The Week Ahead - 12/29/24
A comprehensive look at the upcoming week for US economics, equities and fixed income
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As a reminder, some things I leave in from prior weeks for reference purposes, because it’s in-between updates, etc.. Anything not updated is in italics. As always apologize for typos, errors, etc., as there’s a lot here, and I don’t really have time to do a real double-check (and it’s a staff of 1).
NOTE TUESDAY’S UPDATE WILL BE ON WEDNESDAY
The Week Ahead
I said last week “we can now settle in to a more traditional late December feel (at least in terms of economic catalysts) with a relatively sparse data calendar the next two weeks which are both cut in half by holidays, giving quite a bit of incentive for traders to take one (or both) weeks off. Expect light volumes and lots of ‘out of office’ replies.” So that continues for another week.
In terms of the data, as I noted last week, the BEA cleared the decks of major data releases by moving the personal income and spending report well ahead of its normal schedule of near the end of the month to the 20th, leaving us with just some more “second level” (but still important) data in the upcoming week in Nov pending home sales, home prices, and construction spending, and final Dec manufacturing PMIs (S&P Thursday, ISM Friday) plus the normal weekly reports (jobless claims, mortgage applications, and EIA petroleum inventories).
In terms of Fed speakers, I saw one on the calendar in Barkin on Friday, so there may be others.
No US Treasury auctions outside of Bills (<1 yr).
Another week of no SPX components reporting earnings. We do get BHP on Monday, but no US reporters >$2bn (Greenbrier Companies is the largest on Friday ($1.9bn)).
From Seeking Alpha (links are to their website, see the full earnings calendar):
The earnings season’s wind down is nearly complete, with no major companies due to report quarter results next week.
Ex-US a light week as well. Note most of the rest of the world takes Tuesday off in whole or in part (again wish we did that here). BBG again didn’t do a weekly update like they normally do, but I again looked through their economic calendar (link below) and the major items were they’ve got global Dec PMI’s, Germany employment and South Korea preliminary trade data, and Nov UK and EU Nov consumer credit.
https://www.bloomberg.com/markets/economic-calendar?sref=E10pTi1i
And here’s BoA’s cheat sheets. As I noted two weeks ago, it looks like that was their last one all the way through Jan 10th, so I included just this week (and will update in future weeks w/the data for that week).
And here’s calendars of 2024/2025 major central bank meetings.
Market Drivers
So let’s go through the list of items that I think are most important to the direction of equity markets:
Fed/Bonds
As noted previously this was one of the sections that had grown unwieldy, so I’ve really pared it down. Given I provide daily updates on Fed expectations, Fedspeak, and analyst thoughts on the Fed, it’s duplicative (and time consuming) to gather it all again so, again, I encourage you to look at those (the daily posts) for updates. I will just give more of a quick summary.
To give some background, I noted two weeks ago before the Dec FOMC meeting,
now we have that [CPI] print in hand, as well as the market reaction, and as noted in the Wednesday update, it “sealed a December rate cut by the Fed next week,” but also showed “core inflation remaining well above the Fed’s 2% goal, which all things equal will result in a slower pace of rate cuts than markets were expecting a couple of months ago and raising concerns of a prolonged pause if it continues to show little progress.” In that regard, as I’ve mentioned previously, I foresee what’s being described as a “hawkish cut” by some meaning a pivot to quarterly cuts after December, a reduction in the number of expected 2025 cuts, and some recognition that the endpoint is likely above 3%. Still with the Fed remaining uber-data dependent, Powell will not do much else I don’t think beyond setting expectations that January will likely be a pause. Markets already expect that with just a 25% pricing for a cut (assuming a December cut), so it shouldn’t really cause any sort of market issues.
And then last week,
the strange thing is, I mostly got that right in terms of what happened, but my prediction on the market reaction was certainly not. First, while I foresaw a reduction in 2025 cuts, as I noted in the daily updates, I did think the market might not like it if they went all the way to two, which is what happened. Second, I think Powell “oversold” the slower pace a bit and confused things with his talk about “exiting the recalibration phase” and a “more traditional Fed posture” even as he talked about rates still being “restrictive” and that “we and most other forecasters still feel that we're on track to -- to get down to 2 percent it might take another year or two from here, but I'm confident that that's the path we're on.”
That implies that rates will continue to be cut towards what the committee (on balance) feels is a terminal rate in the 3’s not the 4’s, “it might just take another year or two”. Markets though are saying we might get one or two more cuts, and that’s it. So there’s clearly a disconnect there, and it’s one that we have seen time and time again the last few years. Markets extrapolate recent trends too far (they were expecting 5 cuts in 2025 not too long ago), and I think this may be one of those cases.
That said, just a few cuts before a prolonged hold would be consistent with the 90’s “soft landing” experience, and it’s certainly not implausible that inflation gets “stuck” around current levels and growth and labor markets remain in good enough shape keeping the Fed to just one or two (or I guess no) cuts in 2025, but I think it’s also not unlikely that we see continued softening in labor markets and the economy, and with just 18% of investors expecting a recession in 2025, it feels like a growth scare and a quicker path of Fed rate cuts is underpriced.
As we’re basically just marking time at this point until we get to the week of the NFP report, I don’t have a lot to add, as markets haven’t changed much other than to see 10yr yields push back up towards the 4.7% level (discussed more below), mostly a reflection of increased uncertainty (term premium). Fed pricing remains around 35bps of cuts (so one cut priced, a second 50%) which remains even less than the Fed saw in the Dec “dot plot” (see post below). I continue to find this to be quite hawkish, but until we get some indication of a growth scare or a strong resumption in the trend towards 2% core PCE I don’t see that changing much.
And looking further out there is an even larger disconnect.
Looking at the Treasury markets, with yields rising more on the long end again last week, the 2/10 curve steepened another 9bps w/w to +0.31% Fri according to the St. Louis Fed, the highest since May ‘22. I had said 2 weeks ago “this should steepen further following the FOMC meeting I think,” and it has certainly done so.
