After a year of strong equity returns and rather poor corporate results, the moment of truth has finally arrived. The fourth quarter of 2023 reports are beginning to be published, but most importantly we will have a fresh look at the companies' own forecasts for the new year. As we have mentioned several times before, many assets, sectors and stocks are priced-to-perfection, so any miss or lowering of estimates could result in disappointment. Of course, the reaction of the market has a lot to do with sentiment as well, and currently the "animal spirits" are high. The mini correction of the first week of January brought in fresh buyers who saw it as an opportunity to increase exposure and hence the market could be more forgiving than otherwise. The climax of this "nail-biting" period will be in three weeks, when the mega-Tech names are going to report. Their large weight on the US indices and their contribution to the total profits makes their predictions for this year extremely important for the outlook of the US equity market on a 3-6 month horizon.
The Q4 S&P500 earnings (EPS) growth has come down significantly, which means a lower "bar" to cross. They are now expected to have grown by just 1.3% for the fourth quarter, while this figure stood at 8% three months ago, marking a downward revision of 6.7%. We should note that in a typical quarter analysts usually reduce earnings estimates, as they tend to be overly optimistic, especially at the start of each year. According to FactSet, during the last five years, the average decline in the EPS estimate during any quarter has been 3.5% , similar to the 10-year average decline at 3.3% If we take the last 20 years , the average decline in EPS estimates has been 3.8%. Therefore we see that the decline in estimates which was recorded during the previous quarter (-6.7%) is much larger than the long-term averages. But as already said this fact could also mean that companies can announce positive surprises more easily.
On Friday, the first corporate results by major US banks disappointed. Admittedly, their results were obscured by one-off charges, but overall the announcements failed to provide any fuel for a move higher for their share prices and ended slightly lower (Citi was the exception with a 1% gain). All banks guided for lower net interest income for 2024, which is normal as interest rates are expected to be cut, and as many more depositors are now earning high interests on their current account than last year, when the FED rate increases started. Competition has worked in their favor. We should also note the jump in credit loss provisions by Wells Fargo, primarily attributed to credit card losses and commercial real estate loans.
Major European companies will also start reporting towards the end of this month, with ASML, LVMH, big Pharmaceuticals and Banks being among the first. For MSCI Europe, the 2024 estimates for sales growth are around 2% and for earnings growth are around 5%. These have been revised down modestly recently but still suggest analysts expect record levels of margins to be maintained and, in many sectors, to be expanding. Sectors with record margin expectations include retailing, luxury, autos, cap goods and pharma. Earnings expectations are more muted for transport, semis, real estate and banks. After the recent strong performance by many cyclicals over defensives, growth-sensitive companies may have a lot to prove. It is for this reason that we suggested tilting the portfolios towards more defensive sectors at the end of last year.
US inflation accelerated in December, but the details do not create concern. The monthly headline CPI rose faster (+30bp) than the very small increases in both October (+4bp) and November (+10bp), bringing the yearly change to 3.4%. This compares to the 3.1% figure of the previous month and is a tad higher than the 3.2% of expectations. On the positive side, the main source for this pick up was gasoline prices that declined only slightly in December following large declines in October and November (i.e. a negative base effect). Among the other main components, prices for food at home (groceries) and food away from home (restaurants) continue to see easing in their 12-month changes, which is another positive sign. Core CPI, which excludes food & energy fell below 4% to 3.9%, also a little higher than expectations (3.8%). Overall, the December inflation report did not alter the view that the next move for the FED should be a rate cut, the date of which is still a hot debate.
No surprises from the weekly labor market data in the US. The weekly initial jobless claims were announced at 202k, vs expectations for 205k and compared to 203k of the previous weeks. The more important 4-week continuing claims data moved lower to 1.83mn from 1.87mn previously. Once again, these numbers show that the US labor market remains in good shape, with signs of cooling down still apparent. This slowdown, as we have mentioned before shows in the spike of the 4-week continuing claims to almost 1.9mn, up from 1.6mn one year ago and the monthly non-farm payrolls which are averaging about 200k in the last three months. But we would need to see the weekly claims to rise over 300k and closer to 400k, for a recession to be imminent, and we are still a long way from those levels.
Equity markets rebounded, with the US outperforming Europe and Japan's Nikkei zooming higher by more than 6%. It is also worth noting that the Greek stock market rally continues unabated , with a 5% return year-to-date. Technology (+4%) and Nasdaq (+3%) were the best performers in the US for the week, but their 2024 return remains marginally negative. Europe disappointed with very small weekly gains and most major indices remain negative for this year. The exception is the Swiss SMI which is slightly up (+0.8%).
Bond prices moved higher and yields lower, after the inflation data. The 10-year US yield fell back below 4% and moved towards 3.90%, while the German yield curve also dropped by about 5bp for the week, offering some relief to the bond investors after a bad first two weeks for the new year.
Chart of the Week : The S&P500 rallied in Q4 just as earnings estimates were coming down.
In this chart we show why we think that the Q4 results and the full year guidance for 2024 is a major catalyst for the US equity market on a 3-6 month horizon. The dark blue line shows the path of the downgrades of the EPS estimates which we referenced in the second paragraph of this report. The dotted light blue line shows the S&P500 index in the same period. The index rallied by more than 10% in the same period and almost 20% from the bottom in October. This is not unusual as the market discounts what it thinks will happen in the following 6-12 months. And a significant part of the rally has been the expectation for aggressive interest rate cuts by the FED and a significant rebound in profits. So for the market to maintain the current levels and attempt to move much higher, both conditions must materialize and any change of opinion either on rates or profits would create the ground for a healthy correction. We would like to remind our readers that even a 10% correction in the S&P500 is a rather typical event and does not alter our overall positive stance for the longer-term.
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• Sources: Chart of the Week : Factset, Photo https://finance.yahoo.com/news/hp-hpq-q4-earnings-beat-123100558.html