Economic Mish Mash
One could build a case today for either a strong or weak economy based on recent data releases or from financial headlines. And it could be difficult to say who is right or wrong. In terms of economic strength, financial headlines noted that the US consumer is strong and resilient as seen by April’s total retail sales which rose 0.4%, the second month-to-month increase in the last six months. Industrial production increased 0.2% YOY in April led by a 16% YOY increase in auto and truck production. In terms of housing, the NAHB/Wells Fargo Housing Market Index (HMI) rose to 55 in May, a 10-month high. This NAHB survey of homebuilders is designed to take the pulse of the single-family housing market and it appears that housing may be on the mend. In general, economic activity appears healthy.
However, if one unpacks the April retail sales data it is easy to see that total retail & food services rose 1.6% on a year-over-year basis, a deceleration from the 2.4% YOY gain seen in March. Moreover, this 1.6% YOY increase was well below the level of inflation, which rose 4.9% YOY in April. In other words, real retail sales are negative and are decelerating which does not suggest the consumer is improving. In addition, a deceleration in sales implies corporate margins could be squeezed as consumption declines. What was notable in April’s report is that the standout segment of retail sales was, and continues to be, food services and drinking places, which rose 8.3% YOY before adjustments and 9.4% YOY after seasonal adjustments. See page 3. But in our view, this is not a broadly encouraging picture for an economy that is consumer driven.
Plus, offsetting the nice rebound in homebuilder sentiment was the University of Michigan consumer sentiment index for May. The headline consumer sentiment index tumbled to 57.7 from 63.5 in April. The decline was led by expectations, which fell a sizeable 7.1 points to 53.4. Current conditions also fell 3.7 points and as a result, each component is in recessionary territory. See page 5. In our view, the University of Michigan sentiment indices could be a warning for the homebuilders, since this survey is for May and the homebuilder survey was for April.
In terms of being either strong or weak, inflation data for April was also a tale of two cities. Headline CPI was 4.9% YOY in April, down only slightly from 5% in March. Core CPI was 5.5%, nearly unchanged from the 5.6% reported in March. More importantly, core service CPI was 6.8% versus 7.1% in March and remains stubbornly high.
The producer price index data was much the same. PPI for finished goods was 2.6%, down from 3% in March and final demand PPI was 2.4%, down from 2.8% in March. However, final demand PPI for the service sector was 3%, up from the 2.8% reported in March. Core PPI was also down from the 6.4% YOY pace seen in March, but it nonetheless remains high at 5.4% YOY. See page 4.
The importance of the stubbornly high inflation seen in the service sector is that it gives the FOMC a reason to worry about the embedded inflation in the economy, and to possibly raise rates again in June. This has not been the consensus view, but it has been something that several Federal Reserve governors have hinted at in recent discussions.
Earnings and Valuation
As earning season nears completion, and with over 91% of the S&P 500 companies having reported results, the S&P Dow Jones consensus estimates for 2023 and 2024 are $218.86 and $244.26, which rose $1.15 and fell $0.59, respectively, this week. Refinitiv IBES earnings estimates for 2023 and 2024 are $220.09 and $245.83, falling $0.78 and $0.60, respectively. See page 7.
We match our historic estimates to the S&P Dow Jones estimates since they have the longest historical database and because S&P is careful to see that estimates are uniform and reflect GAAP standards. [GD1] Nevertheless, our 2023 forecast of $180 for the S&P 500 is currently well below both the S&P Dow Jones consensus estimate of $218.86 and the IBES Refinitiv consensus estimate of $220.09. But this does not change the basic valuation standing of the market.
On page 6 we show two versions of our valuation model, one with the S&P Dow Jones estimate of $218.86 for this year and one with our $180 forecast. Surprisingly, there is little difference between these various estimates in terms of whether the equity market is currently overvalued, fairly valued, or undervalued. With both estimates, equities were overvalued prior to the surge in inflation in 2021 and became even more overvalued as interest rates rose in the last twelve months. The only difference is how much the fair value range increases, or not, by the end of the year. In both cases, our other model inputs for 2023 include an inflation target of 3.6% at year end and a fed funds target of 5.25%. We can envision scenarios in which inflation is better or worse in the second half of the year, but we believe our estimates are relatively sensible.
Still, the bottom line is that the equity market appears quite overvalued at current prices when using both the S&P estimates and our forecast. The main difference is that with S&P estimates the midpoint for the 2023 year-end fair value range rises from the year-end level of SPX 2700 to SPX 3235. Using DRG estimates, the midpoint of the fair value range falls from the year-end level of SPX 2700 to SPX 2660. We may be too pessimistic in our earnings estimate; but it is worth pointing out that even with the S&P estimates of an 11% increase in earnings this year and a 12% increase next year, coupled with inflation falling to 2.4% by the end of 2024, our model shows the midpoint of the fair value range to be SPX 3860 at the end of 2024.
In sum, this exercise shows that many things would have to go much better than expected for the stock market to move significantly higher from current levels. This is one of the reasons we remain cautious and would focus on companies and stocks with the most predictable earnings and reliable dividend payouts.
Technical Update
The charts of the S& P 500, Dow Jones Industrial Average, and Nasdaq Composite are technically positive, but each has failed to better critical resistance just above current prices. These levels are: SPX 4,200; DJIA 34,500; and Nasdaq 12,500. The Russell 2000 remains our favorite guide for the broader marketplace since it remains well within a defined range with support at 1,650 and resistance at 2000. See page 9. The 25-day up/down volume oscillator fell to a negative 1.99 reading this week but it is still in neutral territory. The oscillator recorded one-day overbought readings of 3.0 or higher on April 18, April 24, and April 28, but was unable to maintain an overbought reading on a rally. These failed overbought readings revealed a weakness in underlying buying pressure, i.e., demand. See page 10.
Gail Dudack
PLEASE NOTE: Unless otherwise stated, the firm and any affiliated person or entity 1) either does not own any, or owns less than 1%, of the outstanding shares of any public company mentioned, 2) does not receive, and has not within the past 12 months received, investment banking compensation or other compensation from any public company mentioned, and 3) does not expect within the next three months to receive investment banking compensation or other compensation from any public company mentioned. The firm does not currently make markets in any public securities.
