A version of this story first appeared on TKer.co
Stocks rallied to latest all-time highs, with the S&P 500 setting a record intraday high of 5,447.25 on Wednesday and a record closing high of 5,433.74 on Thursday. For the week, the S&P gained 1.6% to finish at 5431.60. The index is now up 13.9% 12 months up to now and up 51.8% from its October 12, 2022 closing low of three,577.03.
Earlier this month, we talked about how bull markets are inclined to last for much longer and generate much stronger returns than the one we proceed to experience.
But prices don’t go up for the sake of going up.
They go up because earnings are going up.
Sure, oftentimes prices may decouple from fundamentals (i.e., an organization’s ability to earn cash) over short-term periods — which is why market-timing is so difficult.
But many analysts argue that’s not what’s happening straight away. They’ll argue that prices are up because the fundamentals are favorable.
Here’s a sampling of what Wall Street’s top stock market pros of identified in recent weeks:
Money flow generation is powerful
One in all the more repeated concerns within the stock market is that valuations are elevated above their long-term averages.
UBS’s Jonathan Golub argues today’s historically high valuations are justified.
“S&P 500 corporations have been generating more money flow over the past 3 a long time, justifying higher valuations,” Golub wrote on Monday.
Resilient profit margins are amplifying earnings growth
With the economy cooling, sales growth isn’t as hot because it was. But that hasn’t had an excessive amount of of an impact on earnings growth.
“[W]e think it is important to indicate that S&P 500 trailing earnings growth is popping higher (now 4% Y/Y up from -1% to start out the 12 months),” Morgan Stanley’s Michael Wilson observed on Monday. “Margin improvement is fueling this rise in earnings growth as top line growth has remained regular all year long.”
Earnings are driving stock prices
Expanding valuations were a big driver of stock market returns over the past 12 months.
Newer gains look like driven by earnings.
“Excellent news – the baton appears to be being passed from valuation to earnings,” Fidelity’s Jurrien Timmer wrote on Wednesday. “This is precisely what is required to sustain the cyclical bull market. Per the weekly chart below, the year-over-year change within the trailing P/E ratio has slowed from +30% to +15%, while the year-over-year change in trailing earnings has accelerated from -2% to +6%.”
Fundamentals suggest it’s not a tech bubble
The megacap tech names have drawn lots of attention as they’ve been liable for much of the stock market’s gains in recent times. But their outperformance is supported by outsized earnings growth, which makes the present run up in prices very different from the dotcom bubble.
“As asset bubbles form, a key reason volatility rises is that stocks start trading purely on momentum, decoupling from their fundamental tether (where fundamentals exist),” BofA’s Benjamin Bowler wrote.
Increased market concentration isn’t an indication of trouble
As we’ve discussed, market concentration in itself isn’t a reason to be too concerned concerning the market.
Global Financial Data (GFD) has a great post exploring market concentration going all the best way back to 1790. High market concentration isn’t a latest phenomenon.
“Based upon our evaluation of the past 150 years, there seems no reason to consider that the increased concentration of the past ten years is the harbinger of a significant bear market,” GFD’s Bryan Taylor wrote. “Increased concentration is the sign of a bull market and bear markets reduce concentration.”
Earnings growth is broadening out
Yes, it’s the case that the megacap tech names have been liable for much of the earnings growth available in the market. But that narrative is shifting.
“Perhaps an important near-term support for the stock market is the continuing acceleration of corporate earnings,” Richard Bernstein Advisors’ Dan Suzuki wrote on Wednesday. “Earnings growth has been accelerating for the reason that end of 2022, and we forecast further acceleration over the following several quarters. Not only is growth accelerating, but critically, it’s also broadening out.”
The underside line
The “bottom line” is an idiom that’s often used as a metaphor to characterize “the essential or salient point.”
The term actually comes from accounting. On an income statement, the highest line is revenue. As you progress down the income statement, you see costs, expenses, interest, taxes, and other items, all of which you subtract from revenue. And what you’re left with is the underside line: earnings.
Analysts agree the prospects for earnings are looking favorable for stocks.
And within the stock market, earnings are an important driver of costs in the long term.
That’s to say: The underside line is the underside line.
Goldman Sachs raises its goal for the S&P 500
On Friday, Goldman Sachs’ David Kostin raised his year-end goal for the S&P 500 to five,600 from 5,200. That is his third revision from his initial goal.
“Our 2024 and 2025 earnings estimates remain unchanged but stellar earnings growth by five mega-cap tech stocks have offset the standard pattern of negative revisions to consensus EPS estimates,” Kostin wrote. “We expect roughly unchanged real yields by year-end and powerful earnings growth will support a 15x P/E for the equal-weight S&P 500 and a 36% premium multiple for the market-cap index.”
Kostin isn’t alone in tweaking his forecasts. His peers at UBS, Morgan Stanley, Deutsche Bank, BMO, CFRA, Oppenheimer, RBC, Societe Generale, BofA, and Barclays are amongst those that’ve also raised their targets.
Don’t be surprised to see more of those revisions because the S&P 500’s performance, to date, has exceeded many strategists’ expectations.
Reviewing the macro crosscurrents
There have been a couple of notable data points and macroeconomic developments from last week to think about:
The Fed holds regular. The Federal Reserve announced it will keep its benchmark rate of interest goal high at a spread of 5.25% to five.5%.
From the Fed’s statement (emphasis added): “Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have remained strong, and the unemployment rate has remained low.
Inflation has eased over the past 12 months but stays elevated. In recent months, there was modest further progress toward the Committee’s 2% inflation objective.”
The central bank’s latest “dot plots” imply fewer rate cuts in 2024 and 2025 than what it previously forecast after the Fed’s March meeting.
