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Market Outlook

How To Thread The Needle In A Choppy Market In 2025

Expect the market to remain turbulent in 2025
  • Stubborn inflation and the fear of inflationary policies such as tariffs, budget deficits, and deportations had led to high 10-year treasury yields jumping to 4.8% before dropping to 4.66% today.
  • This, in turn, has spooked the S&P 500, which gave up its entire post-election bounce before bouncing back today.
  • The S&P 500’s current yield of 4.6% is less attractive compared to the 10-year treasury yield of 4.66%, questioning the risk-reward balance.
  • However, while the 4.66% yield will compete for investors’ funds, patient investors who can stomach a correction should do much better scooping up high-quality bargains.
  • There are enough positives to come from the new administration, such as lower taxes, less regulation, and business-friendly policies, which will trump the negative of high interest rates.

Will 10-year treasury yields of 4.66% drag down the market?

The equity risk premium

The current yield for the S&P 500 (NYSEARCA:SPY) is 4.6% or the 2025 Consensus Bottoms Up EPS of $274/S&P 500 of 5,953 = 4.6%. Comparatively, the 10-year treasury yield stands at 4.66% The commonsense argument is that if the US treasury gives me a risk-free return of 4.66% why should I make a risky equity index investment, yielding even less at 4.6%?

Risk-averse and conservative investors usually require a risk premium to invest in equities. During the great deflationary period from 2009, after the Great Financial Crisis, to Feb. 2020 (pre-pandemic), the equity premium was quite large as shown below. The average yield premium was 2.79%, and it rarely fell below 2%. The 10-year yield averaged 2.43%.

Source:Fountainhead, Yahoo Finance

In an inflationary environment, with the 10-year at 4.66%, we’re getting a discount of 6 basis points or 0.06%, which begs the question

a) Either I should get a premium return for that risk or

b) I should pay less to increase my yield.

Stubborn inflation

With stubborn inflation, a reduction in yields looks unlikely, and many would patiently wait for the reduction in the index to get in at a decent price. Not surprisingly, as of Jan. 14th, we’ve given back almost all the Trump bump, falling to 5,800, a mere 0.5% from the Nov 5th election date close of 5,782, which has now bounced back to 5,953 following the better-than-expected CPI report.

Last September, I was confident that the Fed’s reduction of 0.5% would lead to a 10-year closing between 3.25% and 3.5% in 2025. At an earnings yield of 4.6%, that would have been a fairly decent premium of around 1.25%. Initially, it did drop to 3.6%; however, given sticky inflation readings in the next 3 months and a stronger-than-expected job market and economy, 10-year yields have gone the opposite way climbing to 4.79%, before dropping to 4.66% — leading to the Feds anticipating just two cuts in 2025 in their dot plot from the December 18th FOMC meeting. Four weeks later, the markets have taken a step further, anticipating just a paltry 27 basis points reduction in 2025.

This morning, on Jan. 15th, the CPI report was much better than expected, with core CPI coming in only 0.2% higher from a month earlier, – a drop after increasing 0.3% in each of the previous four months. Its YoY increase was only 3.2%, lower than 3.3% in November and below the 3.3% consensus.

The 10-year yield dropped to 4.66% – a huge 13 basis point drop, leading to a 1.7% increase in the S&P 500 by mid-afternoon to 5,5953.

The Fed’s December meeting minutes also revealed a Fed that was worried about higher inflation from the incoming administration’s tax and tariff policies, which contributed to their forecast of only 2 cuts in 2025. From the FOMC minutes:

Almost all participants judged that upside risks to the inflation outlook had increased.

The S&P 500 (SP500) dropped 1% on January 7th, when PMI data revealed persistent price increases on the services front. It dropped another 1.5% with the massive 256,000 gain in net new jobs created, with the non-farm payrolls released on January 10th. Price action in the treasury clearly confirms this worry and, given how fast traders have sold bonds, suggests that this could well continue. Market headlines blaming the weakness in stocks on bond yields have only increased. Simply, the markets are sanguine until they’re not, and then the dam breaks.

The incoming administration’s volatility premium

I also believe that traders are assigning a “volatility” or even a “drama” premium if you will. Markets hate uncertainty. If you’re a bond manager already facing three years out of the last four of losses, witnessing the bizarre behavior of our elected officials towards the end of the year of getting a simple budget extension is going to weigh on your decisions. Why buy the treasury at 4.79% when the yield could shoot through 5.5% if there is more drama getting anything done in Washington with a razor-thin majority and an executive branch executing through Twitter?