As a reminder, historically when the 2/10 curve uninverts following a long period of inversion the economy is either in a recession or within a few months of one. Given we just got a 3.1% GDP for 3Q and are currently estimating around 2% for 4Q, it seems like the days of the 2/10 curve as an infallible recession indicator may be numbered.
The 3mos/10yr yield curve (considered a better recession signal than 2/10’s w/the last four recessions on average coming a few months after the curve uninverted (prior to that it generally uninverted after a recession had already started)) similarly continued its dramatic resteepening since late Sept +13bps w/w after moving into positive territory for the 1st time since Oct ‘22 two weeks ago also at +0.31% (up +1.44% since Sept 11th). The fact the two yield curves are equal tells you how rich 2-yr yields are.
In that regard (the richness of 2yr yields) the gap between 2yr Treasury yields and Fed Funds remains at just 3bps (after being at a record wide 1.77% before the Sept FOMC meeting), implying that there will be no further net rate cuts over the next 2 years. As I said last week, “ I’ll bet the under on that.” As I mentioned last week, I have shifted some cash into 2 years.
Long term inflation expectations (as measured by the 5-yr, 5-yr forward rate (exp'd inflation starting in 5 yrs over the following 5 yrs), specifically mentioned by Powell at the Nov FOMC press conference (he said the metric was “right where it’s been, consistent with 2% PCE inflation”), moved to a 2-mth high at 2.31% on Thursday (+7bps w/w but just +2bps since the Nov FOMC).
With the increase in inflation exp's offsetting the rise in nominal 10yr Treasury yields, 10yr real rates eased off from the joint highest of the year the previous week -5bps to +2.23%, still remaining well above the 2010-2020 peak of 1% (but down from the post-pandemic peak Oct ‘23 of 2.5%).
10yr real rates using 5-yr, 5-yr forward inflation expectations (subtracted from the 10yr nominal yield) eased off as well (after jumping +22bps the prev week to the highest since Nov ‘23) -2bps to 2.27%,, also well above the 2013-2020 average of around 0.5% (but down from the post-pandemic peak of 2.5% in October '23).
And as a reminder according to BoA the importance of real rates on equity returns has seen the largest increase in the factors they track over the past 5 yrs and explains a larger proportion of stock returns (83% correlation) in their data (to 2006), with the dollar close behind the most correlated (76%) since 2015.
Shorter-term real yields (Fed Funds - core PCE) fell following the FOMC rate cut to 1.82%, the least since Sep ‘23 and down from 2.70% in June (which was the highest since 2007), but still well above anytime in the 2010-2020 period.
And the real prime rate (using core PCE) continues to edge lower from the 5.9% in June, which was the highest since Sep 2007. Now down -90bps at 5.0%, still though more than double the 10yr pre-pandemic avg.
And looking out longer term, one thing to note is the FOMC’s long run projection for the endpoint of the Fed Funds rate (the “neutral rate”) is now the highest since Sep 2018 at 3.0% (and not unlikely to go higher as I said earlier this yr). [This won’t get updated again until March].
As noted last week, for some reason the St. Louis Fed is not updating their 10yr term premium estimate until the following week, so I’ve switched to a different one from MacroMicro which uses a different model (ACM model) which is solely based on interest rates. That hit +0.43% this week just off the Oct ‘23 high which was the highest since 2015. It’s now +54bps since the FOMC did the 50bps cut in Sept.
I had been a broken record since the Spring that I thought at some point (most likely around the election) this could resurface as an issue that will push yields higher perhaps cause some mild equity indigestion as it did in Oct of last yr. I thought maybe the issue had past with the market continuing to grind higher, but now it seems we’re getting some of that.
https://en.macromicro.me/charts/45452/us-10-treasury-term-premium
The extended discussion on term premium (what it is, why it’s important, etc.), can be found in this section in the Feb 4th Week Ahead.
As the MOVE index of expected 30-day bond volatility moved further off the least since Feb 2022 but still remains relatively low considering the jump in 10yr yields this week. Still it's near the highs of the month.
While bond volatility edged higher, 30yr mortgage spreads fell -9bps to 2.27%, the least since June ‘22. They are now down to around +55 bps above the 2010-2020 avg level.
Chicago Fed National Financial Conditions Index and its adjusted counterpart (which are very comprehensive each w/105 indicators) in the week through Dec 20th saw the former remain at the least since Nov ‘21 (but that was revised up from the least since Jul ‘21 in the initial read) but its adjusted counterpart (which attempts to remove the correlation between the various indicators due to broad changes in economic conditions) edged higher (tighter) for a 2nd week from the loosest since Nov ‘21.
I had noted we might see this happen given the dramatic rise in real yields, and it looks like it’s coming through.
https://www.chicagofed.org/research/data/nfci/current-data
Goldman has seen a tightening in their financial conditions index as well.
Looking at the Fed’s balance sheet/QT, we continue to see liquidity drained from the system. The most visible area has been in reverse repos (which is an overnight secured place institutions (mostly money markets and banks) can park excess funds to accrue some interest designed by the Fed originally to keep excess liquidity from pulling down rates too much in other short term markets). RRP has been steadily drained as money has been redirected to purchase the continued sizeable issuance of T-bills (<1 yr duration) of around $800bn/month (accentuated by the $60bn in balance sheet runoff (meaning the Fed has reduced its buying of maturing Treasuries by that amount which the private market has to fill)) which quickly drained ~$1.75 trillion from RRP in the year through March 1st. From then until early July RRP levels had remained relatively stable in the $375-$500bn range, but since early July they resumed their decline (in fits and starts), now hitting new lows.
With the Fed now cutting RRP rates to the low end of the Fed Funds band, it has made parking funds there (versus lending overnight to other institutions or buying T-Bills) less attractive meaning we’re likely to see RRP continue to fall to whatever is the “minimum” level (some participants will use it just due to ease of use, etc.).
Despite that, RRP has finally started to build as it has in every quarter end over the past year, now up to $197bn (although that's by far the lowest of any quarter end the past two years), +$100bn w/w after it fell under $100bn for the 1st time since April ‘21 the previous week (which as I noted meant at this point the Fed has “sopped up” most of that “excess liquidity” (as they have described it)). If we follow history this will continue to increase into Tuesday (the 31st) then fall off sharply on Thursday (the 2nd).
Also, we’ll have to see how the debt ceiling, which comes back into play on the 3rd impacts things. With T-Bill issuance likely to be paused sometime in January (Janet Yellen said last week that “extraordinary measures” would start in January), until the debt ceiling is raised the likely consequence is a build in RRP as money markets, etc., need another home for their short-term lending. This was what BoA predicted back in Sept. Their analysis has been pretty accurate (they saw RRP falling to $185bn by YE (about where it is now).
This liquidity pumped back into the system will also "mask" any liquidity strains from QT in their opinion as long as the Treasury is drawing down the TGA.
As noted previously, despite the drawdown in RRP Dallas Fed Pres Laurie Logan (who is an important voice given her extensive experience in the NY Fed's markets group) has said she believes current liquidity is “more than ample” (and the current NY Fed Pres Williams said something similar two weeks ago) and said she's looking for RRP to fall to "negligible" levels. As I said then “she's the expert so I'll defer to her, but I continue to be on the lookout for funding stresses now that RRP has crossed below $100bn, and I still think at zero RRP the Fed may need to stop QT to avoid another liquidity shortage as they did in late 2018.”
And in terms of those funding stresses another one popped up in SOFR (overnight bank lending) rates, although so far nothing more than we’ve seen in previous quarter ends, and per the note above, to the extent the Treasury starts to draw down the TGA, it will pump liquidity into the system.
And as noted previously, BoA, who had previously estimated that RRP would fall to zero in Oct has pushed that out now to Jan ‘25. For more on BoA’s forecasts for RRP to drop to near zero ($60bn) by Oct you can follow the link and look in this section (but it’s mostly due to RRP yields falling below those of money markets and will be soaked up by bonds (from Fed QT), the Treasury (with a higher TGA), and currency growth (in dollars). If bank reserves increase that would also pull from RRP. They see it building again into early 2025 before declining again towards zero.
And I’ll highlight the below link that I’ve left in for reference regarding the impact of the debt ceiling not being raised on time (this upcoming week which as noted will see the TGA draw start sometime in January). I hope it doesn’t take until July, but if it does go on for a few months, when auctions restart they will need to be resized to “catch up” which will see the influx of liquidity pulled back out. That didn’t really cause any issues when it happened May 2023 (the last late debt ceiling extension), but we also had a lot more liquidity in the system (RRP levels were at record highs above $2tn (arrow) but you can see from the chart they fell sharply from there, down around -$1.7tn over the next 10 months). We have nothing like that amount of “free liquidity” this time around.
For more on BoA pushing back their est for the end of QT to Mar ‘25 from YE ‘24 “which could create a funding blind spot for the Fed” in the event the debt limit (which expires at YE) is not resolved you can follow this link and look in this section. In summary their thinking is that, similar to earlier this year, the Treasury’s depletion of its General Account (TGA) will offset what would otherwise be a continued drawdown of liquidity. That will keep liquidity stable but will rapidly reverse once the debt limit is ultimately raised (which BoA est’s will again be in July as they assume Congress will take it to the very last second as is their habit), which could lead to a funding squeeze. However if the debt limit is raised in advance, the liquidity issue will come quickly as noted above, and we could very easily find ourselves in another 2018 scenario (which resulted in a near bear market).
Also pulling out liquidity from the system has been the repayment of BTFP loans as the Fed looks to wind down that facility by YE. Those have gone from a high of $167bn in March to now just $6bn, consistent with my prediction in September that these would be gone by YE.
Despite the RRP drawdown having reversed for now (RRP was being used for much of this year to supply extra liquidity to other funding needs (T-Bill auctions, BTFP payback, etc.)) bank reserves only saw a modest drop in the week through Wed of -$20bn w/w to $3.22tn, still leaving them with some breathing room from the $3tn level which we haven’t revisited since the indigestion in the credit markets in March ‘23 (which contributed to the banking issues (SVB, etc.)). This means YE liquidity needs are coming from other sources (which is why the Fed restarted some programs to provide extra liquidity if needed).
Overall, bank reserves remain just -$140bn below June 1, 2022 levels ($3.36tn), when the Fed started QT, a much better result than even the most optimistic estimates at the time.
For background on various estimates of when reserves will be “too low” see the Feb 4th Week Ahead.
Getting back to rates, I said 8 months ago 2-year Treasuries were a good buy at 5%, and as I noted once the Fed started its cutting cycle the ship has likely sailed on seeing those yields anytime soon (meaning years). In terms of 10’s I had advised then grabbing some at 4.7% which I had thought seemed like something we wouldn’t see anytime soon, but as I noted six weeks ago “we’re already back to 4.45% and 4.7% doesn’t seem so far away. I still think it will take something ‘new’ to push over 4.5% (a hot inflation print, very strong payrolls report, etc.), but we’ll see.”
As noted last week, the Fed saying the “recalibration phase has ended” was certainly something “new,” and as expected, it, along with concerns about sticky inflation cropping back up and now questions about the inflationary impact of some of Donald Trump’s policies, has seen rates just about there. I still am not sure we see 5% absent another “something new” (like the Fed becoming even more aggressive (for example due to Dec’s data coming in hot (payrolls and CPI/PCE prices)). In terms of much lower yields, as I said 11 weeks ago, we have probably seen the lows until we get a recession:
“while we didn’t quite see 3.5%, I think 3.6% is close enough, and I think we might have been at or near the lows at this point, particularly as the Fed has been raising their neutral rate estimate. If the endpoint for Fed Funds is around 3% (or higher) then it’s hard to see the 10yr trading much lower absent a recession. Similarly 2yrs at 3.6% seem to be very rich and almost certainly too low absent a recession consistent with my statement last week.” In short I’d expect to see 4% on these before we see 3.2%:
At around 3.6% on both the 2 & 10yrs absent a recession I think there’s not much value in either (I’d rather park my cash in short term Treasuries (0-3mths) or safe dividend paying stocks with a track record of growth (dividend aristocrats, etc.) at these levels.
At this point I have started to dip my toes back in to 2yrs as noted above, given it’s now pricing no further net cuts from the Fed over the next 2 years, and I will step up my buying of 10yrs if they do make it to 4.7% which seems highly likely, but keeping plenty of powder dry for a potential run to 5% .
For all the old “final hike” and “first cut” materials, you can reference the Feb 4th blog post.
BoA updated their FOMC Dove-Hawk Chart. Note it’s missing Hammack in ‘26 (Cleveland and Chicago vote every 2 yrs), but otherwise looks right. Also note that Philadelphia Fed Pres' Harker’s term is up next year (which is why they don’t have a name for Philadelphia), something I didn't realize.
Also, I had a little back & forth with them arguing that Schmid should be "Hawkish" considering that he didn't dissent (versus Bowman) and that Goolsbee seemed more dovish than Harker. Here was their response (which makes some sense):
In a recent dot plot (I think June), Goolsbee identified himself as not the outlier, which led us to conclude Harker is the outlier. On the other end of the spectrum, there were two people forecasting 50bp of total cuts this year. We think they’re probably Bowman and Schmid. If we had more granularity, we’d rate Bowman as more hawkish, but with only five categories, I’m comfortable with putting them in the same bucket.
I think this now needs some dramatic changes with Hammack (who dissented voting for no cut in Dec) clearly one of the most hawkish members, Daly at best a Centrist as she sees only 2 cuts in 2025, and perhaps Collins as well. Goolsbee is clearly the most dovish of the members currently.
And I came across one from BBG. I think it’s pretty accurate except Kashkari is definitely not that hawkish (he was calling for a December cut in early November):
Earnings
As a reminder, I have removed most of the background material, which you can get in the Feb 4th blog post. As you know I’ve moved on to 4Q and beyond. You can reference this post from 12/1/24 for stats on 3Q.
No update from Factset this week, so I didn’t update this section other than to provide a couple new posts at the bottom.
Expectations for Q4 earnings improved a tenth this week to +11.9% (still down -2.6% since the start of the quarter, slightly less than the 5 & 10yr avgs (-3.4% & -3.3%) for this period). 11.9% would be the most growth in three years and would mark the 6th consec quarter of earnings growth.
Looking more specifically at Q4, according to Factset, just 5 industries are responsible for most of the 12% in exp'd earnings growth in Q4: Banks (181% exp'd growth), Semiconductors & Semiconductor Equipment (34%), Pharmaceuticals (64%), Interactive Media & Services (25%), and Broadline Retail (48%). "Excluding these five industries, the estimated earnings growth rate for the S&P 500 for the fourth quarter would fall to 1.6% from 12.0%."
In terms of Q4 revenues, SPX co’s are expected to see revenue growth of 4.6% y/y (down two tenths w/w), down from +5.2% on Sept 30. It would mark the 17th consecutive quarter of revenue growth for the index.
In terms of profit margins, co’s are expected to report net profit margin of 12.0% for Q4, which is below the previous quarter’s net profit margin of 12.2%, but above the year-ago net profit margin of 11.2% and the 5-year average of 11.6%.
2025 quarter-by-quarter earnings expectations were mixed this week with some 1H earnings getting pushed later or just priced out. Q1 ‘25 fell seven tenths to +12.1% (-2.0% last 7 wks) & Q2 ‘25 also seven tenths to +11.4% (-1.9% last 7 wks). Q3 was up four tenths to +15.6%, but Q4 edged two tenths lower to +16.7%
The lower Q4 earnings expectations saw FY ‘24 exp's edge down a few cents to $239.92 (still +57 cents above the low 3 weeks ago), still representing +9.5% growth. Looking further back, it remains down just around -2% from July 1, 2023, much better than the typical -6% or so drop we historically see.
2025 earnings expectations also fell for the 1st wk in four a larger -9 cents to $275.15 (still +15.0% growth), up +56 cents from low 4 wks ago which was the least since February.
In terms of the $275.24 exp’d for 2025 Factset notes it will be a record although also notes that there is on average over the past 25 yrs a -6.3% deterioration from where it starts the year (so Jan 1, 2025) w/analysts overestimating in 17 of those yrs. But it should be noted that average includes 4 outlier years (2001, 2008, 2009 & 2020) where the overestimation was b/w 27-43% due to recessions. Excluding those, the difference is just -1.1%.
Factset also notes that “"analysts believe earnings growth for companies outside the 'Magnificent 7' will improve significantly in 2025. While analysts expect the 'Magnificent 7' companies to report earnings growth of 21% in 2025, they expect the other 493 companies to report earnings growth of 13%...a substantial improvement to ...just over 4% earnings growth for these same companies for CY 2024."
In terms of exp’d 2025 revenues, analysts are looking for 5.8%, above the 10-year average of 5.1% (2014 – 2023). Ten of the eleven sectors are projected to report year-over-year growth in revenues, led by the Information Technology sector. The Energy sector is the only sector expected to report a year-over-year decline in earnings.
They also see at a record profit margins at 13%, well above the 10-yr average of 10.8% and the highest since Factset started tracking the metric in 2008 (previous high was 12.6% in 2021).
In terms of how markets are handled earnings beats & misses for 3Q, looking 2 days before to 2 days after an earnings release, Factset saw beats rewarded more than average at +1.6% vs 5yr avg of +1%, and misses punished more than average (-3.1% vs 5yr avg of -2.3%).
Factset’s analysis of analyst bottom-up SPX price targets for the next 12 months as of Thursday was up another 56pts w/w to 6,678, now up ~1,655 points over the past 39 weeks. Health Care remains with the largest upside seen by analysts (+19.7% (up from +17.5% last wk and +13.1% 3 wks ago before the “Kennedy” selloff)) followed by Materials (+16.8%), and Energy (+16.7%), while Consumer Discr remains as the sector expected to see the smallest price increase (-3.3%, the first negative we’ve seen this year).
