Good News: Positive Signs in the U.S. Economy

I hope this message finds you well. I wanted to provide an update on the latest inflation report from April, which indicates some positive trends in the U.S. economy.

The consumer-price index (CPI), which measures the overall cost of goods and services, increased by 3.4% in April compared to the same month last year. This marks the lowest rise in core prices, excluding food and energy, since April 2021, with an annual increase of 3.6%. Both figures were aligned with economists' expectations.

Investors found encouraging signs in this report, reflecting a gradual slowdown in the economy due to the Federal Reserve’s efforts to combat inflation. This optimism was reflected in the yields on 10-year Treasurys, which fell, and in the continued upward movement of major U.S. stock indexes in May.

Despite this positive news, the report alone is unlikely to prompt immediate changes in the Federal Reserve's policy on interest rates. Analysts suggest that more data is needed to confirm a consistent return to pre-pandemic inflation levels before considering rate cuts, potentially delaying any changes until September.

April saw continued price pressures, particularly in gasoline and housing. However, there were signs of relief as year-over-year rent increases slowed, and costs for groceries, vehicles, and medical care decreased.

This report follows three previous readings that indicated persistent price pressures, challenging earlier projections for rapid interest rate cuts. The Federal Reserve remains cautious, with Chair Jerome Powell emphasizing the need for patience in allowing restrictive policies to take effect.

Consumer sentiment has dipped, partly due to expectations of sustained high inflation and interest rates. This has presented a political challenge for President Biden, despite the overall strength of the U.S. economy compared to other wealthy nations.

Nonetheless, there are indications that the initial difficulties of the year might be a temporary phase in a longer-term decline in inflation from recent highs. Gasoline prices have dropped, and a long-awaited slowdown in rent increases is anticipated to provide further relief.

A mixed report on producer prices in April showed continued overall cost increases but included a revised lower reading for March. Cheaper airfare and hospital prices are also expected to contribute to lower inflation metrics.

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Switching gears, here is a first quarter 2024 Earnings Season Recap:

1. Shift in Strategy for Mega-Cap Companies: Mega-cap companies are now focusing more on capital expenditures (Capex) rather than just efficiency, marking a strategic shift. This new approach may impact how the market views these companies in the future.
2. Corporate Earnings Strength: The Q1 2024 earnings season showcased strong corporate earnings, with 60% of S&P companies surpassing expectations by at least one standard deviation (historical average is 51%). Only 10% of companies missed expectations (historical average is 12%). Additionally, 79% of companies beat net income estimates, significantly higher than the 72% average.
3. Market Impact: Despite debates about price action, many of the largest stocks reached new highs, indicating Wall Street's underestimation of growth. This earnings season helped prevent a bear market scenario in April 2024.
4. Earnings Growth Drivers: The overall earnings growth was +7% year-over-year (YoY), primarily driven by the Magnificent Seven stocks, which saw a +48% YoY increase. The remaining 493 stocks experienced a -2% YoY decline. Seven out of eleven sectors reported better-than-expected earnings growth rates compared to January 1st estimates, except for the health care sector due to a one-time charge from BMY. Excluding this charge, the S&P growth rate would have exceeded 10%.
5. Future Outlook: As the market is forward-looking, attention is shifting towards the convergence of earnings growth profiles between mega-cap and small-cap stocks and its implications. Consensus for 2024 shows positive growth for large caps (driven by five key stocks), flat growth for mid caps, and modest growth for small caps. However, expectations include a significant earnings ramp driven by anticipated margin expansion.
6. Revenue Growth: Q1 2024 revenue growth was +3.7% YoY. Although not exceptional, it is a positive sign. However, there is concern that expectations might lean towards an "L" shaped recovery rather than a "V" shaped one for revenue growth. The focus remains on achieving material margin expansion through revenue growth as the year progresses.

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