An emboldened Trump, with a penchant for implausible actions such as annexing Greenland and the Panama Canal, will only increase bond market jitters.

High interest rates hurt Main Street, not just the market

The other factor that worries me about rising interest rates is the higher interest burden on other sectors such as commercial real estate lending, and residential mortgages. Residential mortgage rates are over 7% now, and while over 92% of residential mortgages are at much lower fixed rates, I would think that a significant amount of home purchases (some of which were chasing high-priced homes in short supply due to inventory shortages) have been made at higher mortgage rates in the last two-three years with the hope that they could refinance at cheaper rates – and clearly that hasn’t happened in 2023, and 2024 and from the looks of it, very unlikely to happen in 2025.

Similarly, the commercial real estate market is also likely to face problems.

According to Trepp estimates, roughly $1.7 trillion, or nearly 30% of outstanding debt, is expected to mature from 2024 to 2026. This is commonly referred to as the “maturity wall.” CRE debt relies heavily on refinancing; therefore, most of this debt is going to need to be repriced during this time.

The 4.5% yield threshold

Source: The 4.5% yield threshold (Bloomberg, FactSet, Morgan Stanley Research, The Heisenberg Report)

Last April the S&P 500 P/E fell in tandem with the 10-year rise, and it currently looks to be following the same path, not auguring well for the market in 2025.

Could we get “Trussed”?

UK 10-year bond yields surged by 30 basis points on January 8th, to 4.925%, bringing back bad memories of the harrowing 49 days of Elizabeth Truss’s short-lived premiership in 2022.

Back then, Truss had made the mistake of unveiling an unfunded budget of 45Bn GBP of tax cuts when inflation rates were about 11%! UK Equity, Bond, and Currency markets sank, with many even suggesting that the UK government’s treasury was no better than that of a Third World country. Almost destroying a weak Gilt market ultimately led to her resignation.

Fast-forward to 2025 – the 30 basis point drop to a level not seen since 2008 has 2 repercussions. 1) Bond markets are reacting very strongly to governments not having enough control over their country’s inflation. Punishment was swift and severe. It was the 4th day of drops in the UK bond market.

2) The second repercussion, and what worries me; is this going to happen in the US market as well as the incoming administration starts working on their planned tariff hikes, which will increase inflation; if so, where does the yield stop?

Tax cuts can be inflationary

Trump’s proposed tax cuts reduce tax revenues and increase deficits, which is inflationary.

The incoming administration plans to extend the 2017 tax reductions, reduce the corporate tax rate, and decrease or eliminate taxes on certain types of income. Here is the analysis from taxfoundation.org:

Using the Tax Foundation’s General Equilibrium Model, we estimate Trump’s tax proposals would increase long-run GDP by 0.8 percent, the capital stock by 1.7 percent, wages by 0.8 percent, and employment by 597,000 full-time equivalent jobs.”

“We estimate the proposals would increase the 10-year budget deficit by $3 trillion conventionally and $2.5 trillion dynamically. The debt-to-GDP ratio would increase from its long-run projected level of 201.2 percent to 223.1 percent on a conventional basis and 217 percent on a dynamic basis. Increased deficits and a higher debt load would require higher interest payments on the debt that would reduce American incomes as measured by GNP by almost 0.8 percent; the higher interest payments drive a wedge between the long-run effect on output of 0.8 percent and the long-run effect on GNP of -0.1 percent.

As you can see above, the repercussions can be good for the economy with higher GDP, but it will also be inflationary and expensive to service with higher interest rates. What’s also significant is that the administration believes that they can make up the shortfall by increasing tariffs, which in my opinion will worsen an already high inflation rate.

What the bulls say: There are a lot of positive factors as well

Juxtaposed with the negativity of high interest rates are the positive effects of excellent earnings growth from the S&P 500, lower taxes, and less regulation.

Source: S&P 500 Earnings (FactSet)

FactSet’s estimates call for a strong 14.64% growth in the S&P 500 for 2025 to 274.19, followed by 13.6% growth to 311.44 in 2025. In the years that I’ve been using FactSet, I’ve seen that the variation is not significant for the index. I strongly believe that the S&P 500 earnings would come in between 267 and 281, with an error margin of just 2.5%. But the problem is not in the performance – it’s the valuation, we’re priced to perfection as seen below, and disappointments could be the main catalyst for a drop.

