| | | Market Snapshot
briefing.com
| Dow | 36577.94 | +173.01 | (0.48%) | | Nasdaq | 14533.39 | +100.91 | (0.70%) | | SP 500 | 4643.70 | +21.26 | (0.46%) | | 10-yr Note | +3/32 | 4.20 |
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| | NYSE | Adv 1275 | Dec 1500 | Vol 876 mln | | Nasdaq | Adv 1880 | Dec 2413 | Vol 4.9 bln |
Industry Watch
| Strong: Materials, Information Technology, Industrials, Financials, Health Care |
| | Weak: Energy, Utilities, Real Estate |
Moving the Market
-- Ongoing buying activity despite a November CPI report that was deemed less friendly than hoped
-- Treasury yields moving lower than yesterday, acting as support
-- Gains in some mega cap stocks acting as support for the major indices
-- Seasonally strong period for the market
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Closing Summary
12-Dec-23 16:30 ET
Dow +173.01 at 36577.94, Nasdaq +100.91 at 14533.39, S&P +21.26 at 4643.70
[BRIEFING.COM] The major indices ended the session near their highs of the day. The S&P 500 and Dow Jones Industrial Average each logged a 0.5% gain and the Nasdaq Composite registered a 0.7% gain. Stocks started the session with more muted price action, though, as investors initially reacted to the November Consumer Price Index.
The report was largely in-line with expectations, but market participants got hung up for a bit on the sticky nature of core CPI, which was up 4.0% year-over-year, unchanged from October, and services inflation less rent of shelter, which was up 0.6% month-over-month and up 3.5% year-over-year.
Notably, rate hike expectations did not move much in response to the data. The probability of a 25 basis points rate cut in May stands at 75.8%, versus 74.9% yesterday, according to the CME FedWatch Tool.
Relative strength in the mega cap space offered some support to index performance, but many other stock participated in today's gains. The Vanguard Mega Cap Growth ETF (MGK) registered at 0.8% gain and the Invesco S&P 500 Equal Weight ETF (RSP) logged a 0.2% gain.
Ongoing buying activity in this seasonally strong period for the market was supported by early resilience to selling efforts, along with a fear of missing out on further gains.
Three of the 11 S&P 500 sectors traded down today, but the energy sector (-1.4%) saw the largest decline by a wide margin amid falling energy prices. WTI crude oil futures dropped 3.8% to $68.62/bbl and natural gas futures declined 5.3% to $2.33/mmbtu. That price action was a positive development as it relates to inflation and inflation expectations despite leading to losses in the energy sector today.
The information technology (+0.8%) and financial (+0.7%) sectors led the outperformers.
After some whipsaw action in response to the CPI data, the Treasury market was relatively calm today in front of Wednesday's FOMC meeting, which will include a new policy directive, an updated Summary of Economic Projections, and Fed Chair Powell's press conference. The 2-yr note yield rose one basis points to 4.74% and the 10-yr note yield fell four basis points to 4.20%.
Separately, Oracle (ORCL 100.81, -14.32, -12.4%) was a standout loser today following its mixed fiscal Q2 earnings report and in-line fiscal Q3 guidance.
- Nasdaq Composite: +38.9%
- S&P 500: +21.0%
- Dow Jones industrial Average: +10.4%
- S&P Midcap 400: +8.7%
- Russell 2000: +6.8%
Reviewing today's economic data:
- November NFIB Small Business Optimism 90.6; Prior 90.7
- November CPI 0.1% (Briefing.com consensus 0.0%); Prior 0.0%; November Core CPI 0.3% (Briefing.com consensus 0.3%); Prior 0.2%
- The key takeaway from the report is the recognition that core CPI was "sticky," largely because the shelter index (+0.4%) continues to be sticky. That should continue to give the Fed some pause about cutting rates anytime soon; and it may very well keep the Fed vocalizing the idea that it could possibly raise rates again if progress in fighting inflation stalls.
Wednesday's calendar features:
- 07:00 ET: MBA Mortgage Applications Index (Prior 2.8%)
- 08:30 ET: November PPI (Briefing.com consensus 0.1%; prior -0.5%) and Core PPI (Briefing.com consensus 0.2%; prior 0.0%)
- 14:00 ET: FOMC policy directive and Summary of Economic Projections
- 14:30 ET: Fed Chair Powell's press conference to discuss FOMC decision
Wednesday's economic calendar
12-Dec-23 15:35 ET
Dow +168.84 at 36573.77, Nasdaq +85.65 at 14518.13, S&P +18.45 at 4640.89
[BRIEFING.COM] The major indices continue to climb.