As a reminder the last 20 yrs they have been on avg +6.9% too high, but note they underestimated it five of the past six years (including 2024 unless the SPX crashes).
In terms of analyst ratings, buy and hold ratings continue to dominate at 54% & 40.1% (from 53.7 & 40.1% respectively last wk (sell ratings fell eight tenths to 5.1%)). That 54% though is down from 57.5% in Feb ‘22.
Communication Services (61%), Energy (61%), and Information Technology (61%) sectors have the highest percentages of Buy ratings, while Consumer Staples (41%) and Utilities (48%) have the lowest percentages of Buy ratings. Financials, Industrials, and Utilities have the most sell ratings (8%).
And some other earnings stuff:
Economy
Over the past 2+ years part of my earnings optimism has been due to the economy holding up better than expected. While earnings only track the economy loosely (and markets look forward 6-12 months), there is a clear correlation between recessions, lower earnings, and lower stock prices (although stock prices (being as noted forward looking) generally fall in advance of the recession and bottom 6-9 months before the end of the recession). So if you can see a recession coming it is helpful, although very difficult (especially ahead of the market). You can reference this Week Ahead (see the Economy section) for a lot of material on how every recession is preceded by talk of a “soft landing” as close as a month before the start. On the IRA infrastructure act, the November 26 report has good info on how that should be supportive at least through the end of this year. That report also has the notes about how small caps have shorter debt maturity profiles and more of it.
As I’ve been stating since I switched to the Week Ahead posts in mid-2022, the indicators to me are consistent with solid (which at times has been robust) economic growth, and I have been a broken record that I “certainly [did] not think we’re on the verge of a recession (although as noted above every recession starts out looking like just some economic softening).” But several months ago I added: “That said, I’ve also noted over the past __ weeks or so [it got to 22], we have clearly started to see some moderation in key areas like consumption, manufacturing, construction, exports and housing.” Following that was a stretch of 10 weeks were I changed that to describe “the data [as] fairly strong, more consistent with what we’d been seeing at the start of the year.” That took a turn 5 weeks ago with some weaker than expected data, although as I caveated some of it was impacted by hurricanes or strikes and others like GDP and personal spending while softening remained at robust levels, but the “slew of data” two weeks ago confirmed my statement that “what I can say with confidence is all of this evidences an economy that is slowing from elevated levels but continues to grow at or above trend.”
We didn’t get a lot of data this week, but what we got remained consistent with consumer confidence mixed but confirming the labor market remains in decent shape even as economic conditions weaken a bit, durable goods orders showing strong business cap ex, a bounceback in new home sales which remain around pre-pandemic levels, low initial jobless claims but increasing continuing claims, and both imports and exports saw solid increases.
In that regard I don’t really see any changes to my overall takeaway on the economy from 13 weeks ago, “the situation continues to seem like manufacturing is subdued but trying to bottom, housing perhaps has inflected off the bottom [although that has softened of late with the jump in mortgage rates (although perhaps now buyers have become “used to” higher interest rates)], labor markets (and the services sector and construction in particular) are solid [although it seems there might be some slowing from elevated levels] with very healthy wage growth, and productivity appears to be robust (something I think you’re going to be hearing more and more about)…I continue to feel that any softening does not appear to be morphing into a recession.”
And as I said 18 weeks ago:
without question, the evidence is building that the days of >3% real GDP growth are behind us (although we got there in Q3), and we should be happy to settle into something more around trend (1-3% real (infl adjusted) growth). That though is far from a disaster. The important thing will be to see the softening level out (L-shape) rather than continue to fall turning the “soft landing” into a recession.
So far that’s what we’ve seen.
The Citi Economic Surprise Index fell for a 5th week to the least since October 2nd (when it was going the other direction) at 3.2, now down -40.1 pts from 43.3 five weeks ago, back to around halfway between the highs of the year (47.2 in Feb) and the lows (-47.5 in July).
And GDP estimates are for now consistent with a no recession call (again though remembering GDP going into recessions generally doesn’t look like one is coming (it was up around 2% in Q2 & Q3 2008 well after the recession had started)). After Q3 was revised up to 3.1%, trackers for Q4 are a bit all over the place but mostly in agreement that we should see around 2% (trend) GDP growth again (although they are as low as St Louis Fed’s +1.23% (which is generally too low) to as high as +3.1% from the Atlanta Fed (who has been pretty accurate, but jumps around a lot).
Goldman (who was 3.0% for 3Q vs 2.8% actual 1st est) lowered their 4Q GDP estimate a tenth to +2.3%.
Atlanta Fed (who was right in line in its 3Q est of #GDP (and just a tenth off for 2Q from the 1st est)), saw its 4Q GDP estimate remain at +3.1% as of Tuesday.
BoA (who as a reminder est’d 3.0% for 3Q vs 2.8% actual), didn’t update their 4Q GDP tracking this week. Last week it was at 2.1%. Their “official” house est is 2.0% y/y growth in 4Q.
NY Fed’s 4Q GDP Nowcast (as a reminder, they had 2.91% for 3Q vs 2.8% 1st est) fell back this wk to 1.86% from 1.90%, mostly on the drop in durable goods shipments from Monday’s report. As a reminder, the NY Fed’s model is dynamic and so adjusts in real time as data evolves, but no “parameter revisions” this wk.
They also lowered their Q1 ‘25 GDP forecast to 2.08% from 2.13%.
And the St. Louis Fed GDP tracker, which outside of Q1 this yr (where it was the closest) has undershot actual real GDP since Q3 ‘22, continues to see sub-2% growth although improving +0.13% to 1.27% for Q4 continuing the pattern of lagging all the other GDP trackers.