Source: S&P 500 P/E Ratios (The Heisenberg Report, Datastream)

The last time the S&P 500 P/E was above 20, the 10-year was around 2%, currently, we’re at a P/E of over 21.73, but the 10-year is at 4.66%.

Corporate Debt is doing fine

Credit default risk is low among corporate borrowers as per a Goldman Sachs report.

Good earnings and cash flow over the last few years have led to low debts on several investment grade and lower balance sheets. The level of fallen angels – or companies below investment grade, is at its lowest level in 25 years.

Risk premiums are not mandatory for equity investments

The lack of an equity risk premium is not the end of the world and as we can see from the chart below, in higher interest rate environments from 1985 to 2000, there never was one. The biggest premiums have been in the deflationary era, post the GFC from 2009 before the Fed started raising interest rates to quell inflation.

Source: Equity Risk Premium (Fountainhead, Yahoo Finance)

A high interest rate doesn’t kill the equity market just because of a lack of a risk premium, but it provides competing offerings at much lower risk, and we saw that hurt the equity market in 2022 when the Fed started raising interest rates aggressively to contain inflation. I, myself, put money in high-yield CDs and corporate bonds through 2023.

A 5% Treasury yield should attract buyers

I believe there could be a lot of buying if the treasury breaches 5%. In October 2023, when the Middle East conflict was raging, bond yields briefly touched 5% from where they reversed very steeply, on buying and a subtle push from Treasury Secretary Janet Yellen, who reduced the size of government auctions by $76Bn. Will history be repeated? I think it’s likely that there will be substantial buying of 5% treasury bonds, as do several analysts, and money managers.

Inflation: The worst is likely behind us

The PPI came in a little lower than expected at 0.2% M/M in December 2024, versus a consensus of +0.4% and November’s reading of +0.4%. Even better, the core PPI was flat M/M, significantly lower than the expected rise of 0.3%. The benign numbers triggered a relief rally on Jan. 14th, and the CPI report which came in today (Jan 15th, 2025), did even better with the core CPI beating estimates, leading to a drop of 13 basis points in the 10-year and a huge 1.7% gain in the S&P 500. This could be the beginning of a trend reversal.

Positive effects of lower taxes

Even as we move towards a more inflationary environment with unfunded tax cuts, the Tax Foundation believes that lower taxes would increase long-run GDP by 0.8 percent, capital stock by 1.7 percent, wages by 0.8 percent, and employment by 597,000 full-time equivalent jobs.

Rekindled animal spirits are great for Main Street

Small businesses, which are major employers and contributors to US GDP, are very optimistic about the Trump administration’s policies, which should augur well for the economy. Small businesses are notably excited about higher sales, less regulation, increased chances of finding high-quality labor, stabilizing inflation or price increases, and importantly, better credit conditions due to less regulation. Not surprisingly, the groups’ uncertainty indicator has dropped as well.

What is the best way forward to invest in a difficult year?

Keep realistic expectations

There are enough bullish and bearish factors without either one having a clear edge. In 2023, the S&P had a reasonable P/E of around 18, allowing the big AI bang from Nvidia’s May earnings report, to propel the index to a 24% gain. In 2024, the S&P 500 gained 23% as the AI trend continued, but now inflation has persisted and the S&P trades at an expensive 21.7 times 2025 forward earnings. The chances of a third year of 20% gains are rare; it’s happened only 3 times in the past 100 years, but two of those were in 1935, and 1936 following the great depression, and then the third one in the nineties during the dot-com bubble. So, my expectations have to be very realistic.

Wait for bargains

The correction should continue, which allows us to scoop up bargains: In my opinion, we’re likely to see 5,500 before 6,500 in 2025. The S&P had wiped out the post-election bump, dropping to 5,800, past the 20 and 50 DMAs, before reversing this morning. Should it drop again, I expect strong support around its 200 DMA of 5,582.

Besides, I think this market will continue to correct until interest rates stabilize, which won’t happen until we see a drop in PCE readings (due at the end of January) wage growth, and a reduction in volatility, which is high with the VIX hovering between 17 and 19. There’s also precious little one can do about volatility; this is a Presidential stock-in-trade. The first few weeks of the Trump administration should be fairly volatile, as they roll out their tariff, deportation, and tax plans. The incoming President has stated that they intend to get off the ground very quickly with executive orders on day one, with immigration a big priority, which means we should get a fairly good view of deportations and their inflationary effects. The Trump administration also showed in their previous innings, firing unrealistic salvos as opening bids – and thus I assume a zero chance of 60% tariffs – the realistic number is likely to be much lower, but the drama will unsettle the market.

Focus on the big picture and stick to the fundamentals

To me, the biggest investment factor is always the fundamentals of great companies, which trumps macro, economic, or technical factors in the long run, unless they’ve historically deviated from the norm, and we’re not anywhere close to that. The stellar jobs report for December confirms how strong the economy is, in fact, higher wages are your biggest defense against inflation – good news is good news. It’s idiotic to hope that the labor market weakens, so the Fed can cut rates – very twisted logic, which hopes for weakness in the economy!

Earnings

Earnings will continue to do well, as we saw from FactSet’s estimates and especially across the M-7; No matter how much we complain about the lack of breadth, the M-7 will still carry the economy and the markets. The M-7 are not outliers, they are truly entrenched in the economy and are in the rare, sweet spot of being secular and sustainable growers and stalwarts with strong brands, pricing power, and huge moats.

Stocks to buy on declines

Taiwan Semiconductor Manufacturing Company Limited (TSM) – I first recommended TSMC in August 2023, and continue to add on declines. Its December monthly revenue grew 58% YoY and fourth quarter revenue grew 39% YoY, suggesting a strong beat of its mid-point guidance, and confirming its strength as one of the strongest pillars of the semiconductor industry.

NVIDIA Corporation (NVDA) – The CES showcased a strong Nvidia with its foray into the PC market, its new gaming chips, and the introduction of Cosmos, which takes its Ominverse segment to much higher levels with the addition of Blackwell architecture. Any short-term thinking about Blackwell delivery delays is just noise and a great opportunity. I’ve started buying around $132 and will continue to add on declines. I’ve owned Nvidia for a long time and have recommended it in March 2023, and July 2023.

Alphabet Inc. (GOOG) (GOOGL) does not get enough recognition for its market leadership and moats in Search, YouTube, Google Cloud, and Waymo, with far too much focus on the antitrust ruling. Given the new administration’s anti-regulatory stance, I don’t believe Alphabet will be hurt as badly, and even in the worst case, here’s a sum of the parts valuation, which at $2.6Tr is higher than its current market value of $2.35Tr.

I would also add the following on declines: Duolingo, Inc. (DUOL), the market leader in language learning and a huge beneficiary of AI, Marvell Technology, Inc. (MRVL), which has a strong position in ASICs and is very attractive at 12 times sales growing at 40%, and 41 times earnings growing at 33%,

Corrections are healthy for the market, and I look forward to buying on declines.

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Market Outlook

Don’t Ignore The 10-Year Yield

It All Came Tumbling Down

The likelihood of only two Fed rate cuts in 2025 sent the markets tumbling yesterday, even as Chair Powell was still answering pointed questions about the resilience of the economy and where inflation was headed in 2025. The S&P 500 eventually closed 2.96% lower. shattering the post-election rally.

The markets had been ignoring the 10-year yield for far too long. The 10-year went from 3.6% in September when the Fed started cutting to 4.40% before the FOMC meeting, signaling that inflation wasn’t completely done and that stock valuations were getting frothy. It unraveled yesterday. Analysts are talking about the 10-year possibly reaching 5%, which will remain bad for stock multiples. The S&P 500 and the Nasdaq Comp are down 4.5% from their highs. Let’s see how the PCE report is on Friday.

The last time the S&P 500’s P/E ratio was 22, it was 2021, and the 10-year treasury yield was 1%! We are at 4.5% and climbing! The expectations of 4 cuts in 2025 had kept the markets hopeful that the 10-year would follow suit and head back below 4%. Clearly, that’s not happening. Either the index has to come down or the 10-year has to drop to justify these valuations….

Also don’t forget the Fed’s reluctance to cut big for forecast more cuts in 2025 was based on the Sep, Oct and Nov inflation readings, they’ve not even talked about the possible inflationary impact of tariffs and larger fiscal deficits – somebody has to fund the government when they’re not collecting enough taxes, and the weaknesses in the past two treasury auctions suggest that lenders are demanding better rates to lend to the government.

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Market Outlook

The S&P 500 (SPX), (SPY) Could See Significant Gains In The Next Two Months

6,000 On The Horizon

The Heisenberg report includes an interesting article by Goldman Sachs’ Scott Rubner about trading from the end of October through the end of the year.

