Ketu Desai
By Ketu Desai
Better than feared sums up the recent economic data and earnings season. The economic data shows an economy that is slowing but resilient. The service sector remains strong with services PMIs well into expansion zone. Manufacturing appears to be turning, as manufacturing PMIs are now in positive territory indicating growth. The employment data does show some bifurcation. Sectors such as technology, real estate, and finance are showing weakness, while other sectors such as healthcare, energy, and industrials remain steady. This is best summed up by a quote by the CEO of Waste Management, “We can’t hire a truck driver to drive a trash truck for $90,000 in Houston, Texas, but I can hire an MBA from a small school for $60,000, and I can get them all day long.”
Unemployment claims show that claims by those earning over $200k is 11 percent of claims now vs 2 percent this time last year. The most recent payroll data indicates that 62 percent of industries are creating jobs. The consumer is still sitting on nearly a trillion dollars of excess savings. As inflation is coming down, real wages are increasing. The Fed will likely increase rates another 25bps at their May meeting. The market will focus on the path forward hoping for a pause. Whether the Fed indicates a pause or not at the May meeting, we are getting close to the end, for now.
Earnings can also be described as better than feared. In the business world, 79 percent of companies that have reported have beat earnings expectations by an average of 6.8 percent. This quarter is expected to be the worst of the earnings before earnings start to accelerate later this year and into 2024. The market will soon turn its attention to 2024, when earnings are expected to grow 12 percent. This is an unusual cycle, as we may have negative real growth, but positive nominal growth. Earnings are nominal. Earnings are further supported by the continuing weakening of the dollar.
The dollar is down 12 percent since September is a significant tailwind for earnings. While growth domestically is slowing, growth in China is starting to accelerate. Chinese GDP numbers came in above estimates and sell-side analysts are raising their GDP numbers for the year. Goldman expects 6 percent growth from China this year. Better Chinese growth with a weaker dollar could be a major driver of earnings for global businesses. According to CFTC data, net short positions in SPX futures is the largest since October 2011. Investors have withdrawn money from US equities in 11 of the last 15 weeks. If you are a believer in market internals, price leads data, then there is probably a signal in that homebuilders, semiconductors, materials, and industrials have been very strong. While defensive sectors such as utilities and healthcare have been weak. The combination of a Fed that is close to the end, stabilizing earnings, improving Chinese growth, low positioning, and bearish sentiment, are likely to keep a bid underneath the market.
The rally thus far this year has been top heavy driven by large cap technology. Early in the year it was driven by positioning. More recently it is a flight to businesses that don’t have balance sheet risk due to the regional banking concerns. The net impact was a 6 percent outperformance of market-cap weighted S&P versus equal-weighted. Large cap tech is responsible for more than 100 percent of the S&P’s gain. The other 492 stocks have a negative contribution. The median Russell stock is down 2.4 percent for the year, and a fourth of the index is down 20 percent or more. While large cap tech trades at more than double the price of small and mid-caps, their near-term strong performance could continue. Large cap tech will continue to benefit from flows as investors look to add positioning. They will also look more attractive as the dollar weakens and we are in a period of disinflation.
That said, the upside does seem limited as earnings growth is limited and they trade at 27.3x. For longer-term investors one of the major opportunities is playing the spread between growth and value. The spread is wider than the dot.com bubble. Apple is 34 percent greater than the entire energy sector. S&P value trades at a 25 percent discount to S&P growth, for double the yield and similar earnings growth. The discrepancy is even wider with broader measures. It might take some time, but mean-reversion seems likely.
Looking forward the market will focus on the debt ceiling, earnings, the Fed, and the banking crisis.
Ketu Desai is the Principal of i-squared Wealth Management Inc. (www.isquaredwealth.com), an investment management firm based in New Jersey. ketu@isquaredwealth.com
