Communication Services & AI
Executive Summary: The S&P 500’s Communication Services sector has outperformed all ten of its counterparts so far this year, up 18% ytd. Jackie examines the constituent industries and companies that have been driving the sector’s strong showing, with a particular focus on Meta, up 68% ytd. … Also: Companies in diverse industries are harnessing the power of AI in manifold ways to help people work faster, smarter, and even more deceptively (beware of AI fakes!). This week’s disruptive technologies segment highlights some of the players in the AI space and the innovative products they’re turning out.
Looking Ahead To Earnings Season
Executive Summary: Industry analysts and company managements have an optimism bias that blinds them to encroaching recessions. So when a recession looms, forward earnings’ reliability as an indicator of actual earnings to come falters. … While analysts have been cutting their 2023 and 2024 earnings estimates for S&P 500 companies since last summer, their expectations for next year are still higher than for this year. As long as that remains the case, forward earnings, which have been declining since last summer, soon should stop falling and start moving higher unless a recession happens. … And: S&P 500 earnings growth ex Energy sector could turn positive in Q2 as Energy de-energizes.
Giving Credit Where Credit Is Due
Executive Summary: The spread between the 10-year Treasury bond yield and the federal funds rate inverted in November; such inversions are predictive of credit crunches and recessions. They also tend to predict financial crises that halt Fed tightening. It’s too early to credit the yield-curve inversion for calling a recession, but it was spot on in presaging a crisis like SVB. … Small banks seem vulnerable now to depositor flight, which could prompt a credit crunch impacting small businesses. … But we don’t think a credit crunch would hurt consumer spending and homebuying as much as lower interest rates will boost them. … Our message to the FOMC: Give it a rest.
Other People’s Money
Executive Summary: Will SVB be the financial domino that sets off an economy-wide credit crunch that leads to a recession? Maybe not given the Fed’s intervention; but if so, we don’t see another Great Financial Crisis. … Why have banking crises been a recurring cause of US recessions anyway? The crux of the problem is that bankers tend to take excessive risks because it’s not their own money on the line and the government has their backs. … Also, we take close looks at: how Fed tightening has eroded the value of banks’ bond portfolios, the SVB blame game, and SVB’s economic ripple effects. … And: Dr. Ed reviews “Living” (+).
Banks, Tech & Batteries
Executive Summary: SVB wasn’t last week’s only bank run: Two crypto-friendly banks that served as the major gateways to the crypto world also succumbed to depositors deciding to take their money and run. Jackie performs brief autopsies and looks at their impact on the crypto markets and the banks positioned to take their place. … Also: Counterintuitively at this time of economic uncertainty, the Technology sector has been outperforming the broader index since its February 2 peak. … And our Disruptive Technologies focus today is on the quest to build a better EV battery.
Executive Summary: Within days of the run on SVB, the Fed has donned its “lender of last resort” cape—guaranteeing all bank deposits by all depositors (!), creating a new emergency bank lending facility, and launching a review of what went wrong at SVB. As a result, we don’t see sufficient SVB ripple effects to alter our outlooks for the economy or financial markets. … Also: Inflation has proven both more transitory (consumer goods inflation) and more persistent (consumer services) than expected, but both types have moderated lately. … And: Joe examines the S&P 500 Growth index’s comeback relative to Value after more than a year as the underdog.
The Lender Of Last Resort
Executive Summary: While the Fed and FDIC have acted swiftly to contain the SVB debacle, could it still balloon into a financial crisis like previous ones that triggered a credit crunch and recession? It could if it set off a wave of disintermediation at banks broadly, but we doubt that will happen; we think the regulators’ actions will work. … So the incident doesn’t change our outlooks for the economy, stock market, or bond market. But it does revive the “Fed Put.” That’s because the Fed’s actions to stabilize the banking system also stabilize financial markets.
Run For The (Sand) Hill
Executive Summary: Tightening monetary cycles often end abruptly when “something breaks” and a financial crisis is triggered. If the Silicon Valley Bank run is that something, it could mean tightening ends sooner and bond yields have peaked. We can’t say for sure that’s the case but can say the debacle should keep the tech sector mired in its rolling recession for longer. While the SVB crisis doesn’t change our economic and stock market outlooks for now, it adds uncertainty until resolved in a way that minimizes systemic shock. … Also: A theory for why labor market demand so persistently exceeds supply points a finger at the Baby Boomers. … Dr. Ed reviews “Till” (+ + +).
