22 January 2024 Equities | US

Equities and the MacroSphere: Kudos for SPX – But Do Not Get Giddy!

Summary

Kudos to the S&P 500 (SPX) for scoring a new high and ending a two-year bear market. But do not look for more onward and upward anytime soon.
Industrial bellwethers Fastenal and JB Hunt delivered good results – but more because of company-specific factors than a pickup in economic activity.
Regional banks are still struggling with the fallout from the Silicon Valley Bank crisis. They see little risk of recession, but also little hope that a stronger economy will emerge and ease their problems.
Some 100 companies report this week, spanning the sector spectrum. Among them are Tesla, Netflix, and several airlines.

Market Implications

From what we have seen so far of company earnings, 2024 forecasts of GDP growth near 1.5% appear likely.
We view equities as a hold for now, due to current high valuations.

Kudos for SPX

The S&P 500 for has surpassed its previous January 2022 high, ending the latest bear market episode.

A mild bear. As bear markets go this one was comparatively mild. The cycle from previous high to new high took 24.5 months, versus an average of 37.5 months across 11 bear markets since the mid-1950s. It took 15.2 months to recover from the low point to the new high, versus an average of two years. The full decline was 25% below the high, versus an average loss of 40%. And despite fears, this bear market did not signal a recession as they often do (Chart 1).

But even as we apparently escaped the recession scenario, we caution against overexcitement. As we discussed recently, equity markets are rising on high hopes for strong earning and rate cuts in 2024.

Currently, analysts pencil in an 11% rise in earnings for SPX and 21% for the NASDAQ 100 (NDX). Forward P/E ratios are at the highs of the past 18 years (apart from the distortions during the Covid era). In a few weeks, analysts will revise earnings forecasts for 2024 and we would be unsurprised if they are revised somewhat lower. And the rate cuts scenario depends on inflation and the Federal Reserve.

We can see how high expectations could be deflated in coming weeks. We are not calling for a major selloff, but it is quite possible that equity indices remain in a narrow trading range for some time to come.

What We Learned Last Week

Q4 earnings so far paint a picture of an economy basically on hold.

Regional Banks Still Under a Cloud

We heard from some 15 regional banks. There were no disasters but all of them are struggling with industry-related problems stemming largely from the Silicon Valley banking crisis last March. Loans outstanding and deposits are down by modest amounts, but the key point is the lack of growth. Net interest margins are under pressure from lower rates and higher deposit costs needed to retain deposits. Most banks project further declines of up to 10% in 2024. A positive is that none of the banks predict a recession or a surge in commercial real estate problems, nor are they worried about stubborn inflation. But none of them see a stronger economy that might help them return to growth.

In the industrial sector, two bellwethers surprised on the upside – but both benefited more from company-specific events than a strengthening economy.

Industrial Bellwethers Getting By

Fastenal (FAST), maker of screws, nuts, bolts, and thousands of fastener knick-nacks that manufacturers need to assemble products. It beat on revenue and earnings, largely because of a new strategy of on-site production – locating its factories near major customers. Volumes for large companies jumped 8.5% – but were down 7.4% for residential construction and 3.2% for smaller companies. There was no indication in the outlook that this might change soon.

JB Hunt (JBHT), a major logistics and trucking company, reported a surprising uptick in intermodal traffic (transporting containers and trailers by rail) but could not explain why it happened or whether it expects this to continue. It hopes the freight recession of the past year is nearing a bottom but currently has little visibility. Again, this is more consistent with an economy getting by rather than ramping up.

We admit these early signs are hardly auspicious for smaller caps companies in SPX or the Russell 2000 (RTY). We note that both the equally weighted SPX (SPW) and RTY have been essentially stuck in well-defined trading ranges since mid-2022 (Chart 2).

We have been bullish on RTY in recent months as the market rallied because it appeared undervalued. We are now a hold. RTY companies will have to produce earnings to break out of this range. We remain constructive medium term, but we expect this will be a patient trade for now.

The Week Ahead

Some 100 companies report this week across the sector spectrum. They should provide an interesting if not complete mosaic of how much of the economy is performing.

We expect several major airlines (United Airlines, American Airlines, and Southwest Air, etc.) will deliver messages like Delta Air Lines – strong traffic, higher costs.
In industrials, 3M, General Electric, Lockheed Martin, and Textron represent differing slices of the economy.
In tech, Texas Instruments and Intel should provide colour on how more commodity chip makers plan to enter the AI segment.
In materials, Packaging Corp. is another company that services much of industrial America, so its view on demand will be useful. Steel Dynamics had a robust 2023 because of infrastructure spending and reshoring – does it see these trends ongoing in 2024?
We will see if Netflix can tighten its grip as the leader of the streaming wars.
The cold snaps in much of the US could put Tesla on the spot to discuss how to improve its battery technology.

Key reports this week: