US stock markets continue to make record highs while market breadth is weakening. The tech sector leads the market, and it is not just the Magnificent 7, an equal weighted tech ETF is also making new highs. Non-tech and small caps are weak, which will need to be resolved in the coming months if the bull market in US equities is to be sustained.
US labour market: some initial signs of stress creeping up in jobless claims. The 4-week moving average is inching up, albeit very slowly. While not a concern currently, investors should watch it very carefully to get a sense of whether the labour market finally breaks down due to high interest rates.
US home sales hit by higher mortgage rates: Mortgage rates jumped to over 7% in mid-April, causing new home sales to fall 4.7%. Homebuilders are beginning to struggle now, but is it a case of consolidation before rallying again or is it a turning point for the US housing market? Watch this space carefully.
Nvidia’s earnings: Wow, blew past estimates. This suggests that the momentum is strong for AI investments and demand.
“Analysts were expecting adjusted EPS of $5.65 on revenue of $24.69 billion, according to data from Bloomberg. The company reported adjusted EPS of $1.09 on revenue of $7.19 billion in the same quarter last year. In the current quarter, Nvidia expects revenue of $28 billion, plus or minus 2%. That’s better than the $26.6 billion analysts had expected.”
Importantly, the stock popped. Investors are still trying to catch up, so that means investors are still cautious about AI demand, providing the necessary ammunition to continue to rally. Big Tech should continue to outperform.
US inflation continues its slow easing. Shelter inflation continues to show hope. Small business also less inclined to raise prices.
US economic surprise index has moved to the downside. Bad news is good for stocks as inflation is easing, raising hopes for looser monetary policy.
US stock market breadth is solid. More new highs than new lows. The rally is sustainable.
US recession chatter is louder: Weaker ISM reports for both manufacturing and services, and a soft labour market report has prompted more recession calls. Investors ought to remember that recessions are caused by 1) a monetary-tightening-induced financial crisis turns into a credit crunch; 2) a geopolitical crisis causes oil prices to soar; or 3) speculative asset bubbles burst. All three have caused recessions in the past.
We have experienced a mini financial crisis early last year when a couple of banks failed, but the economy survived and while bank lending standards tightened, businesses continued to operate normally. Small businesses are the most affected, as the NFIB small business optimism index reached the lowest level since 2012. However, inflation has been cited as the main reason for low business confidence. Furthermore, small cap stocks have held up well although it has underperformed large cap stocks by 30% over 5 years. The odds that small businesses, which are focused on the domestic economy, will not fall into a recession are not increasing. That is good news.
A single month of weaker economic report does not cause us to change our minds on the health of the US economy. Importantly, we see positive signals from financial markets. Market breadth has been improving, correcting the damage done by the recent sell off. The NYSE Advance-Decline index has risen to a new high, that is bullish!
US Earnings Update: As the first quarter earnings season progresses, S&P 500 companies are performing strongly against expectations. A higher percentage of these companies are reporting positive earnings surprises, and the magnitude of these surprises exceeds the 10-year average. Consequently, the S&P 500’s earnings for the first quarter have increased compared to both last week and the end of the quarter. Additionally, on a year-over-year basis, the index is experiencing its highest earnings growth rate since the second quarter of 2022. Eight of the eleven sectors are reporting year-over-year earnings growth, led by the Communication Services, Utilities, Consumer Discretionary, and Information Technology sectors. On the other hand, three sectors are reporting a year-over-year decline in earnings: Energy, Health Care, and Materials. Hard to see a recession in the near term when earnings cycle is up.
US Economics: Labour cost rise by the most in a year, putting pressure on the FED to delay rate cuts. But lower than expected non-farm payrolls (+175K v 243K) introduced the prospect of slower end demand. Still a mixed bag when it comes to data that influence monetary policy.
US FED: No change, neither hawk nor dove. Powell continues to tread carefully to lower expectations of both hikes and cuts. US10Y has fallen in the couple of days but the trend remains up.
US Stock Market Action: After an initial scare to start the week, US equity markets ended on a stronger note. However, there is the 50dMA resistance to deal with. Equal weighted indices are also under pressure, so the short term outlook is cautious at best.
Key developments:
Markets reacted to the events in the Middle East, where Israel responded to Iran’s barrage of missiles and drones. A surgical strike without major damage reported by Iran and a lack of follow up by Iran would have settled any concerns of escalations in the oil producing region.
Nonetheless, equity markets continued to fall, driven by (1) profit taking after a three month rally which resulted in a overbought market, (2) bank earnings that were a little disappointing, (3) inflation reports that suggest the rate cuts could be off the table in 2024.
On point (2), although some banks reported less than stellar earnings, the overall trend of bank stocks appear to be healthy for the large banks (KRW), and cautious for the smaller regional banks (KBW). Banks are unlikely to be the key driver of the market weakness.
More likely, a combination of an overbought market and three consecutive months of sticky inflation reports led to the sell off in equity and bond markets. FED funds probabilities of no rate cuts for 2024 have risen from 0% to 17%, pressuring stock valuation and bond yields.
Conclusion: We are still of the view that this is just a correction, and not the beginning of a bear market. Economic growth is intact, and corporate profits are growing. This week will see the Tech giants report earnings and give an insight into AI driven demand. Technically, we are looking at the S&P 500 settling at the 200-day moving average before starting another rally before the US elections heat up.
After a better showing in the manufacturing PMI, some have pointed to the “still weak” back log index as a sign that there is something wrong with US industry. We disagree. The performance of Trucking stocks suggests that the recovery is ongoing and sustainable.
Fitch Ratings came up with a report, “Global Contagion Risk Growing from Rising CRE Losses, Led by Office”. By percentage of assets and capital, small U.S. banks have significantly higher CRE concentrations than banks with over $100 billion in assets. This could result in the failure of a moderate number of predominantly smaller banks. Naturally, people begin to worry that the US banking system will be vulnerable.
So far, there has been no bank failure, according to the FDIC.
The performance of regional banks, community banks remain stable. No signs of systematic failure.
There is no need to worry for now. Just monitor, as any prudent investor should.