The 2-yr note yield rose one basis points to 4.74% and the 10-yr note yield fell four basis points to 4.20%. The US Dollar Index fell 0.2% to 103.84.
Wednesday's calendar features:
- 07:00 ET: MBA Mortgage Applications Index (Prior 2.8%)
- 08:30 ET: November PPI (Briefing.com consensus 0.1%; prior -0.5%) and Core PPI (Briefing.com consensus 0.2%; prior 0.0%)
- 14:00 ET: FOMC policy directive and Summary of Economic Projections
- 14:30 ET: Fed Chair Powell's press conference to discuss FOMC decision
Energy futures slide
12-Dec-23 15:05 ET
Dow +159.60 at 36564.53, Nasdaq +81.22 at 14513.70, S&P +17.01 at 4639.45
[BRIEFING.COM] Stocks continue to climb.
Energy futures settled noticeably lower across the board. WTI crude oil futures dropped 3.8% to $68.62/bbl; natural gas futures declined 5.3% to $2.33/mmbtu; gasoline settled 2.9% lower at $1.98/gallon; heating oil settled 3.8% lower at $2.51.gallon. That price action was a major reason for the underperformance of the S&P 500 energy sector (-1.3%) today, but notably, is a good indication as it relates to inflation and inflation expectations.
The only other S&P 500 sectors trading down are utilities (-0.6%) and communication services (-0.1%).
November deficit up 26% vs. last year amid rising outlays
12-Dec-23 14:30 ET
Dow +114.60 at 36519.53, Nasdaq +67.79 at 14500.27, S&P +11.95 at 4634.39
[BRIEFING.COM] The major averages were largely undeterred in their intraday action following the release of the November Treasury Budget which showed the largest monthly deficit since March 2023, pressured by a rise among outlays including a 45% increase on interest on the government's debt to about $80 bln; to this point, the S&P 500 (+0.26%) is in last place, albeit near HoDs up 12 points.
The Treasury Budget for November showed a deficit of $314.0 bln versus a deficit of $248.5 bln a year ago. The Treasury Budget data is not seasonally adjusted, so the November deficit cannot be compared to the deficit of $66.6 bln for October.
Total receipts of $274.8 bln rose 9.0% compared to last year while total outlays of $588.8 bln increased about 17.6% compared to last year.
The total year-to-date budget deficit now stands at $380.6 bln vs $336.4 bln at this point a year ago.
Gold narrowly lower ahead of November budget
12-Dec-23 13:55 ET
Dow +126.94 at 36531.87, Nasdaq +62.13 at 14494.61, S&P +11.49 at 4633.93
[BRIEFING.COM] With about two hours to go the tech-heavy Nasdaq Composite (+0.43%) has snuck into the lead, this in front of the November treasury budget, which is due at the top of the hour.
Gold futures settled less than $1 lower (flat) at $1,993.20/oz, trading kept under wraps by stronger equities as modest losses in treasury yields and the greenback weren't enough to jostle things further.
Meanwhile, the U.S. Dollar Index is down about -0.2% to $103.89.
Some resolve in the market... and in core CPI
There is resolve in the stock market. We saw it again yesterday, as the major indices refused to give way to selling interest and added to their extraordinary gains since late October. They did so, too, without much support from the mega-cap stocks.
That resolve persisted this morning leading up to the 8:30 a.m. ET release of the November Consumer Price Index, but it will be tested as today's session progresses given that the November Consumer Price Index wasn't as quiescent as market participants might have been hoping.
The Consumer Price Index increased 0.1% month-over-month in November (Briefing.com consensus 0.0%) while the core Consumer Price Index, which excludes food and energy, increased 0.3% month-over-month, as expected. That left the Consumer Price Index up 3.1% year-over-year, versus 3.2% in October, and the core Consumer Price Index up 4.0% year-over-year, unchanged from October.
The key takeaway from the report is the recognition that core CPI was "sticky," largely because the shelter index (+0.4%) continues to be sticky. That should continue to give the Fed some pause about cutting rates anytime soon; and it may very well keep the Fed vocalizing the idea that it could possibly raise rates again if progress in fighting inflation stalls.