Rubner suggests if you’re looking to buy the election dip, you may not get it, for the following reasons: 

For the past 100 years, the last week of October through year-end has been one of the best trading seasons, and even more so during election years. That is, the median return from 10/28 through year-end is 5.2%; in election years, it’s 6.3%.

The fiscal year-end for most mutual funds is October 31, and as October winds up, the supply overhang from mutual funds and pensions lifts. 

The corporate Buyback blackout period, which is usually two weeks before the quarter ends through 48 hours after earnings are released publicly, also starts lifting, 

Buybacks are one of the largest sources of demand for US equities. November stands out. Goldman’s corporate execution desk expects $960 billion worth of executed buybacks this year. So, simple math suggests next month could see ~$100 billion worth. 

Then there’s the thinner markets around Thanksgiving and Christmas, which could lead to a more pronounced effect of large-scale buying on stock prices.

Scott was straightforward. “The global consensus on Wall Street is that we will dip after the election, and investors are waiting for the (-5%) dip to add,” he wrote, adding that he doesn’t see it. “I think the US election will be a clearing event for risk assets and re-risking may happen quickly,” he said.

In another article he goes on to add that FOMO or the (Fear Of Missing Out) would be another factor driving stocks higher, should the much-anticipated pullback during and after the elections not materialize.

Rubner has a 6,000 year-end target for the S&P 500, which may turn out to be conservative.

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Market Outlook

Annual Earnings Forecast for Q2-2024

Analysts forecast that the S&P 500 index’s earnings will likely grow above 12% for the second quarter and about 11-12% for the year to 247.

Source: FactSet

This is way above the 8% average growth, mostly because of a weaker Q2-2023, when earnings actually declined 4% over the previous year. 

Besides, S&P 500 earnings have been stagnant at $220 for the past two years so 2024 had beat the average significantly just to catch up and revert to the mean. 

Here are past 5 years – basically smoothening out the effects of Covid. After the big pandemic fall of 14% in 2020, there was that massive jump of 48% in 2021, and then two years of indigestion and inflation, which now leads to the 12% expected jump in 2024.

FactSet estimates that over the past ten years, actual earnings reported by S&P 500 companies have exceeded estimated earnings by 6.8% on average – everybody sandbags, (under promises and over delivers). I wouldn’t be surprised if earnings actually close over $250 for 2024.

Great, earnings look good with the 11-12% increase, but what about valuations?

The bottom-up target price for the next 12 months for the S&P 500 is 6006.66, which is 7.6% above the closing price of 5,584.54. 

The Forward P/E Ratio is 21.4, which is above the 10-Year Average (17.9), and above the 5-year average of 19.3. 

The two main causes for the high P/E 

a) Out performance and AI expectations, from the Magnificent 7, which controls about 33% of the index.

b) Decline in inflation and expectations of interest rate cuts.

I believe there is exhaustion in the M-7 – there is over participation (everybody and their uncle own Nvidia) and over bought. We we saw it for a bit in the last 3 weeks with Nvidia slowing down, but Apple and Tesla picked up the slack – Tesla rose 40% and 7 days in a row! What looked like a possible correction in the middle of June, never really materialized.

Secondly, now the 10 year has finally come down to about 4.19% and two interest rate cuts are a certainly after benign inflation numbers (still high over 3% and above the Fed target of 2% but definitely in the right direction). I believe the 10 Year will be between 3.5% and 3.75% for the most of 2025, if not lower.

Strategy for the second half of 2024 and beyond. High valuations should keep the index in check, and even cause a 5-7% correction, which is actually a good thing in my opinion. Lower interest rates will keep a floor.

What should we do? In my opinion, 

  1. Lower expectations for sure, if we make a return of 8-10% a year + dividends, that’s great, thus with this target, we can lower risk as well. For most of the year, almost every stock I had recommended had expectation of at least 15% Returns.
  2.  You don’t have to necessarily move away from tech but a mixture of Growth At a Reasonable Price (the GARP strategy) and absolutely looking for and investing in bargains should be the cornerstone of investing for the next 12 months. In two cases recently, GitLabs (GTLB) and Samsara (IOT) waiting for bargain prices have worked very well. I started the first 5% purchase, higher and slowly worked my way down as they kept falling and in both cases the prices are 15- 20% higher than my average cost.
  3. Keep cash handy for corrections and drops – On June 19th, I had sold 15-20% of semi stocks as profit taking; I’m still holding onto about 10% cash, which at 4-5% in money market funds is safe and I won’t invest till I get an outstanding bargain.
  4. Rotation – This week I’ll identify and recommend some GARPS, some dividend picks, and cyclicals.
  1. I picked up Duolingo, consumer, which is expensive – about 40% invested but am adding in the 190 range.

