By John Lau
February 29, 2024 – The S&P 500 has surged to all-time highs near 5,100, thanks primarily to the NVDA earnings explosion. That performance reinvigorated AI enthusiasm and that, in turn, helped to propel stocks higher across the board as the rally has continued to broaden out beyond just the Magnificent Seven. With the latest gains, the S&P 500 now has rallied 21% since November 1 in just over four months. Certainly, that is impressive and very beneficial for our accounts and the rally broadly has been justified by hopes of Fed rate cuts, falling bond yields, declining inflation, Goldilocks (or should I now say “Platinumlocks”) growth and momentum. But at close to 5,100 and projected 2024 S&P earnings at $243[1], the S&P 500 is now trading at nearly 22X forward earnings, a multiple previously only reserved for periods of quantitative easing (QE) and 0% rates, not quantitative tightening (QT) and 5.37% fed funds. So, as the march continues higher, let’s step back and look at the change in fundamental factors that has fueled this rally so we can gauge where we are from a performance vs. fundamentals standpoint.
Factor 1: Dovish Fed expectations. In mid-October the S&P 500 was threatening to break below 4,000 as yields moved higher amid fears the Fed would be higher for longer. However, that all changed with Fed commentary that implied inflation was set to drop sharply and that, in turn, would lead to a less-hawkish Fed. The market took those sentiments and ran with them, as expectations for rate cuts in 2024 exploded from just two expected cuts in October to seven expected cuts by December, starting with the first rate cut expected in March! However, so far this year, those expectations have been substantially reversed. Rate cut expectations have dropped back to around four for this year and all the while, fed funds rate is now at 5.50%, up from the rate in October at 5.375%[2]. So, the S&P 500 has rallied 21% while fed funds has slightly inched up and the market expects four rate cuts, down from seven, but still higher than the Fed’s projection of two.
Factor 2: Yields. On Oct. 19, the 10-year Treasury yield hit (essentially) 5.00%[3]. Over the next three months, pressured by extreme dovish Fed expectations, the 10-year crashed lower to below 4.00%. Since then, the 10-year has rebounded and is threatening to break out of the 3.75%-4.25% trading range it has inhabited for the past several months. So, the S&P 500 has rallied 21% while the 10-year yield has declined from 5.00% to 4.25%, a level it held last summer.
Factor 3: Declining inflation. Inflation has fallen sharply from the highs of over 5% in May to around 4% in October (using Core CPI as the metric). But since then, inflation has been flat as Core CPI is still sitting, essentially, at 4.0% y/y. The Core PCE Price Index has fared slightly better with year-over-year inflation declining from 3.39% to 2.80%[4]. So, the S&P 500 is up 21% while inflation metrics have drifted only slightly lower.
Factor 4: Earnings. Back in October markets expected 2024 S&P 500 EPS to be between $245- $250/share, far above the $225/share in 2023. But since October, earnings expectations have declined to around $243/share. Yes, it’s still showing solid earnings growth, but not quite as great as expected. So, the S&P 500 is up 21% while 2024 expected earnings have declined very slightly since then.
Factor 5: Goldilocks economic growth. Economic growth has continued to point towards a No Landing/Soft Landing, with the labor market remaining very strong while there have been some hints of weakness from the consumer (credit card default rates, soft January retail sales). So, the S&P 500 is up 21% while economic growth has remained stable.
Here’s the point of this analysis: The fact that stocks have rallied since October makes sense. I expect the Fed will cut (it’s just a question of when), yields have fallen sharply allowing multiple expansion, inflation has continued to (slightly) decline while growth has remained resilient. However, if we follow the analysis to its logical conclusion, one cannot help but feel this relentless rally may have gone far beyond either actual improvement in the fundamentals and reasonable expectations of continued improvement. Put simply, at 22X earnings, this market is pricing in perfection with no wiggle room for disappointments. While there has absolutely been positive motion since October, I now view 5,100 in the S&P 500 as enjoyable, but extremely vulnerable to a sudden, potentially violent, reversal if the proverbial “music” stops in this game of financial musical chairs. My preferred tactical strategy essentially reflects the desire to reduce risk as the market moves higher, yet stretches well beyond even very aggressive fundamental justifications. That’s why I’m narrowing the stops and hedging with options to reduce beta. Yes, perhaps trees can grow to the sky in the financial world, and I hope they do. But at this point, with markets this stretched near term, I can’t help but worry any “bad” news could cause a 10% drop in this market a lot easier than any “good” news could cause a 10% rally.
