furthermore, CL sustains partnerships with industry professionals, such as dentists and veterinarians, who use and recommend CL's products. These relationships help maintain market share across numerous banners as customers stay loyal to CL's products. Meanwhile, CL can hike prices without a massive hit to volumes since items like toothpaste, pet food, and deodorant do not fall into easily substituted categories.
Bottom line, it may not be showing up in the stock price today, but we do not view CL's Q4 report as overly concerning. Its FY23 organic sales guidance falling back toward long-term ranges is unfortunate, but it still indicates consistent and steady growth. CL has many advantages on its side, including a massive market share in certain product categories and strong customer loyalty that should help the company wade through 2023 without seeing a significant hit to its long-term financial goals.
Hasbro is playing with losses today after issuing bleak Q4 outlook as toy sales sag (HAS)
It's not all fun and games this morning for toy maker Hasbro (HAS) which is selling off sharply after issuing 4Q22 EPS and revenue guidance that was well below expectations. HAS also joined the ever-growing list of companies to implement a workforce reduction, announcing the elimination of approximately 15% of its positions.
- The bleak Q4 update, and the round of layoffs, shed light on how challenging this holiday shopping season was for toy and game makers, providing a bearish data point for main rival Mattel (MAT).
- On that note, it wouldn't be surprising if MAT followed suit and issued soft guidance ahead of its earnings report on February 8.
- With consumers pulling back on spending, and with many retailers ramping up promotional activity to spark sales, HAS's weak guidance isn't completely out of the blue. In fact, the company signaled that it was anticipating a disappointing holiday season when it lowered its FY22 revenue growth forecast during its Investor Day in early October. Specifically, the outlook was reduced from low-single digit growth to flat to slightly down in constant currency.
- The issue, though, is that the Q4 performance was even worse than many had feared. In particular, the company's Consumer Products segment, which sells toys and games under brands such as Transformers, Nerf, and Monopoly, saw a substantial drop in demand. That business experienced an estimated 26% yr/yr decline in revenue to $1.0 bln, dragging the company's total top-line lower by 17% to $1.68 bln.
- Due to the steeper-than-expected drop in revenue, HAS also missed its adjusted operating margin target of 16% for FY22. However, the shortfall was fairly modest with the company estimating FY22 adjusted operating margin of 15.7-15.8%.
- Profit margins likely held up reasonably well because of strength in HAS's Wizards of the Coast and Digital Gaming segment. This segment, which is best known for its Dungeons & Dragons franchise, generates higher margins. In Q3, Wizards of the Coast and Digital Gaming achieved an adjusted operating profit margin of 33.7%, compared to 12.6% for the Consumer Products segment.
- Looking ahead, it appears that more changes are in the cards for HAS as it navigates through this turbulent environment. In last night's press release, the company stated that a new organization model, commercial alignment, and other leadership changes will be discussed during its Q4 earnings call on February 16.
- One significant leadership change was already announced yesterday with President and COO Eric Nyman stepping down from his roles.
The main takeaway is that the slowdown in discretionary spending hit the toy and game category harder-than-expected this holiday shopping season. In response, MAT is stepping up its cost-cutting efforts, which, in addition to strength in its digital gaming segment, should protect its operating margin and bottom-line in FY23.
Intel misses the mark pretty significantly with Q4 results and Q1 guidance
Intel (INTC -8%) is not looking too chipper today with the stock down big after reporting Q4 results/guidance last night. It was pretty bad all the way around with a miss on EPS and revs. In addition, Intel guided to a loss in Q1 while analysts were expecting a profit and Intel's Q1 revenue guidance of $10.5-11.5 bln was well below analyst expectations.
- What jumped out at us as a bit alarming was that non-GAAP gross margin declined to 43.8% from 55.8% last year. That was below prior guidance of 45.0%. Perhaps more troubling was Intel guiding to a huge sequential decline in Q1 at just 39.0%.
- It does not sound like the business will turn around soon. Intel expects macro weakness to persist at least through the first half of the year, with the possibility of second-half improvements. Factors impacting results are general macro uncertainty, rising rates, geopolitical tensions in Europe, and COVID impacts in Asia, especially in China.