I’ve been pyramiding in the two big pharma companies – Eli and Novo, which is the exact opposite of cost averaging, buying smaller quantities even as they get higher, simply this obesity craze will last, and they’re relatively inured with strong pipelines.

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Market Outlook

S&P 500 Q1-2024 Earnings Season Recap: Strong Growth Signals Amidst High Expectations

Earnings Season Recap – Q1-2024, 93% of S&P 500 companies have reported.

Earnings and revenues haven’t disappointed for Q1-2024

On a year-over-year basis, the S&P 500 is reporting its highest earnings growth rate since Q2 2022. This is a welcome return to profit growth after the 4 quarters decline and slowdown. To recall, S&P 500 earnings have stagnated at about $220 per share in 2022 and 2023.

If 5.7% is the actual growth rate for the quarter, it will mark the highest year-over-year earnings growth rate reported by the index since Q2 2022 (5.8%). 

Overall, 93% of the companies in the S&P 500 have reported actual results for Q1 2024 to date. Of these companies, 78% have reported actual EPS above estimates, which is above the 5-year average of 77% and the 10-year average of 74%. However, the magnitude of the beats is not high – 7.5% above estimates, which is below the 5-year average of 8.5% but above the 10-year average of 6.7%.

Revenues:

60% beat estimates – Below the 5-year average of 69%- and the 10-year average of 64%. Remember, this is after an extraordinary bout of inflation in 2022 and 2023. This had to come down because you’re comparing it to a higher base. The magnitude of beats is also low compared to historical averages – only 0.8% above, compared to 2% for 5-year averages and 1.4% for the 10-year. I suspect it will be difficult to raise prices further without reducing demand.

Overall – if 4.2% is the actual revenue growth for the quarter, it will be the 14th consecutive quarter of revenue growth for the index. 

Where will 2024 end up?

Estimates are looking pretty good – 9.2%, 8.2%, and 17.4% for Q2, Q3 and Q4 respectively. Though I’m hard-pressed to see that kind of a jump in Q4. I suspect quarterly growth will be smoother and not the massive spike in Q4.

The overall calendar 2024 growth call is at 11.1% – consistent with earlier calls and my projections of earnings growth from $220 per share in 2023 to $245 per share for 2024. FactSet had an interesting observation – markets have punished negative EPS surprises, – confirming the one trend we’ve been witnessing ourselves, that markets are overbought, and expectations are too high, and unless you beat severely or raise guidance, your stock will get hammered – Facebook (META) was the biggest example.

Q1-24 net profit margins were solid – indicating that price increases and better expense management vaulted NPM to 11.7% – above the previous quarter’s margin of 11.2% and the 5- and 10-year averages of 11.5% and 11.6%.

Overall S&P 500 earnings and revenue increases look good for 2024-2025. Current estimates for calendar 2025 are an even higher earnings growth of 14.1% – this could come down, though – 2024 is not going to be an easy year to beat by 14.1%!

As you know the S&P 500 is a value-weighted index and large caps such as the M-7 tend to skew the numbers higher, even with Apple and Tesla being negative. Also, the “AI” effect has spread, and copper companies and utilities are getting a second look because of power demands, as are smaller players supplying components towards the gold rush among others – thankfully this is moving to other sectors of the economy.

Valuations remain high, of course, the forward P/E is 20.7 – above the 5-year average of 19.2- and the 10-year average of 17.8. Thankfully, at least interest rates are a little lower at 4.45% compared to 4.75% in April. My inclination is that this will trend lower to 4.1% to 4.25% by the end of the year. 

Bottom line – Harder to find bargains. No major surprises, we remain on track for earnings to get to $245 for 2024 and possibly to $270-$275 for 2024, my cash holdings are down to 6-7%. Wall Street is even more aggressive – closer to 4%.

Categories
Market Outlook

Chair Powell’s Remarks: Navigating the Fine Line Between Employment and Inflation Amidst FOMC Decisions

Image Source: Nerd Wallet, Federal Reserve

From Chair Powell “I don’t see the stag nor the flation”

Fed FOMC meeting: Mixed bag, with wild gyrations in the S&P 500, which at one point during J Powell’s Q&A jumped to an intraday high of 5,096 from the low of 5,013.