China, Defense & AI Videos
Executive Summary: China’s economy has recovered after the country lifted its zero-Covid lockdowns. But that news has been eclipsed by the rising geopolitical tensions between the US and China. Jackie examines the escalating tensions. … Also: A look at projected defense spending in the US and China and how the S&P 500 Aerospace and Defense industry’s stock price index has been faring after a super-strong 2022. … Finally, our Disruptive Technologies segment focuses on how AI is transforming the production of movies and video games.
Profit Margin Recession?
Executive Summary: Today, we examine S&P 500 companies’ revenues, earnings, and profit margins as reported for Q4-2022 and as estimated by industry analysts for 2023. Notably, Q4 revenues grew impressively to a record high, but inflation accounted for much of that. Operating earnings per share fell y/y, and just two S&P 500 sectors saw y/y earnings growth. Profit margins were squeezed by rising labor costs at a time of negative productivity growth. … While Q4 is behind us, its influence isn’t: It has caused analysts to chop earnings expectations for all four quarters of this year. Current 2024 estimates may prove too low if they reflect a recession that never arrives.
Selected Sectors Short Studies
Executive Summary: Our base-case economic outlook is upbeat. Stock investors likewise seem optimistic about the economy given which S&P 500 sectors have led the index’s advance since October. We recommend overweighting five S&P 500 sectors this year: Energy, Financials, Industrials, Information Technology, and Materials. … Also: We zero in on the themes and data supporting two of these recommendations, Information Technology, which stands to benefit from companies spending on productivity-enhancing technologies in this tight labor market, and Industrials, which should benefit from strong spending on infrastructure construction, manufacturing capacity, and industrial machinery in a growing economy.
The ‘Roaring 2020s’ Revisited
Executive Summary: Productivity was poor last year—declining more than it has since 1974—and growth in unit labor costs was high. But the final quarter of 2022 saw significant improvements in both, and we think the worst is over for both. If productivity continues to improve as companies increasingly solve their labor challenges with technological innovations, that should lead to lower inflation, higher real wages, and better profit margins. That’s the thesis of our “Roaring 2020s” outlook. … Also: The economy has been experiencing a rolling recession that started last year. Today, we examine rolling recessions, past and present. … And: Dr. Ed reviews “The Whale” (+ + +).
Consumer Discretionary, Utilities & AI Fake Voice
Executive Summary: Retailers are wary about the effects of high inflation and rising interest rates on consumers’ discretionary spending. But Target this year stands to benefit from easier y/y comparisons and shoppers looking for alternatives to its rapidly shrinking competitor Bed, Bath & Beyond. Jackie examines. … Also: Will demand for electricity outstrip available supply over coming years with retiring fossil-fuel-powered electricity generation replaced by less reliable green alternatives? That’s what one transmission organization projects. . … And: With voice-cloning software readily available, its potential nefarious (as well as silly) uses may spark new opportunities in identity authentication.
On Valuation & Central Banks
Executive Summary: Today, we look at valuations for various investment style indexes. Notably, the S&P 400 MidCaps and S&P 600 SmallCaps—a.k.a. SMidCaps—haven’t been this cheap versus the S&P 500 LargeCaps since 2000. Growth and Value indexes underwent major shifts when the MegaCap-8 stocks were redistributed among them in December. Global markets have been outperforming the US MSCI. They’re collectively still cheap relative to the US. But we wouldn’t stray too far from home for long … And: The underlying structural issues keeping inflation aloft will be solved by market forces, not with monetary policy. … Also: The ECB has been tightening, but perhaps not enough yet.
The Inflation & Valuation Questions
Executive Summary: Are stock valuations too high for our inflationary times? Admittedly, last year’s bear market didn’t maul valuations as severely as most do. But inflation has been moderating in a host of areas, which we expect to continue. And if the economy sticks to the rolling-recession script, as we think it will, stocks aren’t overvalued but fairly valued, in our opinion. … Also: For more perspective on the valuation question, we look at various valuation models’ current readings in their historical context, including a valuation model that takes inflation into account.
