Investment Insights 

 — Steve Orr 

Almost over

The first month of 2024 is almost in the books. Depending on your view, the world changed in a month or did not change at all. For the Bulls among us, warning speeches by Federal Reserve Committee members were ignored as visions of lower interest rates came closer to reality. The economy continues to rock along in second gear and the headline indices are making new highs. What’s not to love?

Our Bear “friends” shuffling along the halls are quick to remind us that a happy economy means the Fed does not need to cut rates, that job growth is actually stalled and that business owners are increasingly worried about this year’s outlook. Last Halloween deficit spending was not going to stop, the S&P 500 was 15% off its highs, conflicts and interest rates were on the rise and the Treasury was increasing its note borrowing. Today, conflicts and interest rates are on the rise and the Treasury is set to increase note borrowing again this summer. And, just like last week, the S&P 500, NASDAQ 100 and Dow Industrials all sit at all-time highs.

In fact, the Dow Industrials set four new records since Friday the 19th, led by stalwarts IBM (+12%), American Express (+11%), Verizon (+9%) and Caterpillar (+7%). While several of those famous names posted good fourth quarter results, only IBM gave an upbeat outlook for 2024. As if to confound investors even more, the Magnificent 7 are driving returns this year, just as they did for most of 2023. The broadening of the rally to mid- and small-cap companies in November and December has completely reversed. Through last Friday, the Magnificent 7, perhaps 6 as Tesla continues to slide, was up 4.1% this month. Mid-cap is about 1% lower, and Small-cap 2%. Emerging Markets, dragged down by China, are 3.4% lower. One surprise? Higher revenues at luxury goods brands LVMH powered the Euro STOXX 50 index to its highest level since March 2000. No, that’s not a typo — in nearly 24 years.

Every sentence above is fact. So, whom to believe? Charge around with our Bulls, or slink back to hibernate with the fur? Earnings results, detailed below, are coming on the heels of last year’s better-than-expected economic performance. Ergo, earnings in consumer and some industrial sectors were slightly better than expected. Looking ahead, our clients and business surveys converge on a common theme: economic activity is OK at the moment, but the next couple of quarters are murky at best. 

What place?

As we went to press, the S&P 500 looked to finish January in the green. Election year Januarys usually post flat to slightly negative returns, so we will gladly take a 2.5% gain. It bears repeating that most of the price action is in the top 10 or so stocks. NYSE decliners are outnumbering advancers, so even as the indices rally, breadth is losing momentum. Yale Hirsch’s “January Barometer” says “as goes January, so goes the year.” Twelve of the last 18 presential election years followed January’s direction. Given the Administration’s spending plans and Congressional deficit spending, we are sticking with our call for stocks to finish the year higher. It may be a bumpy road at times, but stocks should outperform cash this year.

February ranks near the bottom in performance for most stock indices. The Dow Industrials and NASDAQ finish 8th and 9th out of the 12 months on average. Over the past 70 years, an average loss of -0.4% for the S&P 500 places February 11th out of 12 months. This makes sense for the “buy the rumor, sell the news” crowd, as analysts usually adjust their full-year earnings estimates after companies report fourth-quarter earnings. 

In February 294 S&P 500 members turn in their report cards. If last week was industrials, think Magnificent 7 and Super Tech this week. Five of the Magnificent 7 report this week: Tuesday, Microsoft and Google. Then on Thursday the 1st, Apple, Facebook and Amazon. TSLA laid an egg with weaker sales and discounting last week. Tesla’s 26% drop this month is certainly dragging down the Texas Capital index.

For the week, 20% of the S&P report. Old-timers include GM, UPS and Merck. Texas oil giants Exxon and Chevron finish out the week on Friday.

Still growing

Fourth quarter Gross Domestic Product estimated by the Commerce Department came in above expectations at 3.3%. If that figure holds through revisions, 2023’s real GDP growth will be 3.1%, or a full percent above most economists’ expectations. That good number was boosted by an unusually low implied inflation number of 1.5%. That low of an inflation reading does not match CPI or PCE. Overall, the economy continues to grow, sequentially slower since the 2021 rebound. 

GDP is a tally of all production created and sold. That creates income, which is recorded in Gross Domestic Income. They are mirror images of each other. GDP and GDI are usually equal or around two-tenths apart. Since March of last year, GDP has been rising at more than 2.5% per year. At the same time, GDI is falling at around 2% per year. They are now at historical wides. That income growth would be anemic or falling makes sense when you talk to clients who are struggling with inflation, and an uncertain outlook. Falling GDI also explains why consumer sentiment is lower than the economic headlines suggest. Remember how nonfarm payrolls keep getting revised lower? They are part of the income side of the economy. Watch for slowing GDP in in the coming months to close the gap to GDI. 

Numbers, numbers

In addition to the earnings report onslaught, we have plenty of economic numbers to consider. Corelogic’s 20 city home price review, Conference Board Consumer Confidence and, of course, Friday’s January jobs report will all create headlines. Nonfarm payrolls are estimated to rise by 180,000 net new jobs and the unemployment rate to stay stable around 3.8%. The biggest news of the week will be the FOMC’s first meeting of the year on Wednesday.

We expect the Fed to leave short-term rates alone. More important will be their guidance on future rate cuts and their plans on reducing their “Quantitative Tightening” program. The QT program lets about $60 billion per month of Treasury and mortgage bonds mature and not be replaced. Reducing this program means the Treasury will start buying more Treasury bonds. Why is that important?

Wednesday will also see the release of the Treasury’s financing plans for the coming quarters. Wall Street is certain that deficit spending will continue this year. They are fairly certain that spending will require at least $1.9 trillion in new debt. Who is going to buy that debt? The Chinese basically quit in 2013, the Russians in 2014. Regulation changes by Congress forced pension plans and money market funds to take up the slack. Who is left? Our Central Bank seems to be the only portfolio that can print money. Ergo, FOMC officials need to tell Wall Street how much more they can buy — “buy” reducing the QT program.