Weekly Econ Index from the DallasFed (scaled as y/y rise for GDP), which runs a week behind other GDP trackers, remains a little jumpy, falling back to 2.33% in the week through Dec 22nd from 2.77% the prior week (revised slightly from +2.70% ) putting it back into its range this yr (1.49 - 2.66% that it’s left only twice (last week at 2.77% & a month ago when it jumped to 3.21%)). The 13-wk avg remained at 2.14%, evidencing overall economic momentum slightly above trend.
https://www.dallasfed.org/research/wei
Other economy stuff:
Valuations
Like the other sections, I’ll just post current week items regarding the multiple. For the historical stuff, see the Feb 4th blog post.
With equity indices edging higher this week, forward P/E’s did as well:
-The SPX forward P/E up two tenths to 21.8 (still down five tenths the last three weeks from the highest since mid-'21).
-Mid-caps (S&P 400) up one tenth to 15.9 (still down -1.2pts the last four weeks from the highest since early-’21 (17.1)).
-Small caps (S&P 600) were also up one tenth to 15.7 (still down -1.4pts the last four weeks from the highest since early-’21 (17.1)).
-Yardeni's “Megacap-8” (adds NFLX) P/E up two tenths to 30.9, +4.5 pts from the 26.4 it hit 14 weeks ago (which was the least of the yr) and not far from the 31.5 it hit 22 wks ago (which was the highest since Jan ‘22)).
https://yardeni.com/charts/stock-market-p-e-ratios/
Other valuation stuff:
Breadth
Breadth improved over the past week, but it’s got a lot further to go before it really shows up in the indicators.
The McClellan Summation Index ("what the avg stock is doing") continues to fall, down to the least since Nov ‘23, with just the slightest indication the decline may be slowing.
% of stocks over 200-DMAs got a small bounce this week from the least since Nov ‘23 on the NYSE and a little bigger one from the least since Aug on the Nasdaq. The latter is in much better shape than the former, although it at least held the 50% mark.
% of stocks above 50-DMAs, similar to those over 200-DMAs, saw bounces from the least since Nov on the NYSE and since Aug on Nasdaq with the latter seeing more improvement. Former almost hit 25% last week.
% of stocks above 20-DMAs saw bigger bounces than those over 200 & 50-DMAs w/NYSE from the least since Mar ‘23 (but still under 20%) and Nasdaq from the least since Aug (but still under 40%).
Value/Growth was little changed after falling sharply for 3 weeks to the least since Jan ‘22. To say as I did 4 weeks ago that “we’re not seeing the dramatic jump we got following Trump’s victory in 2016,” was I said two weeks ago “a huge understatement”. As I said then, “what we’re seeing now looks more like the action we saw in 2017 when the ratio fell through Trump’s first term until it finally bottomed post-Covid.”
The equal-weighted SPX vs cap weighted ratio like value/growth was little changed after falling sharply for 3 weeks to the least since July (which is near all-time lows). Like value/growth this is the opposite of what we saw immediately following Trump’s victory in 2016, and, again like value/growth, more like what we saw in 2017 when the ratio fell throughout Trump’s 1st term until it finally bottomed post-Covid.
IWM:SPY (small caps to large caps), similar to value/growth and equal-weighted/cap-weighted in not falling further this week but only after dropping sharply for 3 weeks to the least since July. And similar to those other two ratios we haven’t seen the same kind of post-election bump we did in 2016. Unlike those, though, the ratio didn’t really start falling until mid-2018, but it is not holding up better this time around.
Equity sector breadth based on CME Indices over the past week was better than I thought with 9 of 11 sectors green (after every sector was down the prior week) with five up at least +0.8%, and the sector mix was good with no style dominating.
SPX sector flag from Finviz consistent w/lots of green and very few big losers (Accenture a notable standout -4.3%).
Other breadth stuff:
Flows/Positioning
BoA didn’t give the Flow Show update this week. A different services indicated that so just some limited updates on US only fund flows.
ICI data on money market flows saw a +$54.7bn inflow in the week through Dec 24th, bringing YTD flows to ~+$920bn (after $1.15tn in 2023) with total MMF assets at $6.81tn, a record high. Both institutional (+$37.5bn) and retail (+$17.2bn) saw healthy inflows. In terms of totals, 60% is institutional, 40% retail.
Looking at CTA (trend follower) equity positioning, BoA says according to their models “[e]quity longs in the US remain intact but are not stretched entering 2025 as equity vol is elevated and as well equity price trend is not fully long.”
So, after being big sellers on the SPX & RUT two weeks ago, it looks like they didn’t do much last week, with all their net length concentrated in the Nasdaq-100 (NDX). That gives a lot of room for SPX & Russell 2000 positions to add if we prices continue to move to the upside. NDX positioning though is at risk of selling if prices continue to weaken there.
Price trend growth has diverged now between the $SPX, $RUT & $NDX which all were around 67% a week ago. Now they are 64, 71, and 50% respectively. #Japan continued to improve to 31% (from 8% two weeks ago) while #Stoxx50 is -1% (from -28% two weeks ago).
In terms of gamma positioning, BoA says consistent with their previous notes this month (flagging some large options expirations particularly YE positioning around 6055): “SPX gamma has been highly volatile this week. For example, on Monday SPX gamma was +$5.6bn but by Tuesday gamma had risen to +$15.8bn (a 1-day increase of ~$10bn gamma). Behind the scenes, an outsized position in the SPX Dec31 6055 calls (dealers net long ~50k contracts) is helping to drive this exceptional variability in SPX gamma. As of Thursday’s close, $SPX gamma was +$13.9bn (96th %ile ytd). However, due to the looming Dec31 expiry gamma may be quite sensitive to spot moves. The current profile suggests gamma may fall to 0 at an S&P level of 5940 or climb up to +$17bn at 6060.”
As I’ve noted weekly this year, very high levels of gamma have acted as a market stabilizer for most of this year dampening volatility in both directions. When it’s fallen below $2bn or so (as it did 6 weeks ago) we’ve seen heightened volatility (which we did), and while it’s rarely been negative that has been associated with even higher volatility (which is what we saw 5 weeks ago (to the upside)). With gamma currently at the 96th %ile it should act as a stabilizing force and draw equities towards that large gamma footprint at 6055 all things equal. If we were to move past that (which though would mean we’d have to rally +1.4% from current levels) we could see things accelerate to the upside. As BoA notes though a drop under 5940 would see gamma fall to zero which could create a wave of selling.
