The S&P 500 and the Dow Jones Industrial Average recorded a series of new highs in recent sessions, triggered by the US Treasury’s announcement that funding in the first quarter would be less than previously expected and the International Monetary Fund releasing its global forecasts and announcing that a “soft landing” is in sight. (Should we worry?) But the week is far from over since on the horizon are results from many of the Mag 7 stocks, an important FOMC meeting, and January’s job report.
The Importance of AI Earnings
This is also a peak week for earnings announcements with 86 of the S&P 500 companies expected to report. To date, fourth-quarter earnings results have been mixed. And as we go to press, the stock market is trying to digest results from Microsoft Corp. (MSFT – $408.59), Alphabet Inc. A (GOOGL – $151.46), and Advanced Micro Devices, Inc. (AMD – $172.06) which failed to impress investors.
Earnings results will be important for the equity market, particularly for companies in the technology and communication services sectors, which have been leading the advance. Note that the S&P communications services sector includes highflyers like Alphabet Inc. C (GOOG – $153.05), Alphabet Inc. A (GOOGL – $151.46), Meta Platforms, Inc. (META – $400.05), and Netflix, Inc. (NFLX – $562.85), which dominate the market capitalization of the group. It also includes AT&T Inc. (T -$17.53), Verizon Communications Inc. (VZ – $42.47), Walt Disney Company (The) (DIS – $96.94), and Omnicom Group Inc. (OMC – $91.83). Given the lofty PE multiples in the Mag 7 companies, earnings results will be more important than ever. Moreover, any disappointment in the growth prospects for AI-related stocks would be a big negative for the overall marketplace.
The S&P Dow Jones consensus estimate for 2024 of $240.08, was lowered by $0.61 last week. The LSEG IBES estimate for 2024 was $242.61 down $0.56. Keep in mind that based upon the IBES earnings estimate for this year, equities are very richly valued with a PE of 20.3 times. This is particularly high with inflation currently at 3.3%. The sum of this PE and inflation equals 23.6 and is just below the 23.8 level that defines an extremely overvalued equity market. If one uses the S&P Dow Jones consensus estimate, the current 2024 PE is even higher at 20.5 times. See page 9.
It has been our view that the equity market is at an important junction in 2024. Either earnings surge and justify current multiples, or equity prices will stall or decline until earnings improve. Another option is for equity prices to continue to rise, particularly in AI-related stocks, and to simply disconnect from fundamentals. This would be the start of a bubble market similar to those seen prior to the 1972 and 2000 peaks. This helps to explain why potential in AI-related growth is a key element to stock performance this year.
FOMC on Hold
Meanwhile, the economy appears to be stronger than many expected, and this could keep the Fed on hold for at least the next few months. We do not anticipate any significant change in policy this week, but it will be interesting to see how Fed Chairman Jerome Powell handles the press conference which could be lively. It would be unwise for the Fed to lower interest rates in view of recent economic reports. Real GDP grew 3.3% in the fourth quarter, down from the unsustainable rate of 4.9% seen in the third quarter, but strong, nevertheless. The most impressive feature of this fourth quarter growth was that all components were additive, including trade which is typically a drag on GDP. The main strength was the consumer, which was 1.9% of the quarter’s 3.3% increase. It is important to note that the 3.3% rate seen in the fourth quarter, although down on a quarter-over-quarter basis, remained solidly above the long-term average GDP growth rate of 3.2%. See page 3.
In December, personal income grew 4.7% YOY, disposable income grew 6.9% YOY and real disposable income grew 4.2% YOY. This last number is down from 4.4% in November; nonetheless, it is the 12th consecutive month of positive real income growth. This string of positive real income follows 21 consecutive months of weak or negative real income growth seen from April 2021 to December 2022. This 21-month stretch of negative real income growth was the first time negative real income did not translate into an economic recession. See page 4.
The personal savings rate fell from 4.1% to 3.7% in December. Both savings rates were well below the 22-year average of 5.8% or the long-term average of 8.5% and this could mean that many households dipped into their savings for the holidays. Recent data from the St. Louis Federal Reserve helps to explain why good economic data has not had a substantial impact on consumer sentiment. Real personal median income peaked in 2019 at $40,980, fell in 2020 and has been flat ever since. In short, despite a surprisingly strong job market, and a rise in wages, inflation has taken a toll on many households and real median income has not increased. And it helps to explain why some consumers are still struggling despite a recent deceleration in inflation. See page 5.
To understand why consumer sentiment has hovered near recessionary levels, one needs to dig deeper than just the headlines. Household spending has been concentrated on necessities. For example, in the last 3 years spending on gasoline has increased nearly 90%, transportation services spending has increased 77%, and food services and accommodation spending has increased 71%. After being confined to their homes due to COVID mandates, consumers increased spending on recreational services by 78% in the last three years. Plus, we were quite surprised to find that wages in the government sector rose over 8% in 2023, which was far more than the 5% seen in most other industries. See page 6.
Interest payments are another area that has pressured many households. Personal interest payments, increased as much as 66.5% YOY in June 2023, and were still high at 37% YOY in December. Personal taxes were down in 2023 after substantial increases in 2021 and 2022. And what may prove to be the most significant data point in 2024 is the decline in government stimulus. The chart on page 7 shows that while “other” government stimulus is steadily trending lower, it is still well above normal. The surge in fiscal stimulus in 2021 helped boost consumption and the economy and may be the single reason many recessionary signals proved to be either wrong or too early.
Technical Update
A new set of breakouts materialized in the S&P 500 and the Dow Jones Industrials this week generating a series of new all-time highs. The Nasdaq Composite is running to catch up. However, the Russell 2000 remains the most interesting index. After beating key resistance at 2000, it retreated below this level early in the year, and failed at another breakout attempt this week. There is still time for a breakout, and if the Russell succeeds, it would be bullish for the overall equity market. See page 10. The 25-day up/down volume oscillator is at 0.13 and neutral this week after being in overbought territory of 3.0 or higher for 22 of the 25 consecutive trading days ending January 5. To confirm this week’s advance the indicator should reach and remain in overbought territory for a minimum of five consecutive trading sessions in coming weeks.
Gail Dudack
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