Executive Summary: The stock market beat a hasty retreat in February, spooked by reports of January’s economic strength and the Fed’s dreaded possible reaction. So today we look at what March’s releases of economic data for February might bring. They could be bad news for the markets, but we actually expect the best—viewing January’s strength as anomalous and expecting February’s data to confirm our soft-landing outlook. Accordingly, we still think a new bull market was born last October; it’s just not bursting out of the gate as most bulls do. The market may remain volatile pending more clarity on what the Fed will do. … Also: Dr. Ed’s bearish review of “Cocaine Bear” (-).
On Earnings & Fuel Efficiency
Executive Summary: For the S&P 500 index and many of its sectors, forward revenues are at record highs but forward earnings are below their record highs of last year. The disparity indicates a profit-margin squeeze, with several labor-cost-related sources; those stemming from pandemic aftereffects should abate in time. … And: The fuel efficiency of automobiles has been climbing—with more miles traveled on fewer tanks of gasoline. Increasing use of electric vehicles may be driving this trend. Jackie collects the evidence from two places where EV adoption is ahead of the curve, California and Norway. It’s a nascent trend worth watching given the ramifications for global oil demand.
On US Earnings & India’s Economy
Executive Summary: This earnings season stands out from most, and not in a good way: Hearing managements discuss their companies’ Q4 results on conference calls has sent analysts back to their spreadsheets. Consensus earnings estimates for all four quarters of this year have been falling. … Looking at valuations in the context of falling estimates suggests that the S&P 500 isn’t cheap after its runup since October. SMidCaps and overseas stocks are cheaper. … Also: India aims to usurp China as the go-to nation for outsourcing, hoping to shed its “developing” status and become a global trade leader. But first, it may need to clean up its act.
Four Landing Scenarios
Executive Summary: What’s next for the US economy? Of four potential outlooks, we see the greatest odds (40%) of a soft landing in which inflation moderates, the Treasury bond remains below last year’s peak, and the S&P 500 ends the year at a new high. We also see two no-landing possibilities—one disinflationary, one inflationary (20% each)—and a possible hard landing (20%). The first two scenarios would be optimistic for the economy and bullish for stocks, the last two negative and bearish. … Also: We examine data supporting the relatively new no-landing scenarios as well as the latest inflation data. … And: Dr. Ed reviews “Vikings: Valhalla: Season 2” (+ + +).
Industrials, Chinese Spies & MIT’s Picks
Executive Summary: Three pieces of recent legislation incentivize manufacturers to produce their goods on US soil, and the amount being spent on the construction of new factories has risen sharply, presumably in response. Jackie examines the projects planned by three such companies—a solar panel maker, a semiconductor manufacturer, and Ford Motor. … Also: We recap the DOJ’s recent efforts to stop Chinese spies intent on stealing US technology and defense secrets. … And: A look at several innovations on MIT’s short list of life-changing new technologies.
On Consumer Inflation & Housing Activity
Executive Summary: Yesterday’s CPI report for January showed inflation continuing to moderate but slowly. The new information isn’t likely to moderate Fed officials’ hawkishness, though, and doesn’t much change the economic outlook. We continue to see a soft landing with disinflation as the Fed continues to raise the federal funds rate to 5.10%, then keeps it there through year-end. So the stock-market implications of the CPI results are minimal. But stocks and bonds might be ready for some consolidation after their runups since October. … Also: Melissa homes in on why home prices have been holding up and looks at housing market trends.
Guides to Inflation & the Economy
Executive Summary: How investors interpret this morning’s CPI release for January could move the markets; but assessing what the data say about inflation’s stickiness may be tricky given BLS’s new CPI calculation methodology. All eyes will be on services inflation in particular since it hasn’t yet peaked, buoyed by wage inflation. … The long-running hard-vs-soft-landing economic debate now includes a no-landing prospect, which itself has two scenarios—an inflationary version (possibly the long route to a hard landing?) and a disinflationary one. The latter would be ideal, and we think it’s possible. … Also: The economies of Europe and China both dodged bullets this winter, to widespread surprise.
