Thought to ponder…
“What you leave behind is not what is engraved in stone monuments, but what is woven into the lives of others.”
James Kerr
Legacy
The View from 30,000 feet
The S&P500 turned positive for 2024 last week propelled by optimism that soft inflation data would provide the Fed air cover to reduce rates in March, despite the continual drumbeat by a host of Fed Presidents, including Mester, Goolsbee and Barkin, circulating rhetoric that they won’t. The Fed is struggling to hold back expectations due to the continual stream of lower-than-expected inflation indicators across the globe. CME Fed Funds Futures are backing the market view, pointing to a 66% probability that the Fed will reduce rates 25 bps in March. Other big news for the week included the launch of the Bitcoin ETF and the first wave of Q423 earnings releases, which were centered around major banks, who suffered extraordinary write offs associated with the increased cost of FDIC insurance related to last March’s SVB mini-banking crisis. Although, the S&P500 rose 1.8% last week, there were dark clouds on the horizon as the proxy war in the Middle East expanded with strikes led by the US and UK against Iranian backed terrorist organizations who are escalating regional tensions, with what appears to be the intent of drawing the West directly into the conflict in hopes of expelling US forces from the regional bases.
Q4 2024 Earnings Dashboard: Off to a weak start, driven by poor reports from the banks
Escalation in the Middle East intensifies threatening shipping lanes and stoking inflation fears
CPI and PPI continue to paint a picture of disinflationary trends
Focus Point Sector Rotation Model Update: 2023 leaders move to the front of the pack
Q4 2024 Earnings Dashboard: Off to a weak start, driven by poor reports from the banks
The first week of earnings announcements was not kind to the S&P500, with the combined actual and estimated projections for Q4 dropping from +1.60% for the quarter, as of 12/31, to -0.10% after the first big week of earnings announcements.
The disappointments were centered around the major banks, who saw their expected earning plumet from expectations of -2.2% to a combined actual and estimated that now stands at -11.5%.
Bright spots for expectations continue to be led by the Magnificent 7. For example, AMZN, who is expected to earn 0.78 vs. .03 in Q4, is the largest contributor to growth for the Consumer Discretionary sector, which is expected to grow 22.9%. However, if AMZN were excluded the Consumer Discretionary sector, it would be projecting a decline of -3.2%.
Led by outsized gains in wealth management – there’s JPMorgan then there’s everyone else
Escalation in the Middle East intensifies threatening shipping lanes and stoking inflation fears
On January 11th and 12th US and British forces launched strikes against approximately 60 targets in 16 locations inside of Yemen. The attack included approximately 100 precision-guided weapons to target Houthi drone and cruise missile launching locations.
According to the Center for Strategic and International Studies, Iran has been providing the Houthis with about $100m a year of funding over the last decade, including weapons and training.
According to the Institute for the Study of War, the Houthis have been responsible for 27 pirate raids on ships since October 17th and have launch a daily barrage of missiles and drones against targets in the Red Sea.
Shipping rates have surged. The Drewry Composite Container Freight Benchmark Rate per 40 Ft Box, which is published weekly, has now increased 122% since the end of November.
According to the Kiel Institute Research Center the largest areas impacted will be Asia and Europe, who will see shipping delays of up to 20 days from having to detour shipping routes around the Red Sea.
In the larger picture, the markets have taken turmoil in the Middle East in stride with the price of oil down almost -14% since Hamas initially attacked Israel. Additionally, in Europe, which is expected to see the largest impacts of the shipping disruptions, has had only a modest uptick in PPI, with its last data print still showing YoY PPI of -8.8%.
Disruptions in Red Sea shipping traffic impacting global trade but focused on Europe and Asia
CPI and PPI continue to paint a picture of disinflationary trends
Last week we received data on CPI and PPI. The Fed’s preferred measure of inflation is PCE, which won’t be released until January 26th , but inputs from CPI and PPI provide information about what to expect out of PCE, and therefore, what is expected to influence the Fed’s decision about the next move in policy.
Based on CPI and PPI, expectations are that Core PCE will be approximately 0.15% MoM in December, making the 6m annualized change in PCE below the Fed’s targeted range for the first time since 2019. It’s not quite time to pop the cork on the bottle of champagne, but the Fed is going to have trouble holding off the markets planning for a block party.
The last man standing for inflationary pressures was margins, as companies capitalized on inflation expectations to gouge consumers and pad their coffers. This led to a wave a profit led inflation in 2022 and 2023, that is now dissipating, as can be seen in PPI Trade Services, which “tracks the changes in prices received, less the acquisition price of goods sold by wholesalers and retailers” according the Fed. PPI Trade Services peaked at 18.9% YoY in March of 2022 and has now collapsed to -0.9% as of December.
The looming risk to the story is housing, where expectations are for a return to normalized appreciation, with regional disinflation. Unfortunately, the supply demand dynamics in the housing markets and lower rate creates the potential to reignite upward price pressures in the housing market, which would upset the apple cart for inflation returning to the Fed’s target range in 2024 and wreak havoc with market expectations for the pace of cuts.
The wave of profit led inflation is receding, but might not be able to count on home price weakness
Focus Point Sector Rotation Model Update: 2023 leaders move to the front of the pack
The Focus Point Sector Rotation Model is a combined trend following and mean reversion model that utilizes seven factors to analyze daily price data on sectors to determine the strength of upward trends.
The leaders of 2023 have quietly climbed back to the top of the depth charts, while Energy has completely broken down into a down trend.
The story of dispersion and concentration in sectors has also reappeared, with the equal weight S&P500 down over -1% and small caps flirting with being down -4% for the month, while the S&P500 is up.
Additionally, the average and median sectors of the S&P500 are also down on the year, indicating the concentration of gains is in the sectors with the strongest uptrends, with the other sectors either lagging or being left for dead.
Putting it all together
The equity markets continue to chase the 10-year yield around like a star struck lover, which led to a better week for equities last week pulling the S&P500 into positive territory on the year. However, the gains were not disbursed evenly. Investors are again flocking to Info Tech, Communication Services and Discretionary, with an emphasis on the growthy, high flying Magnificent 7, less Apple and Tesla which have been identified as playing a weak hand and expensive.
Early indications of PCE, the Fed’s preferred measure of inflation, are that the trend of disinflation is embedded. Risks to the story are with oil, which is not pricing in risk from the conflict in the Middle East, and housing, which is suffering from a supply/demand imbalance and may not cooperate with the disinflationary theme.
The larger picture is that inflation continues to fall at a faster pace than expected, the labor market remains strong, which is causing resiliency in demand and corporate profits. It’s hard to be pessimistic with this as the backdrop, but with expectations for S&P500 earnings to grow at 11.8% in 2024, well above historical averages, and six rate cuts priced in versus a Fed that’s broadcasting three cuts, it’s also hard to feel like the markets aren’t priced for perfection.