Disclosures:
Investment advisory services offered through Robertson Stephens Wealth Management, LLC (“Robertson Stephens”), an SEC-registered investment advisor. Registration does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. This material is for general informational purposes only and should not be construed as investment, tax or legal advice. It does not constitute a recommendation or offer to buy or sell any security, has not been tailored to the needs of any specific investor, and should not provide the basis for any investment decision. Please consult with your Advisor prior to making any investment decisions. The information contained herein was compiled from sources believed to be reliable, but Robertson Stephens does not guarantee its accuracy or completeness. Information, views and opinions are current as of the date of this presentation, are based on the information available at the time, and are subject to change based on market and other conditions. Robertson Stephens assumes no duty to update this information. Unless otherwise noted, any individual opinions presented are those of the author and not necessarily those of Robertson Stephens. Performance may be compared to several indices. Indices are unmanaged and reflect the reinvestment of all income or dividends but do not reflect the deduction of any fees or expenses which would reduce returns. A complete list of Robertson Stephens Investment Office recommendations over the previous 12 months is available upon request. Past performance does not guarantee future results. Forward-looking performance objectives, targets or estimates are not guaranteed and may not be achieved. Investing entails risks, including possible loss of principal. Alternative investments are speculative and involve substantial risks including significant loss of principal, high illiquidity, long time horizons, uneven growth rates, high fees, onerous tax consequences, limited transparency and limited regulation. Alternative investments are not suitable for all investors and are only available to qualified investors. Please refer to the private placement memorandum for a complete listing and description of terms and risks. This material is an investment advisory publication intended for investment advisory clients and prospective clients only. Robertson Stephens only transacts business in states in which it is properly registered or is excluded or exempted from registration. A copy of Robertson Stephens’ current written disclosure brochure filed with the SEC which discusses, among other things, Robertson Stephens’ business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. © 2024 Robertson Stephens Wealth Management, LLC. All rights reserved. Robertson Stephens is a registered trademark of Robertson Stephens Wealth Management, LLC in the United States and elsewhere.
Securities offered through Fortune Financial Services, Inc. Member FINRA/SIPC. Robertson Stephens Wealth Management, LLC and Fortune Financial Services, Inc. are separate entities and are not affiliated.
For information about Robertson Stephens, go to www.rscapital.com.
[1] Morgan Stanley
[2] Federal Reserve Bank of New York
[3] YCharts
[4] Bureau of Economic Analysis 02/29/2024 release
Is the S&P at 5,100 Sustainable?
By John Lau
February 29, 2024 – The S&P 500 has surged to all-time highs near 5,100, thanks primarily to the NVDA earnings explosion. That performance reinvigorated AI enthusiasm and that, in turn, helped to propel stocks higher across the board as the rally has continued to broaden out beyond just the Magnificent Seven. With the latest gains, the S&P 500 now has rallied 21% since November 1 in just over four months. Certainly, that is impressive and very beneficial for our accounts and the rally broadly has been justified by hopes of Fed rate cuts, falling bond yields, declining inflation, Goldilocks (or should I now say “Platinumlocks”) growth and momentum. But at close to 5,100 and projected 2024 S&P earnings at $243[1], the S&P 500 is now trading at nearly 22X forward earnings, a multiple previously only reserved for periods of quantitative easing (QE) and 0% rates, not quantitative tightening (QT) and 5.37% fed funds. So, as the march continues higher, let’s step back and look at the change in fundamental factors that has fueled this rally so we can gauge where we are from a performance vs. fundamentals standpoint.
Factor 1: Dovish Fed expectations. In mid-October the S&P 500 was threatening to break below 4,000 as yields moved higher amid fears the Fed would be higher for longer. However, that all changed with Fed commentary that implied inflation was set to drop sharply and that, in turn, would lead to a less-hawkish Fed. The market took those sentiments and ran with them, as expectations for rate cuts in 2024 exploded from just two expected cuts in October to seven expected cuts by December, starting with the first rate cut expected in March! However, so far this year, those expectations have been substantially reversed. Rate cut expectations have dropped back to around four for this year and all the while, fed funds rate is now at 5.50%, up from the rate in October at 5.375%[2]. So, the S&P 500 has rallied 21% while fed funds has slightly inched up and the market expects four rate cuts, down from seven, but still higher than the Fed’s projection of two.
Factor 2: Yields. On Oct. 19, the 10-year Treasury yield hit (essentially) 5.00%[3]. Over the next three months, pressured by extreme dovish Fed expectations, the 10-year crashed lower to below 4.00%. Since then, the 10-year has rebounded and is threatening to break out of the 3.75%-4.25% trading range it has inhabited for the past several months. So, the S&P 500 has rallied 21% while the 10-year yield has declined from 5.00% to 4.25%, a level it held last summer.