Treasuries have seen much, if not all, of their overnight gains unwound in the wake of the report, which was also accompanied by a release indicating real average hourly earnings increased 0.2% month-over-month and 0.8% from November 2022 to November 2023. That should be a good portent for consumer spending along with the ongoing strength of the labor market.
The Fed is apt to take notice of that consideration, too.
The 2-yr note yield, at 4.64% just before the release, is at 4.71% now, down two basis points from yesterday. The 10-yr note yield, at 4.16% just before the release, is at 4.21% now, down three basis points from yesterday. The Treasury market will be working later today to digest the results of a $21 billion 30-yr bond reopening at 1:00 p.m. ET.
The equity futures market has lost some of its pre-report steam, but it hasn't come entirely unglued.
Currently, the S&P 500 futures are up one point and are trading roughly in-line with fair value, the Nasdaq 100 futures are up 21 points and are trading 0.2% above fair value, and the Dow Jones Industrial Average futures are up 70 points and are trading 0.2% above fair value.
Notwithstanding the pullback from earlier highs, there is still some resolve in those readings. That makes sense given the abiding recognition that the stock market has had a mostly one-track mind since late October that can give any seller some pause.
That thinking computes at the index level, but it isn't constant below the index level as stocks like Oracle (ORCL) and Hasbro (HAS) are finding out. The former is down 9% following its mixed fiscal Q2 results and in-line fiscal Q3 guidance, whereas the latter is down 4.3% after acknowledging weaker toy sales have contributed to a decision to reduce its workforce by approximately 900 positions.
-- Patrick J. O'Hare, Briefing.com
Ford Motor's EV ambitions head into reverse as it reportedly halves F-150 Lightning production (F)
Looking back to this time about one year ago, Ford Motor (F) was empathically bullish about its EV growth prospects, stating during the 3Q22 earnings call that it was adding shifts to meet rising demand for the Mustang Mach-E and F-150 Lightnings. Since then, though, demand for EVs has lost a lot of its charge, softening under the weight of higher interest rates, causing Ford to take a U-turn on its EV growth expectations.
According to Automotive News, Ford is now planning to cut its F-150 Lightning production by 50% next year to an average of about 1,600 trucks per week. The magnitude of the reduction is a bit jarring, although it doesn't come as a major surprise that Ford is slowing production.
- During the 3Q23 earnings call on October 26, the company stated that it planned to delay approximately $12 bln in EV investments and that it was adjusting future capacity to better match market demand for high-end EVs.
- Additionally, Ford acknowledged that it was forced to lower prices on vehicles due to changes in the EV market.
- Accordingly, the company's Model e segment posted a sizable EBIT loss of ($1.3) bln during the quarter.
- This isn't a company-specific issue as Ford's rival, General Motors (GM), also recently announced that it intends to scale back on EV production. In fact, GM stated during its Q3 earnings call that it will no longer provide EV production targets in order to focus on matching demand and to maintain strong pricing.
- While EV leader Tesla (TSLA) has maintained its FY23 production outlook of 1.8 mln vehicles throughout the year, it's widely expected that its production growth will slow sharply in 2024 from the 50%+ rates it has achieved in recent years.
- It's worth noting, though, that EV demand is still quite healthy, even though it's not as strong as many had anticipated. For instance, Ford's F-150 Lightning pickup truck generated sales growth of 52% in October, followed by sales growth of over 100% in November with nearly 4,400 EV trucks sold.
- The key moving forward will be to improve the profitability of the Model e segment, which will be easier said than done in the wake of a new labor agreement with the UAW that included wage increases of at least 25% for most employees. Passing those wage increases onto the customer will be especially difficult in a high interest rate environment where many people are cutting back on spending.
Given the challenging EV market and the substantial losses for the Model e segment, dialing back on EV investments and production is a sensible move. Perhaps by this time next year, stronger market conditions will have Ford returning to its bullish EV outlook, but the immediate road ahead continues to look bumpy.
Oracle pulling back sharply following lackluster NovQ results (ORCL)
Oracle (ORCL -11%) is under pressure today following its Q2 (Nov) earnings results last night. The company beat on EPS, but just barely. It was Oracle's smallest EPS upside in five quarters. More troublesome was its revenue miss. It was just barely below expectations but it's being viewed as a disappointment. The Q3 (Feb) guidance was in-line.