Executive Summary: Perversely, the financial markets’ vote of confidence in the Fed’s ability to subdue inflation without getting the economy into trouble represents a threat to those very efforts, in Fed officials’ eyes, loosening financial conditions as the Fed tightens them. So Fed officials have been trying to squelch investor optimism. … A close look at the data relevant to financial conditions reveals them as tight, but in a good way—tight enough to bring inflation down without a recession but not tight enough to provoke a credit crunch that results in a recession. We continue to stand behind our disinflationary soft-landing forecast. … Also: Dr. Ed reviews the film “Mr. Jones” (+ + +).
Financials, Cruise Lines & AI Search
Executive Summary: The stock market’s strength since October has been a beckoning beacon for the capital markets: IPOs have revived, bond markets have calmed, and bond issuance has picked up. It may be halcyon days for the capital markets if investors in the shares of alternative fund managers are correct. These bellwethers of capital markets activity have outperformed the S&P 500 dramatically since September. … Also: Consumers are spending on travel again—sparking earnings recoveries for Royal Caribbean and the S&P 500 Hotels, Resorts & Cruise Lines industry generally. … And: AI is poised to transform search, but market dominance may be up for grabs.
The Third & Fourth Scenarios
Executive Summary: Strong economic releases last week raise new uncertainties for financial markets. No longer is the economic debate limited to the hard-or-soft-landing question. Two no-landing scenarios are in the running now—one bearish for stocks (if inflation can’t be controlled) and one bullish (if inflation moderates). We still forecast a soft landing with moderating inflation, which would be bullish. Minneapolis Fed President Neel Kashkari seems to be concerned about the inflationary-no-landing scenario. … Also: Fixed-income markets have sent interest rates higher in response to the robust economic data. … And: A look at the European Central Bank’s tightening course ahead.
Earnings & Valuation
Executive Summary: While earnings recessions usually don’t occur without economic recessions, recent data suggest a possible decoupling. Analysts have been lowering their earnings estimates, and a recession in forward earnings could occur if forward margins decline faster than forward revenues grow. Yet we see no recession ahead in the broad economy—or in earnings—but a soft landing, with real GDP growth approximating 1.0% during the first half of this year and 2.0% during the second half. … Also: Valuations have been rebounding across the board for S&P indexes since October 12, surprisingly so for the S&P 500 and its Value index. Comparatively low valuations in overseas stock markets have begun luring global investors.
US Economy: Still Flying & Disinflating
Executive Summary: Last week brought plenty of affirmation for stock-market bulls, with lots of favorable data releases and a less hawkish-sounding Fed Chair Powell. The data depicted an economy that has not been landing at all but remaining quite airborne amid more signs of disinflation. … Powell said in his post-FOMC meeting presser that disinflation has a ways to go. Until inflation declines to the Fed’s target level, monetary policy will remain restrictive, he said, confirming that two more 25bps hikes in the federal funds rate are likely, followed by a pause. We review the latest disinflation readings, and Dr. Ed reviews another movie: “To Leslie” (+ +).
All About Tech & Productivity
Executive Summary: Robotics and artificial intelligence are transforming myriad companies in multiple industries—allowing producers and service providers alike to work more efficiently, become more agile, and make up for productivity lost through repeated hiring and training in this tight job market. Rising adoption of robotics and AI solutions over time should drive gains in corporate productivity and mitigate businesses’ labor challenges. After all, robots never sleep! Jackie reports on some of the innovative ways that companies in various industries are putting tireless robots to work.
Executive Summary: It’s almost a given that the FOMC will decide today to ratchet up the federal funds rate by another 25bps. Less certain are how hawkish FOMC members will sound discussing the future course of monetary policy—starting with Fed Chair Powell today—and how much their words may perturb financial markets. But since the Fed remains ever “data dependent,” we can gain insight into their thinking by examining the recent data releases that are likely to affect it. … Also: Improving global growth prospects are igniting commodities markets, especially for gold, copper, and other metals. Melissa takes a look.
