Investment Insights

 — Steve Orr 

Fourteen

Another week, another all-time high for the S&P 500 and NASDAQ 100. Oh, and the Dow Industrials. On a percentage return basis, Small Cap stocks actually won the performance derby for the week, but remain some 17% below their all-time highs. The S&P 500 closed above 5,000 for the first time, thanks to mega-tech earnings.

The big index has risen 120 points since the start of the month. Meta (grandparents: “Facebook”) and Nvidia account for 44 of those points alone. Two names accounting for a third of the market’s advance is narrow breadth in anyone’s book. Microsoft currently holds the top spot in the market capitalization race, at $3.1 trillion. That’s nearly twice the market capitalization of the entire U.S. energy sector. Are Word and Excel really more valuable than driving to work? Perhaps in the age of work-from-home…

Clients ask us from time to time what a Bull run looks like. Since Halloween, the S&P 500 has risen in 14 of 15 weeks. The last time a run like this occurred was March of 1972. So this Bull run is a rare sight indeed. Gentlemen do not talk about stock performance in 1973–74. So let’s move along.

The 5,000 level on the S&P 500 comes early in the year for most forecasts, ours included. Price usually leads earnings, and last year’s +26% return for the big index should be a warm-up for big jumps in earnings. Back to Corso: “Not so fast my friend.” A good portion of last year’s run-up was driven by hopes for the Fed cutting interest rates and, again, great earnings by tech companies. Wall Street analysts are still looking for sizable jumps in earnings later this year. 

No fight

After mid-December’s FOMC meeting, Chairman Powell brought up the idea that the Committee would begin looking at possible rate cuts. Since then, Wall Street has focused solely on when and how many times the Fed will lower short-term interest rates. We find Powell to be fairly direct in his communication style, although he has dumped on markets several times over the years. Regardless, markets do tend to overreact in both directions. Powell and his fellow FOMC members have spent the past several weeks telling markets that there will be no rush to cut rates.

Looking at the economy and projected slowdowns this year, we agree. Last year’s third quarter real GDP grew at 4.9% and fourth quarter at 3.3%, and this quarter is trundling along toward a slightly lower 2.5%. Supposing 2% is the average growth for the first half of the year, we do not think there is a “real” or “nominal” reason for the Fed to cut rates. On our fear ledger, Nixon’s brow beating of the Fed in 1972 comes to mind. The Fed obediently cut rates, adding fuel to the S&P 500’s rally. Along came inflation and a Bear to beat all Bears. Again, not to be discussed in polite company. We’ll see in the coming months what Powell’s spine is made of. 

Still rising

Tuesday’s release of January’s consumer price index should show prices growing 3% year-over-year. The Core measure, which strips out lower gasoline prices, slips to 3.7% from December’s 3.9%. This would be the smallest rise in the Core since April 2021. The Fed does get some credit for slowing the advance in inflation. Taking interest rates from near zero to above 5.25% in 16 months ought to have some impact. Two points: First, prices are continuing to rise at a faster pace than the past decade. Outside of the 2020-21 shutdown, CPI has only been higher for three of the last 30 years. Second, inflation as measured by the CPI is the rate of increase in prices. Prices are not going back down to pre-shutdown levels. Remember, after Fed Chairman Volker beat back the teens-level inflation by the end of 1983, prices were 50% above 1978 levels.

According to the Dallas Fed, Texans are feeling the effects of inflation, with 52% of the population feeling “high inflation stress.” Their staff economists calculate Texas CPI at 4.6% and Core at 5.4%. Both are well above this week’s expected national CPI reading for January of 3%. 

Two-thirds

Traders have taken the measure of two-thirds of the S&P 500’s earnings reports. Six of the Magnificent 7 have reported — Nivida is next week. To date, earnings are beating estimates by almost 4%, well above early forecasts of barely 1%. FactSet tells us that if year-over-year earnings growth remains positive, the fourth quarter will mark two consecutive quarters of earnings growth. Just what markets need when prices have pushed valuations above 22 times earnings. Coca-Cola, Cisco and Deere are heavy weight headliners this week.

Our indicator dashboard says valuations are stretched, trend is strong and sentiment is turning overly optimistic. Scoring leaves us in a green zone but neutral on stocks. The primary, intermediate and short-term trend for stocks is higher. Yes, stocks are overbought on a weekly and daily basis. We have learned the hard way that markets will remain overbought longer than you believe they should be. Take what the market gives, not what you expect to give.