- Let's break down the numbers. Q2 Cloud Revenue (IaaS plus SaaS) rose 25% yr/yr to $4.8 bln while Cloud Infrastructure (IaaS) revenue jumped 52% yr/yr to $1.6 bln. Q2 Cloud Application (SaaS) revenue rose 15% yr/yr to $3.2 bln. Those are good growth numbers, but the yr/yr growth slowed from Q1 (Aug), when Oracle posted +30%, +66%, +17% growth, respectively. Remaining Performance Obligations (RPO) climbed to over $65 bln, up only slightly from "nearly $65 bln" in Q1.
- An issue in recent quarters is that Oracle is in the process of transitioning its Cerner unit to the cloud. This transition is resulting in some near-term headwinds to Cerner's growth rates as customers move from license purchases, which are recognized upfront, to cloud subscriptions, which are recognized ratably.
- Management said that Cloud Infrastructure demand is huge and growing at an unprecedented rate. In response, Oracle is in the process of expanding 66 of its existing cloud datacenters and building 100 new cloud datacenters. The only limiting factor is its ability to get the datacenters handed over and filled up fast enough. Oracle estimates that in Q2 alone, there were hundreds of millions of dollars that it would have been able to recognize if capacity was available. In the next few weeks, Oracle expects to sign a couple more billion dollar Cloud Infrastructure contracts.
- Non-GAAP operating margin is a metric we like to track. In Q2, including Cerner, it grew to 43% from 41% a year ago and 41% in Q1. As Oracle continues to benefit from economies of scale in the cloud and drive Cerner profitability to Oracle standards, Oracle expects it will be able to expand operating margin.
Overall, demand seems good but transitioning Cerner clients to cloud subscriptions is creating a headwind. In terms of why the stock is lower, we think it's a combination of factors. The smaller than usual EPS beat and slight revenue miss was a letdown. Also, the yr/yr growth numbers for its cloud segment slowed relative to Q1. Another factor is likely the fact that the stock is up 15% over the last six weeks, which perhaps indicates that expectations were running ahead of these lackluster numbers.
Hasbro transforming into smaller, more streamlined company as toy sales remain stubbornly soft (HAS)
After a disappointing holiday season in 2022, toy and game maker Hasbro (HAS) is facing another blue Christmas this year as sales remain stubbornly sluggish amid soft consumer spending trends and elevated inventory levels. As a result, the company is implementing another major restructuring plan that includes a workforce reduction of 1,100 positions, or nearly 20% of its total workforce.
- This past January, the owner of the Play-Doh, Monopoly, and Transformers brands announced the elimination of approximately 1,000 jobs, putting it on track to achieve $250-$300 mln in annual run-rate cost savings by the end of 2025. Since then, business conditions haven't materially improved with CEO Chris Cocks stating in last night's press release that market headwinds have proven to be stronger and more persistent than anticipated.
- It has indeed been a very rough stretch for HAS, as illustrated by five consecutive quarters of yr/yr sales declines. The company's main rival, Mattel (MAT), has faced similar challenges, but it has fared better lately, thanks to a Barbie boom in the wake of the blockbuster Barbie movie.
- In Q3, MAT's revenue increased by over 9% compared to a 10% decline for HAS.
- HAS does have its own star performers in Magic: The Gathering and Dungeons & Dragons, but the success of those brands wasn't enough to offset weakness across the Consumer Products segment.
- Fueled by the launch of Baldur's Gate III in August, HAS's Wizards of the Coast and Digital Gaming segment generated strong sales growth of 40% in Q3 to $423.6 mln.
- However, at 64% of total Q3 revenue, the Consumer Products segment has a much larger impact on HAS's overall sales. Due to lackluster industry sales trends and inventory management efforts, Q3 revenue slid by 18% for consumer products.
- Looking ahead, HAS expects the weak demand trends to persist into 2024, prompting it to ramp up its cost-savings initiatives. The initial forecast of $250-$300 mln in annual cost savings has now been pushed higher to $350-$400 mln by the end of 2025.
- One positive is that the company's margins are improving as it executes its reorganization. In Q3, adjusted operating profit margin expanded by 6.7 percentage points to 22.8%. Also, HAS is making good progress reducing its inventory as its owned inventory declined by 27% last quarter.