Principally, the Fed will keep monetary policy tight until inflation rates cool further. Which means the chances of a rate cut within the near term will remain low.
Inflation cools. The Consumer Price Index (CPI) in May was up 3.3% from a 12 months ago, down from the three.4% rate in April. Adjusted for food and energy prices, core CPI was up 3.4%, down from the three.6% rate within the prior month. This was the bottom increase in core CPI since April 2021.
On a month-over-month basis, CPI was unchanged as energy prices fell 2%. Core CPI increased by 0.2%.
In the event you annualize the three-month trend within the monthly figures — a mirrored image of the short-term trend in prices — CPI was rising at a 2.8% rate and core CPI was climbing at a 3.3% rate.
Overall, while many broad measures of inflation proceed to hover above the Fed’s goal rate of two%, they’re way down from peak levels in the summertime of 2022.
Inflation expectations were mixed. From the Latest York Fed’s May Survey of Consumer Expectations: “Median inflation expectations on the one-year horizon declined to three.2% in May from 3.3% in April, were unchanged on the three-year horizon at 2.8%, and increased on the five-year horizon to three.0% from 2.8%.”
Gas prices fall. From AAA: “One other week, one other slide in gas prices because the national average for a gallon of gasoline dipped two cents since last Thursday to $3.46. The principal reasons for the decline are lackluster gasoline demand and burgeoning supply. … In accordance with latest data from the Energy Information Administration (EIA), gas demand crept higher from 8.94 million b/d to 9.04 last week. Meanwhile, total domestic gasoline stocks jumped from 230.9 to 233.5 million barrels as production increased last week, averaging 10.1 million barrels per day. Mediocre gasoline demand, increasing supply, and stable oil costs will likely result in falling pump prices.”
Mortgage rates tick lower. In accordance with Freddie Mac, the common 30-year fixed-rate mortgage declined to six.95% from 6.99% the week prior. From Freddie Mac: “Mortgage rates continued to fall back this week as incoming data suggests the economy is cooling to a more sustainable level of growth. Top-line inflation numbers were flat but shelter inflation, which measures rent and homeownership costs, increased showing that housing affordability continues to be an ongoing impediment for buyers on the home hunt.”
There are 146 million housing units within the U.S., of which 86 million are owner-occupied. 39% are mortgage-free. Of those carrying mortgage debt, just about all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged. All of that is to say: Most householders are usually not particularly sensitive to movements in home prices or mortgage rates.
Unemployment claims tick higher. Initial claims for unemployment advantages rose to 242,000 through the week ending June 8, up from 229,000 the week prior. This was the best print since August 2023. While that is above the September 2022 low of 187,000, it continues to trend at levels historically related to economic growth.
Sentiment deteriorates. From the University of Michigan’s June Surveys of Consumers: “Consumer sentiment was little modified in June; this month’s reading was a statistically insignificant 3.5 index points below May and throughout the margin of error. Sentiment is currently about 31% above the trough seen in June 2022 amid the escalation in inflation. Assessments of non-public funds dipped, attributable to modestly rising concerns over high prices in addition to weakening incomes. Overall, consumers perceive few changes within the economy from May.”
Card spending is holding up. From JPMorgan: “As of 07 Jun 2024, our Chase Consumer Card spending data (unadjusted) was 1.7% below the identical day last 12 months. Based on the Chase Consumer Card data through 07 Jun 2024, our estimate of the US Census May control measure of retail sales m/m is 0.67%.”
From Bank of America: “Total card spending per HH was up 1.6% y/y within the week ending June 8, in keeping with BAC aggregated credit & debit card data. Retail ex auto spending per HH got here in at 0.4% y/y within the week ending Jun 8. Card spending appears to be off to a solid start in June.”
Small business optimism improves. The NFIB’s Small Business Optimism Index ticked higher in May.
Importantly, the more tangible “hard” components of the index proceed to carry up a lot better than the more sentiment-oriented “soft” components.
Take into account that in times of perceived stress, soft data tends to be more exaggerated than actual hard data.
Near-term GDP growth estimates look good. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 3.1% rate in Q2.
Putting all of it together
We proceed to get evidence that we’re experiencing a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
This comes because the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to get inflation under control. While it’s true that the Fed has taken a less hawkish tone in 2023 and 2024 than in 2022, and that almost all economists agree that the ultimate rate of interest hike of the cycle has either already happened, inflation still has to stay cool for a bit of while before the central bank is comfortable with price stability.
So we should always expect the central bank to maintain monetary policy tight, which suggests we should always be prepared for relatively tight financial conditions (e.g., higher rates of interest, tighter lending standards, and lower stock valuations) to linger. All this implies monetary policy will likely be unfriendly to markets in the meanwhile, and the chance the economy slips right into a recession will likely be relatively elevated.
At the identical time, we also know that stocks are discounting mechanisms — meaning that prices may have bottomed before the Fed signals a significant dovish turn in monetary policy.
Also, it’s vital to keep in mind that while recession risks could also be elevated, consumers are coming from a really strong financial position. Unemployed individuals are getting jobs, and people with jobs are getting raises.
Similarly, business funds are healthy as many corporations locked in low rates of interest on their debt in recent times. Whilst the specter of higher debt servicing costs looms, elevated profit margins give corporations room to soak up higher costs.
At this point, any downturn is unlikely to show into economic calamity on condition that the financial health of consumers and businesses stays very strong.
And as all the time, long-term investors should keep in mind that recessions and bear markets are only a part of the deal once you enter the stock market with the aim of generating long-term returns. While markets have recently had some bumpy years, the long-run outlook for stocks stays positive.