Market Correction in Response to Inflation Concerns and Geopolitical Tensions

View in browser

You are receiving this communication because you are a client of or have expressed interest in NorthCoast Asset Management

May 2024

Current Equity Exposure

The equity market experienced a significant correction this month as stubborn inflation shifted the market narratives from the expectation of a Goldilocks outcome to a “high for long” Fed policy. The S&P 500 and the Nasdaq lost 4.1% and 4.4%, respectively, for the month, while the Dow lagged by retreating 4.9%. We remain cautious about the higher-than-expected inflation, the potential of further Fed repricing implied by the recent Fed official talks, rich equity valuations, as well as elevated geopolitical tensions. Also, high market concentration and stretched positioning increased downside risks. In addition, the unprecedented direct military clash between Iran and Israel has sparked concerns of a broader conflict, and the possibility of escalation in the region casts a shadow over risky assets. With this backdrop, we maintained our allocation to U.S. equities at 59% and international equity exposure at 74%.

The Factors

Valuation

Valuation metrics for equity remained negative. P/E decreased from 25.1 at the end of March to 24.3 at the end of April.
Forward P/E decreased to 21.0
at the end of April from 21.7 at the end of March.
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 expanded after contracting for 16 consecutive months, with the ISM manufacturing index jumping to 50.3 in March from 47.8 in February.
The University of Michigan Consumer Confidence Index declined to 77.2 in April from 79.4 in March, as rising gasoline prices and a stock market correction weighed on consumer outlook.
The NAHB index remained unchanged at 51 in April.

Technical

Technical indicators were positive overall, with positive momentum and fear signals outweighing negative reversal signals.
The S&P 500 was 7% above its 200-day moving average, 1% above the 100-day average, and 2% below the 50-day average.
The VIX index climbed in the middle of the month, reaching 19.2 with an escalation of conflict in the Middle East. It fell later in the month and settled at 15.7 at month-end.

Macroeconomic

Nonfarm payrolls rose by 303,000 in March, exceeding consensus expectations. The initial jobless claims remained low and steady, with the four-week moving average falling to 213,250 as of April 20.
Retail sales rose 0.7% in March, and February sales were revised up from 0.6% to 0.9%.
U.S. industrial production climbed 0.4% in March after rising 0.4% in February (revised upward from 0.1%)

What's Driving the Markets?

Inflation more than bumpy: For three consecutive months, the U.S. consumer price index has surprised to the upside. March's headline CPI rose by 0.36%, lifting the annual rate of the headline CPI from 3.2% to 3.5%. Core CPI came in at 0.4% and was up 3.8% relative to a year ago. Medical care services (jumped 0.6% in March) and transportation services (car insurance and maintenance) contributed to the upside surprise while shelter prices remained high. More concerning may have been a material increase in "supercore" inflation, which measures service inflation excluding food, energy, and housing. This measure jumped 0.7% in March, the most significant increase in the last ten months. On a more positive note, inflation in the OER (Owners' equivalent rent) component held steady at 0.44% m/m. With March's inflation estimates surprising to the upside amid continued tightness in the labor market and a resilient economy, the futures market is now pricing only an 8% chance of a rate cut at the Fed's June meeting and a 35% chance in the September meeting.

Conflict in the Middle East: The unprecedented direct attack on Israel by Iran in response to an earlier airstrike marked an escalation of conflict in the region. Investors have been wondering what the impact of the conflict will be on their investment strategies. While geopolitical conflicts are usually difficult to predict, the impact so far this time is relatively muted, and the focus is more on commodities, especially oil and gold. Due to the ongoing conflict in the Middle East, oil prices have risen steadily since last October, reaching a peak of $92 per barrel in anticipation of the recent direct attack. However, oil prices have slightly declined since then, largely shrugging off the latest escalation. This is because Iranian and Russian exports remain stable, and the major Middle East oil exporters have been supplying more than their production. At the same time, if the Israel-Iran conflict stays contained, the U.S. equity market seems less worried about geopolitical risks than the trends in inflation and corporate earnings. Although we believe that the shocks triggered by geopolitical events are usually temporary, we are closely monitoring the development in the region.

Q1 earnings: As of April 26, among the 46% of S&P 500 companies that have reported Q1 results, 77% have reported a positive EPS surprise, and 60% have reported a positive revenue surprise. The blended YoY earnings growth for the S&P 500 is 3.5%. Shares of Google's parent company, Alphabet, surged after its announcement of Q1 earnings that exceeded expectations, accompanied by the company's first dividend payment. Tesla increased more than 10% in premarket trading after Elon Musk pledged to introduce more affordable vehicles potentially late this year. However, consensus forecasts for earnings overall have decreased significantly over the past few months, as IBES now forecasts a 3% year-over-year EPS growth for the S&P500, a decline from the 10-12% projections last summer. In addition, while earnings from major banks mostly met or exceeded forecasts, banks may face deteriorating conditions if interest rates remain elevated, as lower short-term rates are crucial for stimulating increased borrowing and improving interest margins.

As of 4/30/24. 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.

NorthCoast and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

The information contained herein has been prepared by NorthCoast Asset Management ("NorthCoast") on the basis of publicly available information, internally developed data and other third party sources believed to be reliable. NorthCoast has not sought to independently verify information obtained from public and third party sources and makes no representations or warranties as to accuracy, completeness or reliability of such information. All opinions and views constitute judgments as of the date of writing without regard to the date on which the reader may receive or access the information, and are subject to change at any time without notice and with no obligation to update. This material is for informational and illustrative purposes only and is intended solely for the information of those to whom it is distributed by NorthCoast. No part of this material may be reproduced or retransmitted in any manner without the prior written permission of NorthCoast. NorthCoast does not represent, warrant or guarantee that this information is suitable for any investment purpose and it should not be used as a basis for investment decisions. © 2023 NorthCoast Asset Management.

PAST PERFORMANCE DOES NOT GUARANTEE OR INDICATE FUTURE RESULTS.

This material should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or investment products or to adopt any investment strategy. The reader should not assume that any investments in companies, securities, sectors, strategies and/or markets identified or described herein were or will be profitable and no representation is made that any investor will or is likely to achieve results comparable to those shown or will make any profit or will be able to avoid incurring substantial losses. Performance differences for certain investors may occur due to various factors, including timing of investment. Investment return will fluctuate and may be volatile, especially over short time horizons.

INVESTING ENTAILS RISKS, INCLUDING POSSIBLE LOSS OF SOME OR ALL OF THE INVESTOR'S PRINCIPAL.

The investment views and market opinions/analyses expressed herein may not reflect those of NorthCoast as a whole and different views may be expressed based on different investment styles, objectives, views or philosophies. To the extent that these materials contain statements about the future, such statements are forward looking and subject to a number of risks and uncertainties.