- In the PC market, Intel says it saw further deterioration as it ended 2022. On the last call in October, Intel said it expected 2023 PC consumption TAM of 270-295 mln units. But now, the company expects the lower end of that range as a more likely outcome. Customers are working down current inventories rather than buying new chips. The silver lining is that PC usage data remains strong and its installed base is roughly 10% higher than pre-COVID levels. Also, Intel says it grew share in 2H22 and expects that positive momentum to continue in 2023.
- In the server market, inventory burn drove server CPU shipments down mid-single-digits in 2022, with hyperscale up, offset by declines in enterprise and rest of world. Intel expects Q1 server consumption TAM to decline both sequentially and yr/yr at an accelerated rate, with 1H23 server consumption TAM down yr/yr before returning to growth in 2H23. While all segments have weakened, enterprise and rest of world, especially China, continues to be weaker than hyperscale.
In our preview yesterday, we recommended caution heading into this report, but the final result was even worse than we expected and the troubles seem like they will linger through 1H23 at least. The big miss, significant downside guidance in Q1 and margin compression are all worrying signs. This report is dragging down many chip names today, including close rivals AMD, NVDA. It is also bad news for the chip equipment space.
Some analysts are now raising concerns about cash, so we were a little surprised to not see a dividend cut. Intel pays a huge 5.3% yield. Management was asked about it on the call and said it's committed to maintaining a competitive dividend. However, we think it may get cut at some point.
KLA Corporation under selling pressure as slowing chip equipment demand hangs over shares (KLAC)
After a few of KLA Corp's (KLAC -5%) competitors, like ASML (ASML) and Lam Research (LRCX), posted mild DecQ earnings reports this week, investors were not expecting overly exciting numbers from KLAC in Q2 (Dec). The bar was likely further lowered following LRCX's MarQ outlook, which missed analyst forecasts. Meanwhile, the market was pricing in downtrodden commentary surrounding wafer fab equipment (WFE) demand throughout 2023, as ASML and LRCX outlined.
So, since KLAC registered beats on its top and bottom lines in Q2 and provided Q3 (Mar) guidance that was better than LRCX, why are shares experiencing a sell-the-news reaction? KLAC's report coincided with discouraging DecQ numbers from chip giant Intel (INTC), sending a shockwave across the semiconductor industry today. Shares of KLAC may have also become overextended, climbing around 15% from January 5 lows, promoting some profit-taking today.
- Revenue in Q2 was solid, jumping 26.8% yr/yr to $2.98 bln, exceeding KLAC's $2.65-2.95 bln outlook. Likewise, adjusted EPS of $7.38 represented 32.0% growth yr/yr, topping the midpoint of KLAC's forecasted range of $6.30-7.70.
- Adjusted gross margins of 61.0% did miss KLAC's 61.5-63.5% estimate. The issue that clipped roughly 200 bps off margins in Q2 was KLAC increasing its noncash inventory reserves as it adjusted factory output expectations and supply chain commitments to align with current demand, which endured accelerated weakness over the past few months.
- On a lighter note, KLAC mentioned that technology roadmap investments tend to be more resilient and are associated with the company's higher value offerings, where it continues to deal with supply constraints. This inhibits KLAC's ability to add the volumes needed to meet current demand, which management noted adds confidence in its business expectations as customers align shipment slots with roadmap requirements.
- Still, it is hard to look past the broader trend pointing to a challenging year ahead for KLAC. As we have heard from many others in the WFE space, industry spending will slow. KLAC predicts WFE spending will contract by around 20% yr/yr in 2023, identical to LRCX's forecast.
- This waning demand, especially in consumer-driven end markets like PCs and smartphones, is already cropping up in KLAC's near-term guidance. The company expects Q3 adjusted earnings of $4.52-5.92 and revs of $2.2-2.5 bln; the midpoints of each missed analyst projections.
It is no secret that, by now, the market expects difficulties this year for semiconductor equipment organizations such as KLAC. However, as we have heard from its peers lately, KLAC is focused on the long haul. Management remains confident that secular trends, including broad-based customer demand across multiple production nodes and the increasing roles semiconductors play in industrial applications, will drive long-term demand. As such, KLAC still expects to reach its 2026 targets, including +9-11% annualized sales growth, an additional 1.25 pts of WFE market share, and 40-50% incremental operating margins. In the meantime, KLAC could be in for a bumpy ride on its way to achieving these goals.