Overall, HAS is navigating through one of its most challenging periods in recent history, but once the tide turns back in its favor, a more streamlined company with clean inventory will be positioned to generate strong earnings growth once again.
Casey's General fuels up on another solid EPS beat in Q2, raised FY24 inside comp guidance (CASY)
Casey's General (CASY) is looking to gas-and-go today after clearing Q2 (Oct) earnings estimates handily and hiking the low end of its FY24 (Apr) same-store inside sales growth forecast. The convenience store chain operating purely across the Midwest has been a consistent outperformer over the years, helped by its strong diversification, with two-thirds of its revenue dependent on gasoline sales while the other third stems from inside store sales.
- Headline results were sound in Q2; inside same-store sales tracked +2.9% higher, total sales grew in-line with consensus at 2.2% yr/yr to $4.06 bln, and EPS of $4.24 translated to CASY's second consecutive beat.
- Inside margins continued to expand sequentially, edging 50 bps higher to 41.1%, aided largely by easing commodity costs (particularly cheese prices, as pizza is one of CASY's top-selling items). CASY noted that notable standouts from inside its stores included whole pizzas, bakery goods, and dispended beverages; same-store prepared food and beverage sales climbed +6.1%.
- On the fuel side, comps were flat, but fuel margins inched 0.7 cents higher sequentially to 42.3 cents per gallon. Management repeated that due to no significant macro events impacting wholesale fuel costs, with each passing quarter, it is growing more confident that higher industry fuel margins are here to stay. Furthermore, CASY is meaningfully outpacing the midcontinent regions, which saw comps down by approximately 5% in the quarter, underscoring its impressive competitive edge and consumer loyalty.
- Looking ahead, CASY left a few FY24 predictions unchanged, such as inside margins of 40-41% and fuel comps of negative 1% to positive 1%. However, it did raise its same-store inside sales growth estimate to +3.5-5.0% from +3.0-5.0%. Additionally, CASY outlined its EBITDA growth forecast, projecting 8-10%, consistent with its long-term financial goal. Thus far through November, numbers are tracking in-line with CASY's updated FY24 outlook.
Consistency continued to be the general theme in Q2. CASY has carved out an economic moat by operating exclusively in the Midwest. Across many communities where CASY is located, grocery and food options are limited, making CASY a go-to for these underserved rural areas. Dollar General (DG) employs a similar tactic, filling the void left by mom-and-pop shops and bridging the gap between the nearest Walmart (WMT) or large grocer. However, unlike DG, CASY primarily depends on gas, a product with low elasticity and stable long-term demand. While the rise of electric vehicles could threaten CASY, given its location in the United States, where cities are sparse and long-distance travel is standard, it likely will not pose a material threat to CASY's operations. It would also not be out of character for CASY to add charging stations if EV use overtakes internal combustion use. Therefore, we continue to like CASY over the long run.
Shake Shack heats up on CEO Randy Garutti's upcoming retirement and reiterated Q4 guidance (SHAK)
Shake Shack (SHAK +7%) heats up today after shaking up the leadership role and reiterating its Q4 financial forecasts. CEO Randy Garutti announced his retirement today, departing SHAK in 2024 upon the Board naming a successor. Mr. Garutti served as SHAK's CEO for over a decade, moving into the corner office in April 2012. Throughout his tenure, Mr. Garutti launched SHAK's IPO, steered through the pandemic despite having relatively few drive-thru locations, and expanded SHAK's footprint overseas. When stacked against some of its closest rivals, including MCD, WEN, and QSR, shares of SHAK have also performed well, up approximately 100% since pandemic lows.
So why is the market excited about Mr. Garutti's retirement?
- A fresh face tends to ignite enthusiasm as investors buy into the potential of a newcomer tapping into the company's potential. We suspect the new CEO will further Mr. Garutti's existing central pillars of adding more Shacks boasting the newer, drive-thru format domestically and abroad. The current CEO has also discussed entering several new markets in the United States and internationally over the coming years.
- While same-store sales momentum picked up in October, helping SHAK achieve +2.3% comp growth in Q3, traffic trends have declined. During Q3, SHAK endured a 4.2% drop in traffic, a deterioration from the 1.3% decline posted in Q2. Macroeconomic challenges certainly play a role, as consumers reduce their dining out frequency in light of cumulative inflationary pressures. A new CEO could implement new ways to reverse SHAK's recent traffic woes, perhaps enhancing menu items, offering discounts, or finding ways to cut expenses.