BoA est's that risk parity strategies were sellers of equities, bonds, and commodities last week, but continue to heavily overweight bonds and underweight commodities & equities. As I suggested 10 wks ago though given the (relatively) lower equity volatility on a 30-day lookback window vs bonds, the gap should narrow, and we’ve been seeing that slowly happen since then which may be adding to the pressure on bonds. Commodities exposure is the least since mid-2023.
#oott
BoA est’s that volatility targeters (vol control), were big sellers last week taking back most of the increase in positioning since October which I mentioned seemed likely with the increased volatility post-FOMC. With last week remaining relatively volatile, I doubt we’ll see them rebuild much, if any, this week.
And BBoA notes “the amount of both S&P 500 and NASDAQ-100 futures that leveraged & inverse ETFs would theoretically need to trade for each 1% [move] slightly increased with spot [last] week,” but remains well below the Nov highs.
And some other notes on positioning:
And MS agrees with BoA & Goldman on buybacks likely breaking records this year.
And I’ve noted rebalancing is something to watch out for towards the end of the year and might also have been involved in Friday’s weakness.
Sentiment
Sentiment (which I treat separately from positioning) is one of those things that really only matters at the extremes (and even then, like positioning, it really is typically helpful more at extreme lows vs extreme highs (“it takes bulls to have a bull market”, etc.)). Last week I had noted “even before the selloff we saw sentiment fading back on some metrics, so I’d imagine when we get the readings this week, people will be much more cautious,” and that was broadly what we saw, but very marginally, and some like CNN’s Fear & Greed index actually improved, with investors still not heavily buying protection as seen from the 10-DMA put/call ratio, so certainly not yet a tailwind.
The 10-DMA of the equity put/call ratio (black/red line) a little surprisingly continues to evidence little concern remaining around the lowest since July (which was the least since Apr ‘22) indicating investors are still not interested in downside protection vs capturing upside returns despite recent weakness.
When it’s increasing it normally equates to a consolidation in equities and increase in volatility and vice versa (although we saw plenty of volatility this week without it lifting much).
CNN Fear & Greed Index continued its improvement after hitting “Extreme Fear” territory for the 1st time since Aug on Dec 19th up to 34, +6pts w/w, but remaining in “Fear” well below the 62 (“Greed”) it started the month at.
Looking at the components:
Extreme Greed = None
Greed = 5-day put/call options (from Fear)
Neutral = market volatility (VIX & 50-DMA); safe haven demand (20-day difference in stock/bond returns) (from Fear)
Fear = junk bond demand; market momentum (SPX >125-DMA)
Extreme Fear = stock price strength (net new 52-week highs); stock price breadth (McClellan Volume Summation Index)
https://www.cnn.com/markets/fear-and-greed
After “surging” 10 wks ago to 7.0, BofA’s Bull & Bear Indicator has done nothing but fall as ex-US metrics dominate (it’s a global metric), falling for a 10th week, -0.3pts now -1.9pts the past 3 wks), to 3.4, an 11-mth low on “HY bond & EM asset outflows, greater hedging against fall in S&P500, very poor global stock index breadth (>50% of global equity indices trading below both 50dma & 200dma);… Indicator levels reflect inability of uber-bullish US AI/tech sentiment to offset significant global cross-asset angst (see China, EM HY debt, EM FX, global cyclicals…).”
Helene Meisler's followers remain bullish for an 8th straight week, but a little less so than the previous week (after hitting the most bullish since April ‘21 five weeks ago), now at 54.4% voting next 100pts up, down from 63.7% the previous week (and 66.8% five weeks ago).
As a reminder this group is generally not a contrarian indicator. I took a shot at updating the chart.
Seasonality
As I said 4 weeks ago, if you’re basing your decisions just on seasonality, it doesn’t get any better than this through the end of the year (and into the start of next year). We’re now into the “Santa Rally” period (last 5 sessions of December and first two of Jan) which is generally very strong (although so far the SPX is negative through the first three sessions). Looking into January, though, things get dicier. In all years the 1st two weeks of January are strong with solid returns and up two-thirds of the time. However, while I don’t have the specific stats, I believe in yr 1 of the Presidential cycle January is less so (the year overall is for sure), which also coincides with the fact that year 3 of bull markets are generally weak. So in 2025 we’ll be moving from very strong seasonality to some of the weakest on the cycle clock. Of course, as always remember that seasonality is like climate. It gives you an idea of what generally happens, but it is not something to base your decision on whether to bring an umbrella.
And as we consider seasonality, a really nice post from Callie Cox about how you need to take historical analogies w/a grain of salt (unless you've dug into the history). Her chart on Presidential election yr performance w/ & w/o 2008 (when the SPX was -17% in Oct) is a wonderful example.
https://www.optimisticallie.com/p/a-history-lesson
For references to all of the “up YTD through Feb” see the March 3rd post. For all the very positive stats through March (strong 1Q, strong two consec quarters, etc.) see the April 14h post.
For the “as January goes so goes the year”, see the February 4th Week Ahead.
Final Thoughts
I noted last week
I can talk all I want about seasonality, systematic flows, earnings, breadth, valuations, etc., but at the end of the day it’s all overwhelmed when there is a macro-level change, which is what that was. The good news is that normally such a change is digested, and unless it has a long term impact on the overall picture, markets resume with whatever they were doing. While I do think “things have changed” at the margin, particularly in terms of the Fed’s requirement for further rate cuts (further disinflation), markets had already priced out almost all of the 2025 cuts, and this really just gave rates a little more of a push, but they remain well below the 5% level that really caused equity indigestion in 2023. I also think this sets up for a potential tailwind if/when some of that hawkishness turns back more dovish, but that’s for further down the line.
