Perspectives - Week of 5/13/24

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I just returned from three days in Reno for my burning man camp’s annual spring cleaning. Seventeen of us unpacked two containers jammed with kitchen and camp gear, sorted it, cleaned it, tested it, and put it all back.? Many hands make light work, and we got it all done in two days, with plenty of time to enjoy each other’s company.? And we are Feed the Artists, of course, which meant that great food was always present. ?FtA is ready for the playa, with fingers crossed that the weather gods smile on us this year.?

With that said, the hour is getting late, which means that this week’s WAAR will get right to the point.

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The State of the Market

Last week the stock market continued its recovery from the modest 6% drawdown in recent weeks. At last week’s high of 5240, the S&P 500 is not far from its all-time high of 5264 in late March. ?With 79% of stocks above their 200-day moving average, this is a reasonably broad bull market.

With the S&P 500 index up 49% from its October 2022 bottom, this remains a modest cyclical bull by historical standards.

Soft Landings

The market is betting on a soft landing, and so far, it has gotten it.? Late cycle probabilities are receding while mid-cycle vibes are ascending.

For the landing to be stuck, earnings need to materialize, which they are doing.

With 459 companies reporting Q1 earnings, 79% are beating estimates by an average of 8.41%.? Per the chart below, the year-over-year growth estimate has improved from +2% at the start of earnings season to +7%.

Trailing EPS are now at $225 and climbing, with $75 going to dividends and $90 to share buybacks.? That’s a payout of $165, or 73%.

The market remains on-course in terms of tracking past soft landing analogs, including the 1994-1995 and 1966-68 cycles.

While the 1994-1998 cycle remains of interest given the parallels in narrative (internet vs AI), the 1966-68 analog remains compelling as well.? Per the chart below, that soft landing episode happened at a similar point in the secular bull market, and a few years after the stock/bond correlation turned positive.

Yet, the yield curve signal remains in place, casting doubts on how long this favorable narrative can continue.

While I don’t want to say that the yield curve no longer matters, there clearly are some mitigating circumstances that are delaying and potentially even softening its effects.? With the excess labor demand receding, the Fed has room to give back at least a few of its rate hikes, even though inflation remains relatively sticky at 3-3.5%.

While the inflation data remain sticky, the bond market’s “what, me worry?” attitude towards inflation remains unflappable.? The TIPS forward curve trading in the mid-2’s as far as the eye can see.? This is keeping a lid on the term premium, and therefore nominal yields, at least for the time being.

With tens trading at 4.5%, the pressure from the Fed model has abated for now.? But in my view, rising bonds yields could be an ongoing source of pressure, which could at least partially offset the good earnings vibes.?

It’s worth keeping an eye on commodities here, as a possible guide for both bond yields and inflation expectations.? While the Bloomberg Commodity Spot index is barely off its cycle low, commodity-sensitive equities are performing well.? That could be a tell that something is brewing.

Secular Context

My sense is that we are in the 7th inning of a cyclical bull market, and that the 1966-68 analog is a possible guide for where we are in the soft landing recovery.? In terms of the secular context, I think we are also in the 7th inning.?

While other chartists may disagree with my approach, in my view this secular bull market started in 2009, when the deviation from the central trend was at its steepest.? In that sense, we continue to closely track both the 1982-2000 and 1949-1968 super-cycle.

In terms of valuation, on a price-to-total-cash basis we are tracking the 1949-1968 secular trend quite closely, which again brings us to that 1966-1968 soft landing analog.

The CAPE model (cyclically adjusted P/E) continues to project a moderation in 10-year annualized returns, from the double digits of the past decade to mid-single digits going forward.? This is using the 5-year cyclically adjusted price/FCF ratio.

It’s not the end of the world, following 15 years of robust returns, but it’s in-line with a maturing secular bull market.? The clock is ticking, but for now time appears to be still on our side, both cyclically and secularly.

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