- Speaking of which, increasing labor costs remain a meaningful headwind. SHAK was upbeat about how higher wages have lowered turnover but mentioned that continued wage increases would not settle anytime soon, causing it to be part of its pricing structure going forward. Therefore, SHAK must improve profitability in other areas. This will likely be a focal point of the new CEO.
Alongside bubbling excitement over a new CEO, SHAK reiterating its Q4 revenue and same-store sales growth targets are contributing to today's solid price appreciation. SHAK continues to expect revs of $276.25-281.75 mln and comps of low-single digits. Additionally, the company left its Q4 operating profit margin outlook of approximately 19% unchanged. The reiterated guidance illustrates that the improving trends SHAK witnessed in October, such as accelerating comps, sustained their upward momentum.
Current CEO Randy Garutti has done a solid job over his 10+ years as SHAK's leader. The company is focused on where it wants to go and how it wants to get there, a credit to Mr. Garutti's leadership. We suspect the new CEO will continue these initiatives. However, whoever takes the reigns will likely have to contend with lingering headwinds, including wage inflation and traffic declines, which could inhibit more aggressive long-term plans.
The Big Picture
Last Updated: 08-Dec-23 16:23 ET | Archive
Preparing for 2024
Your author detests this time of year. Don't get me wrong and paint me as a Grinch. The disdain has nothing to do with Christmas. Rather, it has everything to do with penning a year-ahead outlook.
They are a necessary evil in this business, we suppose, but in truth they are all educated guesses because no one knows the future with certainty.
We know what we know, and we extrapolate from there, which is why many pundits are forecasting a soft landing for the economy, continued improvement in inflation, a Fed that will cut rates in 2024, a double-digit increase in S&P 500 earnings, and another good year for the stock market.
Still, others prognosticate that the Fed's aggressive tightening cycle will drive the economy into recession, which in turn means the labor market will deteriorate, earnings will disappoint, and the stock market won't have a good year.
Oh, and lest we forget, 2024 is a presidential election year that will be ripe with projections, poll analysis, and mudslinging on both sides of the aisle.
What is one to do with all these views? Like Nassim Taleb says, "Invest in preparedness, not in prediction."
Striking a Balance
The simple takeaway is that an investor's portfolio should be prepared to capitalize on positive outcomes and to weather negative developments.
Such preparation often entails having a balanced portfolio, typically expressed as a "60-40" portfolio: 60% in equities and 40% in bonds with a skew toward higher quality in both markets.
The 60-40 approach is a bit of a catch-all construct. To be fair, it may be better suited for someone in their 50s than it is for someone in their 20s or their 80s, but the composition will ultimately have a lot to do with risk tolerance, which varies across age groups. A risk-averse 20-something may be just fine with a 60-40 portfolio, whereas a risk-taking 70-something might be entirely comfortable with a 70-30 portfolio.
The good news as 2024 approaches is that there is opportunity on both sides of the portfolio for investors of all ages, unlike past years when bond yields offered little to no real yield without taking on excess risk.
A 1-yr T-bill yields 5.12%; a 30-yr bond yields 4.32%; and the ICE BofA AAA US Corporate Index Effective Yield is 4.76%.
Stocks, meanwhile, are still attractively valued. We say that with an eye on the equal-weighted S&P 500, which trades at 15.3x forward twelve-month earnings versus a 10-year average of 16.4x, according to FactSet.
Meanwhile, small-cap and mid-cap stocks have value-based appeal without qualification. The S&P Midcap 400 trades at 13.7x forward 12-month earnings, versus a 10-year average of 15.6x, and the S&P Small Cap 600 trades at 13.1x forward twelve-month earnings, versus a 10-year average of 15.2x, according to FactSet.
 
"The" S&P 500
What about "the" S&P 500? The market-cap weighted S&P 500 trades at 18.7x forward twelve-month earnings. That is a slight premium to its 10-year average of 17.5x, so it isn't terribly overvalued but it also isn't cheap either.
The hang-up with the market-cap weighted S&P 500 is the concentration risk embedded in the so-called "Magnificent Seven." That would be Apple (AAPL), Microsoft (MSFT), Alphabet (GOOG), Amazon.com (AMZN), NVIDIA (NVDA), Tesla (TSLA), and Meta Platforms (META).
