As you read this note, the S&P 500 is entering the heart of Q4 2023 earnings season. This allows us to step back and look at the earnings rebound to date and the trajectory for 2024. The earnings recovery is approaching its one-year anniversary. The year/year change in the S&P 500 hit its low point at a decline of -12.7% in the fourth quarter of 2022. As of the third quarter of 2023, the growth rate had rebounded nicely to a -1.5% decline. It is expected to end the calendar year of 2023 at +11.1%. This rebound is expected to continue into this calendar year, with a consensus growth rate of 12.8%. One of the points that I want you to really remember is that the markets hit their high and started to decline in January of 2022. This was way before the earnings reflected the decline of -12.7% in the year. The stock market is a discounting mechanism. It will reflect "what is expected," not what the current reporting is. Please remember this.
So, as we start 2024, remember that the dilemma is whether the Fed needs to ease to avoid a recession or if there is going to simply be a soft landing- where there remains continued growth. Hence, the title of this week's note, "Earnings Acceleration is Important For the Longevity of the Bull Market." Earnings bottom one-to-two quarters after the end of bear markets, on average. As a result, P/E expansion is common during the first year of bull markets, as the "P" rises faster than the "E." Moving into year two, earnings growth gains momentum, and this P/E measure tends to be flat to down. This cycle, earnings and stock market trends have played out roughly on track. Earnings troughed one quarter after the 9/30/22 bear market low! One of the strange phenomena of this bull phase is that even as earnings growth has rebounded, sales growth has continued to slow. The implication is that the earnings rebound has been driven by margin improvement. I believe this is why the technology sector has been so strong! Technology is infinitely helpful at expanding margins, adding efficiency, decreasing inventories, using less labor, and purchasing and selling at the optimal locations. Now, when you throw this whole AI movement on top of these technology companies, WOW, earnings growth can really surprise to the upside.
Given that this expectation for earnings is sort of the consensus, what points am I collectively paying attention to:
- Where are we in this earnings cycle? Can this rebound in earnings continue throughout 2024 and into 2025?
- Where are we with inflation and the Fed? Note that "this time" inflation is a monetary thing. It is not an economic thing. There was so much money printed and sloshing around inflation was guaranteed to raise its ugly head. But when will the economy finish burning off this excess liquidity? This excess liquidity will continue to add to the purchasing power and make it difficult for the Fed to lower interest rates.
- Where are we in the cycle work from a historical perspective? Ignoring the Fed, interest rates, earnings, and the presidential cycle, where are we in the cycles of the markets?
- Where are we on a relative strength measurement and are we overvalued? And if we are overvalued, is the equity market due for a correction? And if it is due for a correction, is it to be a simple digestion or something more significant?
These are the points I want to touch on with some charts this week.
To put the market in perspective, let's look at how the S&P 500 has done since the Great Financial Crisis. As can be seen below, it has had a nice rise, but not without bouts of pullbacks:
As we started 2024, it started immediately feeling way different than the start of 2023. The first week was negative, and the first few weeks have recognized an exodus from the equity market. This can be for any number of reasons, but the fact is that it happened. Below is the comment from Goldman Sachs from this past weekend. Note that as of January 17th, there has been quite measurable amounts of money coming out of the equity market:
Investor inflows continued to be negative for a 3rd consecutive week with about a $1 billion in outflows, according to Goldman's data. This almost implied that investors had quickly soured on stocks in the first few weeks of 2024, bothered by the rise in interest rates and somewhat inflationary comments from some Fed governors. See the chart below showing this money leaving the markets. Note that the first two weeks of 2024 there was almost the same amount of money sucked out of equities that there was money put into equities in the last three weeks of 2023. These last three weeks of 2023 were very strong for the equity markets. I have circled these two instances on the graph:
Now I want to show the cycle work. This takes into account all presidential periods going back to the early 1900's. Note that the first part of this year tends to be quite a tug-o-war, but the year tends to finish quite strong going into the election:
An important point is that as can be seen in the following chart, 10-year US Government bonds spent the last quarter of 2023 declining. At the same time, this seemed to be either a coincidence or fuel to the equity markets in the strong up move from late October till year-end. Then rates stopped declining and made an about face, right at the same time as the equity prices began the year selling off and money was being pulled out of stocks as shown in chart #3 above. This is really the quandary for the Fed today. Is inflation still too strong? Is the economy moving toward the Fed's 2% inflation target? Is inflation declining and economic growth declining to an extent that we are moving towards a recession? The bond and equity markets are sitting at the ready to move as more economic indicators are released later this week.
Thomas Lee of Fundstrat put the next picture together to show how the markets see-sawed in 2022 and 2023. Note that there were bottoms as evidenced by the blue circles and the BTD (buy the dip) notation, and profit taking at the high points as seen with the red circles and the Eh.... notation. Well, a couple of weeks ago it appeared that we hit one of those red-circle times. But, just as the market spent the first three weeks on a pullback with money being removed from equities, all of the sudden in the last three days of last week, the markets caught their breath and moved to new highs to end the week.
This brings me to my final table. Since the S&P 500, Dow Jones Industrial Average and NASDAQ all traded at new all-time highs last week, what does the market normally do when it has been at least a year since the old highs were hit? Well, these are pretty compelling statistics. Going back to 1950, there is a significant probability of the markets being higher a year from now. Actually 13 out of 14 instances this has been the case, and an initial pullback in the first month of this happening is quite reasonable!
In closing, even though as noted in chart #4 above that the first part of this year could be a little frustrating, the year should end in the positive if history is any precedent. The chart above further supports this. I believe that this means that last year will prove to have been much easier than this year could end up being, but in the end the overall S&P 500 could produce a positive follow-on return. As you know, we are always here to address any questions you may have and do what we can to help you feel comfortable that your financial situation is being addressed per your individual situation.
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