Weekly Market View

President Biden & Speaker McCarthy came to an agreement in principle on the debt ceiling. This will provide relief for markets and sentiment as it removes the low probability of an economic disaster. This is provided that the House & Senate vote and approve the deal and that is not a certainty as each party has some representatives that want to cede no ground to the other side. The vote could take place Wednesday. There has been some public push back from hardline conservatives and a few progressives and thus the risk to the deal is real. We expect some “no” votes from a handful of Republicans and “yes” votes from enough Democrats to result in passage of the Biden-McCarthy agreement.

Often, the financial media engages in extreme hyperbole about data or earnings. The release of Nvidia’s report last week was extraordinary. The beat in expected earnings was significant, but it was the forward-looking guidance that was jaw dropping. One must remember that we are discussing a large cap stock, one of the biggest in the S&P. Expected sales for the coming quarter are $11 billion versus estimates that were $7.15 billion.?An increase of over 50%, mostly based on AI chip demand, where NVDA is a leader. The demand is coming from a multitude of sectors beyond cloud companies.

We rarely discuss a single stock in our note. This, however, was market moving beyond NVDA. We want to caution investors on a couple of levels. NVDA was already white-hot in 2023, yet the stock rallied 26%. Superb growth rarely comes cheap as far as multiples but, while not making recommendations on any single company, some data may be helpful to analyze the current market environment.

The S&P return in 2023 is top heavy, driven by a handful of companies. The five largest stocks make up 24.10% of the S&P.?The top 10 equal 31.4%. In 1980, inflation led to energy stocks holding 7 of the 10 biggest cap levels, which totaled 25.6% of the index. Even the Dot com bubble saw a lower December 2000 top ten of 23.4%. The point? Despite good outlooks for the specific sector, the stocks spent the next few years revaluing as optimism led to higher than justified pricing. This is not a call that we are there at this moment, but AI, which will be an economic game changer [estimates have the technology adding 7% to Global GDP over a decade] does not mean valuation no longer matters.

Our favorite measurement to demonstrate the valuation challenges ahead for these market leaders, the estimated Free Cash Flow Yield of the five biggest stocks is just 3.3% compared to the broader market level of 4.7%. What this tells us is that the rally has mostly been driven by valuation expansion, not fundamental growth. In sum, the Big 5 are more expensive relative to the market than they were in December 2021, the peak before the 2022 bear. [Data from Distillate Capital]

On Friday the Fed’s favorite inflation gauge, the PCE Index rose 4.4% for the 12 months ending in April, up from 4.2%. While we have been adamant about the continued decline of inflation in 2023, this number was a disappointment. We will see if this was a hiccup in the down trend and we get to the 3s in headline CPI by Q4. The narrative for Fed response is the June meeting may still be a pause, but prognosticators believe at best, it will be a pause and future hikes are on the table. The delicate balancing act between inflation fighting and economic growth continues, with an uncertain path ahead.

The holiday shortened week ahead will be dominated first by the debt ceiling vote, but we also have significant economic reports including the Fed Beige Book, ISM Manufacturing and the US Employment report. We will continue to pay attention to weekly jobless claims and continuing claims as they are a good signal for impending economic weakness.