Factor 3: Declining inflation. Inflation has fallen sharply from the highs of over 5% in May to around 4% in October (using Core CPI as the metric). But since then, inflation has been flat as Core CPI is still sitting, essentially, at 4.0% y/y. The Core PCE Price Index has fared slightly better with year-over-year inflation declining from 3.39% to 2.80%[4]. So, the S&P 500 is up 21% while inflation metrics have drifted only slightly lower.
Factor 4: Earnings. Back in October markets expected 2024 S&P 500 EPS to be between $245- $250/share, far above the $225/share in 2023. But since October, earnings expectations have declined to around $243/share. Yes, it’s still showing solid earnings growth, but not quite as great as expected. So, the S&P 500 is up 21% while 2024 expected earnings have declined very slightly since then.
Factor 5: Goldilocks economic growth. Economic growth has continued to point towards a No Landing/Soft Landing, with the labor market remaining very strong while there have been some hints of weakness from the consumer (credit card default rates, soft January retail sales). So, the S&P 500 is up 21% while economic growth has remained stable.
Here’s the point of this analysis: The fact that stocks have rallied since October makes sense. I expect the Fed will cut (it’s just a question of when), yields have fallen sharply allowing multiple expansion, inflation has continued to (slightly) decline while growth has remained resilient. However, if we follow the analysis to its logical conclusion, one cannot help but feel this relentless rally may have gone far beyond either actual improvement in the fundamentals and reasonable expectations of continued improvement. Put simply, at 22X earnings, this market is pricing in perfection with no wiggle room for disappointments. While there has absolutely been positive motion since October, I now view 5,100 in the S&P 500 as enjoyable, but extremely vulnerable to a sudden, potentially violent, reversal if the proverbial “music” stops in this game of financial musical chairs. My preferred tactical strategy essentially reflects the desire to reduce risk as the market moves higher, yet stretches well beyond even very aggressive fundamental justifications. That’s why I’m narrowing the stops and hedging with options to reduce beta. Yes, perhaps trees can grow to the sky in the financial world, and I hope they do. But at this point, with markets this stretched near term, I can’t help but worry any “bad” news could cause a 10% drop in this market a lot easier than any “good” news could cause a 10% rally.
Disclosures:
Investment advisory services offered through Robertson Stephens Wealth Management, LLC (“Robertson Stephens”), an SEC-registered investment advisor. Registration does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. This material is for general informational purposes only and should not be construed as investment, tax or legal advice. It does not constitute a recommendation or offer to buy or sell any security, has not been tailored to the needs of any specific investor, and should not provide the basis for any investment decision. Please consult with your Advisor prior to making any investment decisions. The information contained herein was compiled from sources believed to be reliable, but Robertson Stephens does not guarantee its accuracy or completeness. Information, views and opinions are current as of the date of this presentation, are based on the information available at the time, and are subject to change based on market and other conditions. Robertson Stephens assumes no duty to update this information. Unless otherwise noted, any individual opinions presented are those of the author and not necessarily those of Robertson Stephens. Performance may be compared to several indices. Indices are unmanaged and reflect the reinvestment of all income or dividends but do not reflect the deduction of any fees or expenses which would reduce returns. A complete list of Robertson Stephens Investment Office recommendations over the previous 12 months is available upon request. Past performance does not guarantee future results. Forward-looking performance objectives, targets or estimates are not guaranteed and may not be achieved. Investing entails risks, including possible loss of principal. Alternative investments are speculative and involve substantial risks including significant loss of principal, high illiquidity, long time horizons, uneven growth rates, high fees, onerous tax consequences, limited transparency and limited regulation. Alternative investments are not suitable for all investors and are only available to qualified investors. Please refer to the private placement memorandum for a complete listing and description of terms and risks. This material is an investment advisory publication intended for investment advisory clients and prospective clients only. Robertson Stephens only transacts business in states in which it is properly registered or is excluded or exempted from registration. A copy of Robertson Stephens’ current written disclosure brochure filed with the SEC which discusses, among other things, Robertson Stephens’ business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. © 2024 Robertson Stephens Wealth Management, LLC. All rights reserved. Robertson Stephens is a registered trademark of Robertson Stephens Wealth Management, LLC in the United States and elsewhere.
Securities offered through Fortune Financial Services, Inc. Member FINRA/SIPC. Robertson Stephens Wealth Management, LLC and Fortune Financial Services, Inc. are separate entities and are not affiliated.
For information about Robertson Stephens, go to www.rscapital.com.
[1] Morgan Stanley
[2] Federal Reserve Bank of New York
[3] YCharts
[4] Bureau of Economic Analysis 02/29/2024 release
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