The Big Picture
Last Updated: 27-Jan-23 15:13 ET | Archive
Running into a wall of valuation constraint
It is good to be an economic report these days, because the stock market likes you either way. If you are better than expected, then you are the picture of a soft landing. If you are worse than expected, then you are the reason why the Fed will stop raising the target range for the fed funds rate.
You can do no wrong -- or so it seems -- but in truth you are a problem either way.
Multiple Expansion
The problem isn't so much the data as it is the position in which the stock market now sits.
With the run in stocks we have seen this month, the S&P 500 trades at 18.0x forward twelve-month earnings. That is a premium to the 10-year historical average of 17.2x, which has been established with the 10-yr note yield averaging 2.17% over the same period and core PCE price inflation averaging 2.12%. Today, the 10-yr note yield sits at 3.52% and core-PCE is up 4.4% year-over-year.
The multiple for the S&P 500, however, has expanded from 16.7x at the start of the year with price gains exceeding the change in earnings estimates. Specifically, the S&P 500 is up 6.5% year-to-date while the forward twelve-month earnings estimate has declined 1.2% over the same period to $226.59, according to FactSet.
Judging by the early returns of the fourth quarter earnings reporting period, the forward 12-month earnings estimate is not done going down yet either.
Accordingly, an economic report that gets the stock market excited about a soft landing at this point, and which drives stock prices higher, should create only fleeting satisfaction because it will also create a stiffer valuation headwind for the stock market.
In other words, the upside should be capped because a floor in earnings estimates hasn't been reached yet.
That is where a weak economic report creates bigger problems, notwithstanding the notion that it will convince the Fed to stop raising interest rates.
There isn't a floor in earnings estimates yet; hence, data that point to a continued deterioration in economic activity also point to the likelihood of a further deterioration in earnings estimates, which creates... valuation concerns.
An Open Question
In effect, the stock market, which has had an undeniably strong start to the year, is stuck between a rock and a hard place. That's true because the economy appears to be stuck between a rock and a soft place, which is to say it is neither strong nor in recession.
The question is, does it get stronger or weaker? The answer is self-evident with the long and variable lags of prior rate hikes that began last March. The open question is, just how much weaker will the economy get?
The answer is instrumental for earnings estimates, which in turn are instrumental for the stock market's return prospects.
Judging by the price action alone to begin the year, the stock market thinks an inflection in the earnings estimate trend is near. We think the price action is misleading in that respect.
In our estimation, the price action is more tactical than fundamental. To that end, it has not escaped our eye that the gains this month have come on relatively light volume, that highly-shorted stocks have been some of the biggest winners, and that low-priced, profitless "story stocks" have found a following again. It has been fun, if not entirely fundamental.
Granted there is a fundamental component with long-term rates having come down, inflation improving, and some economic data not being as bad as feared, particularly the employment data. Still, a 16.6% year-to-date gain in the Invesco S&P 500 High Beta ETF underscores the tactical rush to capitalize on beaten-down growth stocks that suffered the final blow of 2022 in the form of tax-loss selling.
What It All Means
The rally to start the year has been a welcome sight for investors, yet it is pulling forward valuation concerns knowing that stock prices have been rising sharply while earnings estimates have been falling.
In turn, it has led to an easing of financial conditions, along with the decline in Treasury yields, that is running afoul of the Fed's policy tightening efforts. How that registers at next week's FOMC meeting remains to be seen, yet we suspect Fed Chair Powell will provide some pushback.
Even if he doesn't, though, the main concern is that the stock market has gotten ahead of itself, having spun the economic reports in its favor whether they have been better than expected or weaker than expected.
The market, however, will do what it wants to do. In January it has wanted to trade higher, but it is running itself into a wall of valuation constraint.
With earnings estimates destined to keep slipping, and the 10-yr note yield and core PCE sitting well above their 10-yr average, the forward 12-month P/E ratio for the S&P 500 should not be trading at much of a premium, if any at all, to its 10-year average.
Our thinking is that the new year rally will be hitting a top soon given that the bottom is still falling out on earnings estimates.
-- Patrick J. O'Hare, Briefing.com
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