The tenor though didn’t seem overly hawkish, instead, it seemed more cautious – clearly, they have a lot of work to do ahead and can’t take any chances either – a very fine tightrope to walk, Powell wants to stick to his dual mandate of keeping employment strong and inflation under control. He kept talking about balances – a difficult task, indeed,

The big positive seemed to be the reduction in quantitative tightening to $25Bn from $60Bn. The markets were expecting $30Bn

The Federal Open Market Committee did decide to ease its quantitative tightening by slowing the pace of its balance sheet runoff. The FOMC will reduce the monthly redemption cap on Treasury securities from $60B billion to $25B.

Let’s wait for the Friday payroll report.

Categories
Market Outlook

Market Analysis: S&P 500’s Recent Decline and Interest Rate Implications

S&P 500 5,022 down 243 points, 4.6% from its all-time high of 5,265.

10-Year US Treasury 4.6%, possibly breaching its Oct 2023 high of 4.98%

There has been a lot of consternation regarding the market in the last two weeks, with the index dropping almost 5% and the 10-year jumping from 4.25 to a high of 4.67% because of the fear of higher for longer interest rates due to stubborn inflation and the reluctance of the Fed to cut rates till they put the inflation genie back in the bottle for good.

Let’s look at it chronologically from Oct 2023.

In late October 2023, when the 10-year was close to breaching 5% Janet Yellen signaled lower interest rates by borrowing $76Bn less than anticipated for the last quarter of 2023.  A nod to the nasty run-up in rates, which if unfettered could have been harmful to the economy. The Feds had stopped raising interest rates after the last quarter-point raise in July, and by October, the consensus viewpoint was developing that the markets had done the Fed’s work with the 10-year treasury circling 5%. 

Around the same time, multiple Fed officials had said rising Treasury yields are indicative that financial conditions are tightening, possibly making additional rate hikes unnecessary, when the 10-year Treasury yield topped 4.9% on Wednesday, a first since 2007. During this run-up in interest rates, the S&P 500 had dropped to 4,120 from its July high of 4,560.

Once the 10-year treasury topped out, and Q3 2023 earnings season also exceeded expectations it set up the S&P 500 for a furious run up from the October low of 4,120 to about 4,800 by Dec 2023. A massive gain of almost 700 points or about 17%! helped by the Dec dot plot indicating possibly 3 cuts in 2024

We had another positive run in Q1, to the all-time high of 5,265 – both on AI-related earnings and expectations of the 3 cuts materializing in 2024.

My takeaways

  • A drop of 4.6% compared to the rise from 4,120 in October to 5,265 (28%) is an overdue correction, not a reason to panic.
  • The earnings yield of the S&P 500 = $245/5,022 = 4.9%, which is just above the 10-year treasury yield of 4.6% – we’re getting just 0.3% higher for a riskier investment compared to a risk-free investment of a government security. That’s a very small risk premium, I would think the S&P 500 is likely to fall further to see some semblance of the historic and mean premium of at least 1 to 1.5%.
  • The same argument that the Fed used in October is likely to happen as the treasury inches towards 5% – 
  • a) the market itself has made financial conditions worse, (done the Fed’s work – a 0.6% rise in the treasury is more than 2 quarter-point hikes!) 
  • b) Buying a risk-free (US Government) long-duration bond paying 5% is a damn good yield and when funds start buying bonds, the yields fall. There will be buyers from all over the world for that kind of yield. Especially in the event of further turmoil in the Middle East – that’s the flight to quality and safety. I don’t see yields topping 5% – I would be shocked if it did.
  • The Vix (Volatility Index) or the fear gauge as it is known has shot up to 18-19, after being dormant to steady in the 12 to 14 range through Q1-2024. Computerized trading desks or CTA’s, trade based on volatility which will cause sudden drops and a lot of choppiness, which scares investors. Zero-day options are not helping either. For example, if I see a 1% down day, my first reaction is to lower my buying limits.
  • Earnings season should be good, but misses are likely to be hammered disproportionately given the weakness in the market. Semiconductor monopoly ASML, which missed bookings but assured the same full-year guidance and a great 2025, dropped 8% today.
  • The graph below is a good contrarian indicator and makes me shake my head at supposedly professional investors. Fund managers have record low cash levels – they’re overextended at only 4.2% cash. When they need the money to pick up bargains, they don’t have it! Some professionals! This won’t help the market recover easily.
  • This is another good chart.