Executive Summary: Old-fashioned stock picking may be coming back into fashion as momentum investing stumbles. The breadth of stocks participating in the recent rally is improving, which could even the playing field for active versus passive equity managers and give the former a shot at outperforming the latter. … We recommend overweighting four S&P 500 sectors this year (Energy, Financials, Industrials, and Materials), market-weighting two (Tech and Health Care), and underweighting the remaining five. Our choices reflect our soft-landing expectations for the US and global economies in 2023 (with better growth in 2024)… Also: The latest Fed business surveys depict a slowing US economy and lower inflation.
ABCs of GDP & PCED
Executive Summary: The global financial markets are reflecting expectations for an improved global economy, and the US stock market is siding with the optimists on the US economic outlook, us among them: We continue to see greater odds of a soft landing (60%) than a hard one (40%). … Recent GDP and inflation data support our soft-landing scenario. Q4 GDP was strong, but a look under the hood suggests it was boosted by unintended inventories and Q1 GDP might be tempered by inventory liquidation. The past three months of PCED inflation data highlights reassuring downward progress, especially in goods inflation. … And: Dr. Ed reviews “Argentina 1985” (+ + +).
Transportation, Semiconductors & Digital Wallets
Executive Summary: Shifts in consumer purchasing have left retailers overstocked and shippers of goods feeling the pinch. But the sense among transport company managements is that demand for their services will normalize this year. Transportation stocks have been rallying in anticipation. … Another industry impacted by shifts in consumer spending is semiconductors, as computer sales have slid dramatically. And like the transports, semiconductor stocks have been outperforming the broader market as investors look past the pain. … Speaking of pain, the big banks have finally bitten the bullet and decided to develop a digital wallet of their own.
What’s in StyleAt S&P and the Fed?
Executive Summary: Standard & Poor’s last month reshuffled the components of its S&P Growth and Value indexes, with dramatic impacts on their valuation metrics. Ejected from the Pure Growth index were most of the MegaCap-8 companies, along with their gargantuan capitalizations; now only Apple remains. The forward P/Es of the S&P 500 Growth and Pure Growth indexes plummeted as a result. … Also: While FOMC members can’t share what’s been on their minds during the current pre-meeting quiet period, Melissa recaps what they last said about their expectations for monetary policy.
Executive Summary: Both the stock market’s and the bond market’s October bottoms have held so far—following the script we outlined as a possibility back that month. It involved moderating inflation, which we’ve seen, an end to Fed tightening, which we should see soon, and better GDP growth than we had expected, i.e., no landing so far. On the other hand, yesterday’s LEI report suggests a hard landing, while the CEI suggests a soft landing. … Also: We share insights from market maven Joe Feshbach, who notes some auspicious signs in measures of breadth. … And: We look at some total-return statistics to emphasize the importance of dividends to returns.
Another Recession Alarm Ahead
Executive Summary: Brace yourself for December’s Leading Economic Indicators and Coincident Economic Indicators coming out today. They are likely to trigger another recession alarm. But we still see greater odds of a soft landing (60%) than a hard one (40%). … What can the LEI and CEI tell us about the economy and what can’t they? Today, we discuss their usefulness and limitations. … Also: They aren’t the only economic indicators worth watching. … And: Dr. Ed reviews “The Menu” (+ + +).
Health Care, Going Global & ChatGPT
Executive Summary: The S&P 500 Health Care sector sheltered investors from the ravages of last year’s bear market, but it’s been underperforming since the market began to recover in mid-October. Jackie examines why other sectors might be more alluring now and why investors are looking past meager 2023 growth prospects for select health care companies active in M&A. … Also: Why have global stocks begun outperforming US stocks? Fears not materializing in Europe and China are part of the picture, US economic uncertainty and middling earnings growth prospects are another. … And: In a world where AI programs can write like humans, what could go wrong? Plenty.
Some Happy Developments
Executive Summary: When the equal-weighted S&P 500 price index outperforms the market-cap-weighted one, that signals rising stock market breadth. That’s what’s been happening since October 12, the date that the bear market probably ended. … Also: Wall Street has turned more bullish on prospects for Europe’s economy and stock markets in the wake of two big happy developments there. We’re in the bullish camp. … European economic indicators suggest a budding recovery—with improving energy markets tempering inflation and bolstering industrial production as well as both consumer and business sentiment.