The declines last week also pushed markets into a relatively oversold condition. Putting that along with the reduction in bullishness, very favorable seasonality, solid economic growth, continued strong earnings expectations, continued record buybacks, reduced valuations, and systematic flows that, while having become more of a modest headwind versus the strong tailwind of a week ago, are not at the level of overwhelming the other factors (although that could happen if we were to see further equity weakness. So my hope, as I indicated in the Friday update, is that we get our traditional “Santa Rally” which is the last 5 sessions of December and first two of Jan.
And the Santa Rally started off great on Tuesday, paused on Thursday and reversed on Friday. We’ve still got four more days, so we’ll see what they bring. But we remain oversold, and the Santa Rally period is seasonally very strong. Buybacks continue to be robust, valuations and sentiment have eased off giving scope to rebuild (but far from “too low”), the economy remains in good shape, and there are still strong expectations for 2025 earnings. But we’re starting to lose some other tailwinds. Volatility has picked up making systematic flows less supportive and with seasonality turning less favorable as we cross deeper into January along with worries about the potential for the Fed further paring back on rate cuts and the new administration and its ability (and/or inability) to execute on its promises (along with YE rebalancing) it seems some might be selling in advance. Breadth stopped going down but remains weak, and long duration yields continue to climb. So overall, the picture for this week remains mildly bullish, but the headwinds are increasing.
This has been my mantra all year, but this will almost certainly change as soon as next week given the changes we’re seeing:
Overall this feels like a bull market (the economy is growing, earnings are growing, the Fed is much more likely to be cutting than hiking as its next move, the technical picture and seasonality are strong overall for this year, balance sheets are solid, there’s lots of liquidity, and there’s lots of stocks other than the biggest ones that are performing well (the equal weight SPX hit a new ATH to start December, etc.). So if/when we do get that sharp pullback I would think it will likely be an opportunity to buy (like most sharp pullbacks are), not a reason to run for the hills.
And as always just remember pullbacks/corrections are just part of the plan.
Portfolio Notes
Sold out of SBH, ULTA, trimmed NSANY, ABEV.
No buys.
Cash = 30% (held mostly in SGOV, MINT & BOXX (BOXX mimics SGOV but no dividend, all capital appreciation so get long term capital gains if you hold for a year) but also some non-TBill (>1yr duration) Treasury ETF’s (if you exclude those longer duration TBill ETF’s, cash is around 11%)).
Positions (after around the top 20 I don’t keep track of their order on a frequent basis as they’re all less than 0.5% of my portfolio).
Core positions (each 5% or more of portfolio (first 2 around 10% each, total around 25%) Note the core of my portfolio is energy infrastructure, specifically petroleum focused pipelines (weighted towards MLP’s due to the tax advantages). If you want to know more about reasons to own pipeline companies here are a couple of starter articles, but I’m happy to answer questions or steer you in the right direction. https://finance.yahoo.com/news/pipeline-stocks-101-investor-guide-000940473.html; https://www.globalxetfs.com/energy-mlp-insights-u-s-midstream-pipelines-are-still-attractive-and-can-benefit-from-global-catalysts/)
EPD, ET, PAA, SHY
Secondary core positions (each at least 2% of portfolio)
ENB
For the rest I’ll split based on how I think about them (these are all less than 2% of the portfolio each)
High quality, high conviction (long term), roughly in order of sizing
ENB, CTRA, GILD, GOOGL, PYPL, SCHW, PFE, ARCC, T, AM, TRP, XOM, SHEL, JWN, TPR, KHC, ADNT, CVS, O, BWA, GSK, EQNR, CMCSA, APA, DVN, ADNT, OXY, JWN, RHHBY, TLH, NTR, E, ING, VZ, KMI, VSS, VNOM, TFC, MPLX, KMI, VOD, FSK, CVX, ING, HBAN, STLA, NEM, CCJ, BTI, AES, RRC, FRT, BMY, VICI, DGS, WES, INDA, MPLX, CVE, KIM, MTB, BAYRY, SOFI, BEP, BIIB, SAN, TEF, KVUE, SLB, KT, SQM, ALB, F, MAC, VNM, MFC, GPN, CI, LYG, NKE, ORCC, LVMUY, EMN, ADBE, NVDA, BCE, KEY, BAX, SNOW, DAL, RTX, NOC, BAC, GD, M, BIO, GIS, OCSL, MSM, VRSN
High quality, less conviction due to valuation
Higher risk due to business or sector issues; own due to depressed valuation or long term growth potential (secular tailwinds), but at this point I am looking to scale out of these names on strength. These are generally smaller positions.
ILMN, AGNC, FXI, LADR, URNM, URA, STWD, PARA, CFG, YUMC, ORAN, KSS, CHWY, TIGO, TCNNF, TCEHY, JD, WBA, ACCO, KVUE, KLG, CLB, HBI, IBIT, UNG, EEMV, VNM, SABR, NSANY, VNQI, ST, SLV, WBD, BNS, EWS, IJS, NOK, SIL, CURLF, WVFC, VTRS, NYCB, ABEV, PEAK, LBTYK, RBGLY, LAC, CMP, CZR, BBWI, LAC, EWZ, CPER, MBUU, HRTX, MSOS, SIRI, M, CE,
Note: CQP, EPD, ET, MPLX, PAA, WES all issue K-1s (PAGP is the same as PAA but with a 1099).
Reminder: I am generally a long term investor (12+ month horizon) but about 20% of my portfolio is more short term oriented (just looking for a retracement of a big move for example). This is probably a little more given the current environment. I do like to get paid while I wait though so I am a sucker for a good well supported dividend. I also supplement that with selling calls and puts. When I sell a stock, I almost always use a 1-2% trailstop. If you don’t know what that is, you can look it up on investopedia. But that allows me to continue to participate in a move if it just keeps going. Sometimes those don’t sell for days. When I sell calls or puts I go out 30-60 days and look to buy back at half price. Rather than monitor them I just put in a GTC order at the half price mark.
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