Collectively, those seven stocks are the main reason why the market-cap weighted S&P 500 is up 20% this year. Their influence is reflected in the fact that the equal-weighted S&P 500 is up only 6.6%.
The index will struggle if these stocks are struggling, but the basis for why they might be struggling is key to the rest of the market. If they are struggling because the economy is performing better than expected, thereby fostering a rotation into more value-oriented stocks, then "the market" could still do okay.
If they are struggling for fundamental reasons, then it is likely those struggles would be more universal in nature, which would not be okay for "the market." However, economic challenges that lead to fundamental struggles for stocks would be an opportunity for the bond side of an investment portfolio.
To Cut or Not to Cut
Interest rates will be key to the market's performance in 2024. The rally at the end of 2023 has been predicated in large part on the thinking that the Fed will be cutting rates in 2024, not so much because it has to due to a rapidly deteriorating economic environment, but because it can due to inflation steadily retreating to the Fed's two percent target.
Prior to the solid November employment report, the fed funds futures market had been pricing in five rate cuts before the end of 2024. Things shifted a bit after the aforementioned employment report, and now "only" four rate cuts are expected.
This view has been priced in even though most Fed officials are still suggesting they are not thinking about rate cuts. Fed Governor Waller came the closest in saying that the policy rate could be lowered if inflation continues to fall for several more months.
The risk for the market is that the Fed, which waited far too long to raise rates and watched inflation run amok, now waits too long to lower rates out of fear of cutting rates too soon and inflaming inflation again. The market would likely be agitated by this thinking, particularly if inflation keeps coming down, sensing that there would be a heightened risk of recession with real rates staying too high for too long.
The good news is that the Fed has room to cut rates to support economic growth, if need be, which is some ammunition it lacked for the better part of the last 15 years.
Price Matters
Rate cuts would be good for the stock market, but you want rate cuts happening for the right reasons. In this case, that would be inflation getting back to target without a concomitant recession. Recessions are bad for earnings.
Data from Yale University Professor Robert Shiller indicates the average peak-to-trough earnings drop in a recession, dating back to 1960, has been about 31%. The current bottom-up EPS estimate for calendar year 2024 is 246.36, according to FactSet, which is 11.5% higher than the calendar year 2023 estimate.
It is important to highlight that 31% is an average, so it is possible to have a much smaller earnings decline or a much larger earnings decline. In any case, it is best for a market trading at 18.7x the calendar year estimate already that earnings don't decline at all.
That consideration is why we see more opportunity in the equal-weighted S&P 500, and in small-cap and mid-cap stocks, because they aren't priced at this time for quiescent outcomes. That's not to say they wouldn't suffer in the event of a downward revision to earnings estimates, but they are priced more attractively for the possibility that the economic outcome is more adverse than expected. In turn, they are priced more attractively for an economic outcome that is as expected or better.
The state of the labor market is going to be a guiding force for the economy. Consumer spending accounts for close to 70% of GDP, and consumers who are employed are consumers who spend.
2023 is coming to an end with the labor market in good shape. The unemployment rate of 3.7% is near a 54-year low and the 4-week moving average for initial claims is 221,000, roughly where it was before the pandemic. The four-week moving average of 1.872 million for continuing jobless claims is running slightly higher than where it was before the pandemic but remains at a relatively low level overall.
The trend in jobless claims will be important to watch, as that should hold valuable clues for the economic trend.
What It All Means
In about a year from now, we will know what it all means for 2024. We don't know today. We can only make educated guesses.
A balanced investment portfolio, however, takes some of the guesswork out of the equation, because it is effectively ready to handle any situation or opportunity as it arises.
2024 will have its share of situations and opportunities, but trying to pinpoint an endpoint price target is a fool's errand. Some pundits are required to do it, and more power to them for hitting the mark. Most do not. According to FactSet, "industry analysts on average have overestimated the final price of the index by about 7.2% one year in advance during the previous 20 years."
The aggregate prediction today among industry analysts is that the S&P 500 will close at 5,068.41 in 12 months. That's roughly 10% higher than where the S&P 500 is trading today. So, if you need a price target, there you go.
This price target Grinch doesn't have the heart to provide one knowing the future is uncertain, making the endpoint a moving target.
Just remember, as the recently deceased Charlie Munger put it, "Opportunity comes to the prepared mind."
-- Patrick J. O'Hare, Briefing.com
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