Inflation: Persistent, Transitory, or Both?
Executive Summary: Consensus economic views seem to be mostly pessimistic. Big bank CEOs are preparing for a mild recession. Americans are skittish about a downturn, most economists project a recession, and lots of investment strategists remain bearish. But not us: We don’t foresee recessions this year in the US, Europe, or China. And we think 2023 will be an up year for the stock market. … Also: Goods inflation is proving transitory. Services is less so, hiked by unusually high rent inflation. And: a closer look at the Fed’s core services ex housing costs CPI. … Dr. Ed’s review of “The Banshees of Inisherin” (+).
Financials, Materials & Robots
Executive Summary: Yes, most banks and brokerages’ Q4 results will be down y/y, but investors already knew that. As long as earnings reports don’t bring much new negative news, the S&P 500 Financials sector’s rebound may continue, buoyed by easy y/y comparisons ahead. … Also: The World Bank‘s global growth forecast for this year is now a grim 1.7%. But you’d never know it from the surge in metals prices and the S&P 500 Materials sector since October. The strong dollar, China’s lockdown unlocking, and Europe’s energy resourcefulness no doubt have helped. … Also: How robots are about to transform farming, EV fueling, and manufacturing productivity.
Executive Summary: Might the worst be over for corporate earnings? The earnings recession in some industries likely continued during Q4, with economically sensitive ones the worst hit. But Q4 may mark the bottom for earnings growth, as we don’t see a broad-based recession this year. … In yesterday’s Morning Briefing, we likened Fed Chair Powell’s bond-market conundrum to his predecessor Greenspan’s. But does Powell have a lever to hike bond yields that Greenspan didn’t? Perhaps, but pulling it is no option. … Consumers aren’t tapped out yet: Their revolving debt as a percent of income is only around pre-pandemic levels. … And: The labor market remains unbalanced.
Executive Summary: US bond markets haven’t responded as expected to the Fed’s warnings not to expect the federal funds rate to be lowered this year. Bond investors seem unfazed by this, which is fazing Fed Chair Jerome Powell. He’s been fretting that easy financial conditions aren’t what the Fed needs to see at this time of tightening by the Fed. It’s all reminiscent of “Greenspan’s conundrum” during the early 2000s. The bond market then too seemed unaffected by the Fed’s tightening. This time, Fed officials have turned more hawkish because investors aren’t listening to their warnings. Perhaps, Fed officials should listen to the bond market.
Executive Summary: We still see greater odds that the economy will glide to a soft landing (60%) than plummet to a hard one (40%), which nearly everyone else expects. What might a soft landing look like? The happiest—and most contrary—of scenarios would be a return of the “Old Normal,” which actually wouldn’t entail a landing at all: real GDP growth of at least 2.0%, moderating inflation, and not much more monetary tightening. … We expect this week’s market-moving news to be mostly reassuring, with a subdued CPI release and earnings reports that don’t disappoint. … Recent news has cut both ways—a concerning NM-PMI but auspicious capital-spending signs. … Movie review: “Tár” (+).
All About Central Banks
Executive Summary: Bears warning that the worst is yet to come for financial assets and the economy emphasize the effects on asset prices of central banks’ recent tightening policy moves, in the US and around the world. Yes, the unconventionally easy monetary policy that greased financial markets for more than a decade is over, but quite a bit of the tightening that has replaced it has been discounted by financial markets already. Moreover, most asset bubbles have burst already without much collateral damage. And the US markets continue to benefit from record foreign capital inflows. … Also: Melissa recaps recent monetary policy developments in Europe, Japan, and China.
Recession in 2023: 60/40 or 40/60?
Executive Summary: With last year thankfully behind us, we take stock of what could go both wrong and right for the economy in 2023. We’re optimistic that 2023 will be better than 2022 for several reasons, but that’s a contrarian viewpoint. We maintain our 60% subjective odds that the economy will achieve a soft landing in 2023 and 40% odds that it will land hard, with a broad-based recession and no bull market resuming for stocks. Much depends on what happens with Fed policy and inflation. … Dr. Ed reviews “Causeway” (+).