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February 2024
Current Equity Exposure
Stocks started the year with a modest pullback, then rebounded in the second half of the month before retreating on the last trading day following the Fed’s interest rates decision. The S&P 500 and the Dow advanced 1.7% and 1.3%, respectively, while the technology-heavy Nasdaq underperformed by returning 1.0% for the month. The recent market movement can be attributed to the emergence of a “goldilocks” scenario where inflation will moderate, allowing central banks to cut rates early and aggressively. While we agree that inflation will moderate at a consistent pace this year, we anticipate a slower pace than market expectations, and expect core CPI to end up higher than 2% this year. Despite speculation following a dovish FOMC meeting in December, we believe a rate cut announcement in March is unlikely given the strength of the U.S. economy. Also, the post-meeting statement in FOMC’s January meeting makes it clear that the Fed will not cut rates “until it has gained greater confidence that inflation is moving sustainably toward 2 percent,” making a March rate cut increasingly unlikely. We are now forecasting a cut in May. On the corporate side, corporate earnings and profit margins have remained resilient despite higher interest rates and costs. However, we anticipate margin pressures in the medium term, given high interest rates, wage pressures, and inflation staying slightly higher than target levels. With this backdrop, we maintain a cautious allocation to equities and keep our U.S. equity exposure at 49%. We cut our international equity exposure from 76% to 66% during the month, given the softening macro and valuation signals in our international cash scaling model compared with last month.
The Factors
Valuation
Valuation metrics for equity remained negative. P/E increased from 22.9 at the end of December to 23.5 at the end of January.
Forward P/E increased to 23.0 at the end of January from 22.1 at the end of December.
Inflation-adjusted valuation metrics continued to be negative.
Equity valuation metrics relative to bonds remained negative with high bond yields.
Sentiment
U.S. manufacturing activity contracted for the 14th consecutive month, with the ISM manufacturing index remaining at 47.4 in December.
The University of Michigan Consumer Confidence Index increased significantly to 78.8 in January from 69.7 in December, driven by a notable improvement in inflation expectations.
The NAHB index climbed 7 points to 44 but remained below the neutral level.
Technical
Technical indicators were positive overall, with positive momentum and fear signals outweighing negative reversal signals.
The S&P 500 was 9% above its 200-day moving average, 7% above the 100-day average, and 3% above the 50-day average.
The VIX index started to climb from an extremely low level and settled at 14.4 at the end of the month.
Macroeconomic
Nonfarm payrolls rose by 216,000 in December, stronger than expectations. The four-week moving average of initial jobless claims remained steady at 202,250 as of January 20, the lowest level since February 2023.
Retail sales remained healthy, with 0.6% growth in December.
U.S. industrial production rose 0.1% in December.
What's Driving the Markets?
Resilient economic and improved sentiment data:After a pullback at the year-end, retail sales registered a robust gain of 0.6% in December, contradicting concerns about a decline in consumer activity. Also, manufacturing activity remained resilient, with a 0.1% increase in industrial production despite a PMI reading below 50. The housing market has also welcomed some good news, with mortgage rates falling from nearly 8.0% to about 6.6%. House prices saw another 2.3% increase in the fourth quarter, and housing permits continued to rise in December. Sentiment signals have also improved recently. The University of Michigan consumer sentiment index surged to 78.8 in January from 69.7 in December with increased optimism about the inflation outlook, recent stock market gains, and resilient labor market. Homebuilder confidence also saw a significant increase in the NAHB index at the beginning of the year for the second consecutive month. Lower mortgage rates have improved affordability, leading to increased buyer traffic, and the anticipation of multiple rate cuts by the Fed is expected to boost buyer activity further.
Mixed outlook for China: Despite China's headline GDP growth ending at 5.2%, above the target of 5%, we have a mixed outlook for its 2024 growth. We anticipate the extended and substantial contraction in property investment will partially offset the positive effect of policy stimulus. We observed an additional weakening in key indicators for property investment, with home prices declining most significantly in almost nine years. Also, high-frequency signals indicated a 40% year-over-year drop in property sales in the first half of January. On the consumption side, retail sales increased by 2.7% in December, lower than the third quarter's average of 4%. Despite expectations for stronger holiday tourism, we expect weakening household finances due to labor market challenges, rising debts and declining housing prices. On the positive side, the Chinese government and regulators have implemented various stimulus measures to boost confidence and stimulate demand, including a rise in fiscal deficit to 3.8% of GDP versus 3% of GDP.
Q4 Earnings:The Q4 earnings report is under way. Among the 25% of S&P 500 companies that have reported results, 69% have reported a positive EPS surprise, and 68% have reported a positive revenue surprise. However, the blended YOY earnings decline for the S&P 500 is -1.4%. We believe that the downward trend for earnings is likely to continue for the following reasons: 1) The activity data has generally softened recently, with ISM manufacturing PMI below 50 for the 14th consecutive month and the Empire State manufacturing survey suggesting further decline. 2) Positive earnings surprises alone are insufficient to boost market performance, especially since Q4 EPS projections have been significantly lowered, with the S&P500 EPS YOY growth dropping from 10% to 2%. 3) The primary driver of the Q4 market rally, the decrease in bond yields, is likely reaching the limit for now as the reprising of the Fed rate cut has been too aggressive in the last quarter. Also, corporate pricing power is diminishing and most of the pent-up demand has largely been absorbed.
As of 1/31/24. Data provided by Bloomberg, NorthCoast Asset Management, Federal Reserve History.
1 The NorthCoast Navigator is a market barometer displaying NorthCoast's current U.S. and international equity exposure and outlook. This aggregate metric is determined by multiple data points across four broad market-moving dimensions: Technical, Sentiment, Macroeconomic, and Valuation. The daily result determines equity exposure in our tactical strategies.
NorthCoast Asset Management is a d/b/a of, and investment advisory services are offered through, Connectus Wealth, LLC, an investment adviser registered with the United States Securities and Exchange Commission (SEC). Registration with the SEC or any state securities authority does not imply a certain level of skill or training. More information about Connectus can be found at www.connectuswealth.com.
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