As we have already mentioned in our 2024 Outlook we are moving into the fifth year of an experiment which started with the pandemic measures and we are now going to be witnessing the end-result. (to access this publication please click the link below: https://www.kendra.ch/post/2024-outlook-a-five-year-experiment-is-still-under-way).
With all financial assets currently priced-to-perfection, we can only hope that things turn out as rosy as they are expected to. To begin with, economies are forecasted to "soft-land", or in other words economic growth to be low but positive, while company earnings are expected to grow by 12% in the US and 5% in Europe. At the same time, inflation is expected to move further closer to the central banks' targets and interest rates are expected to be cut aggressively, starting as early as March or April, but with the previous conditions still being met. If all the above forecasts prove to be accurate at the same time, then financial markets can celebrate further this year.
But we have already seen some first signs of recalibrations of the above, perfect scenario. The US corporate earnings growth for the last quarter of the year has been revised down by a whopping 7% already, leaving the 2024 estimates at risk for downward revisions as well. Market expectations for a rate cut by the FED in March were at 95% probability ten days ago, and now they are at just 25%. It is no surprise that bonds and equities started the year in correction mode, as the above-described scenario could be challenged in the weeks and months to come.
The minutes of the last FED meeting were released, showing a committee which is indeed in transition from rate hikes to rate cuts. The timing of when to start lowering rates was not discussed and the precise path forward was said to depend on the data. But they also did not rule out the risk that they may need to raise rates further, nor did they rule out the risk of needing to maintain the current level of rates for longer than expected. They also noted that easing financial conditions could make attaining their goals more difficult. Overall, the minutes showed that the bond market had jumped ahead of itself at the end of 2023.
Eurozone December inflation increased, but less than already expected. After seven consecutive months of declines, headline CPI increased by 0.5pp to 2.9% on a yearly basis, less than the forecasted 3%. The main reason behind the increase in inflation was higher energy costs which can largely be attributed to the base effect. On the contrary, Core inflation fell 0.2pp to 3.4%, but also matched consensus expectations. The decline in core inflation was driven by a fall in consumer goods inflation (-0.4pp to 2.5% on a yearly basis) more than offsetting the unchanged consumer services inflation which came in at 4% on a yearly basis.
The US labor market has cooled down, but remained rather robust according to the latest data. The December non-farm payrolls rose to 216K in December, higher than expectations for 170k, but there were major downward revisions to October and November data (down 71K in total, to 105K and 173K respectively). Some of this pickup in strength in December seems to be due to seasonal adjustment issues as well as strike effects that pushed up the number. It should also be noted that the participation rate in the household survey, based on which the non-farm payrolls are calculated, fell to below 50%, which is the lowest level since 1991. We have often expressed skepticism on the reliability of the employment data in the last two years, and this statistic only makes us even more worried that the data do not really reflect the real situation. Focusing instead on the trend, it is obvious that the US labor market has cooled in terms of new hirings, but massive layoffs are yet to be seen.
Equity markets moved broadly lower, with the US underperforming as the Tech-related names were sold rather aggressively (see chart of the week). Nasdaq corrected by almost 4% in those first four days of trading, which led to the S&P500 losing 1.5%. European indices fell by about 0.8% on average, but the Swiss SMI gained 0.4%, in a reversal of last year's dismal performance. Investors in European equities primarily bought Healthcare (+3%), Energy (+1.5%), Staples and Financials, which rose by 0.2%. Technology fell by almost 5% while Consumer Discretionary shares lost 2.8%. A similar sectorial performance for the week was seen in the US: Healthcare +2% , Energy +1%, Technology -4%, Consumer Discretionary -3.5%.
The bond market also corrected with yields moving higher, as the scenario of interest rate cuts as soon as March is now being challenged. The 10-year US yield moved back above 4% to close the week at 4.05%, up more than 20bp from the December low and the German equivalent is now at 2.15%, also 20bp higher. The correction was deeper in corporate bonds, both investment grade and high yield, as spreads (the extra risk to hold a corporate bond rather than treasuries) moved higher . Emerging market debt fell by almost 1.5% and US high yield spreads moved higher by a whopping 35bp in just this first week.
The Q4 corporate results are about to start in the US, with the major banks reporting first as usual. According to FactSet, the consensus estimate for Q4 EPS fell by 6.8% over the final three months of the year and this is the largest decline since Q3 of 2022. Nine of eleven sectors saw a decrease over the course of the quarter, led by healthcare and materials. Utilities and Tech were the only sectors that saw increase. However, the bigger issue will be the 2024 outlooks and the potential downside risk to consensus estimates for 12% earnings growth.
Chart of the Week : The "Magnificent-7" started the year with a hangover.
All of the mega-cap stocks that stunned the financial world with their 2023 performance moved lower in the first week of the new year. Apple was the worst performer, with a 6% drop as its stock fell victim of a series of analysts' downgrades and a potential anti-trust investigation by the authorities. Of course these negative returns are only a "blip" compared to the outsized gains of last year, but it could be a sign that the market will want to move into other sectors and companies which are valued more attractively. As we already mentioned in our 2024 Outlook, we believe that Healthcare, Energy and Staples can stage a comeback , while offering at the same time valuable income in the form of dividends.
• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.
• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.
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• Sources: Chart of the Week : KSH/Factset, Photo: adobe stock