If Q1 has risen more than 10%, on every occasion except 1987 (the year of the Black Monday crash) it has closed the year higher. That doesn’t preclude drawdowns and the average pullback in the years was 11%, with a low of 3%.

  • I feel the best way to play this uncertainty is patience and lower limits – the first quarter was exceptional and unlikely to be replicated. 

 THE LONG-TERM STORY FOR QUALITY STOCKS IS VERY MUCH INTACT, but we would be better off getting good prices. The first to recover will be the high-level quality stocks – see how steady Microsoft is compared to the rest. 

  • In the last 15 days, my buy trades and recommendations have been limited as you may have noticed and strictly averaging lower with lower limits. I intend to keep it that way.
Categories
Market Outlook

Macro Approach, Market Valuations, and the Outlook: Navigating Euphoria and Fundamentals

The Macro approach and historic valuations, market breadth, outlook.

Top down market strategy is relevant and sometimes essential when you want to compare the S&P 500 against historical benchmarks. I did this in a series of articles for seeking alpha under Fountainhead, and spoke about the same things that Hussman does – historical valuations, poor market breadth, interest rate correlations, smaller categories dominating, and future earnings being misleading especially when they start to falter. I still pretty much look at the macro backdrop every week even now, but it’s a great backdrop, an important framework and benchmark but not a primary factor or thesis for making individual stock decisions. I stopped doing the market outlook top down series a while ago, when I realized I was better off focusing on getting into the weeds, than trying to get better returns by forecasting market direction. As an example, I was trying to predict a 4-6% correction in the S&P 500 when the AI revolution was happening right before my eyes, again ironical because my first article recommending Nvidia was in October 2022 at $108! And that’s been the story for the better part of 3 decades. 

There are several who posit like Hussman and several rebutting parts or all of his thesis – the correlation with the Nifty Fifty gets the most pushback as does with the 1999 internet bust. In the 2007-2008 Great Financial Crisis bust, the financial sector had the highest concentration of the S&P 500, and financials are cyclical with P/E’s rarely exceeding 12-14, and then they were at 20, with expectations of 25% growth, their debt to equity ratios were like 33:1 – ABSURD!!. 

The point is – extremely difficult to compare the bull market euphoria peaks, and to a great extent that time is better spent getting into the weeds of individual stocks and also using the macro backdrop as a variable but not the prime one. Also how are we going to make better returns trying to time the S&P 500, through downturns or predicting bubbles?

A great company bought at a good price will also go through a drop when the market turns bad – sometimes only because the sentiment has turned and more often on its own demerits and reduction in earnings power, often we’ve overpaid or not taken profits when the going was good. There is no escaping the inevitable downturn, and we try our best to mitigate it. Profit taking is important, not chasing momentum is important; Not overpaying is equally important. Buying quality companies is very important. Diversification is important, I do want to have less tech or AI stocks and am always looking out for good ones in other sectors, without getting into value traps just because they’re cheap. There are a bunch of strategists who’re advising buying the Russell 2000 as a de-risking strategy because the gap between the valuations of the Russell 2000 and the Nasdaq 100 is the widest in decades. There is some merit in that, but de-risking is a strange way to put it, because by definition the Russell 2000 has the biggest loss making stocks with the highest earnings risk!

In terms of macro strategy, I put out the Factset S&P 500 monthly earnings report on the group, which I follow for the broader Price/ Earnings multiple, earnings and earnings growth. I will after the PCE report next week – in my opinion, the market is overpriced by about 10% for sure, the last decade P/E was about 18-19, we’re at 21 now, with the Index at 5,100 / $245 earning per share. If you look at the earnings yield it is 245/5100 = 4.8%. The first question you would ask is why am I investing in the market when the 10 year risk free treasury gives me 4.2%, what, am I getting only 0.6% extra for the extra risk?? The historical risk premium in the last two decades has been closer to 1.5%, I ran the numbers from 1962 for the articles I wrote, the other decades have their own idiosyncratic reasons and are not comparable.

Categories
Market Outlook

S&P 500 Earnings Overview: Q4 2023 Insights and Valuation Metrics

source

FactSet reported the following for S&P 500 earnings through 2/9.

This is a very helpful 10,000 feet view and provides good benchmarking and comparisons.

Earnings Scorecard: For Q4 2023 (with 67% of S&P 500 companies reporting actual results), 75% of S&P 500 companies have reported a positive EPS surprise, which is below the 5-year average of 77% but above the 10-year average of 74%

Earnings Growth: For Q4 2023, the blended (year-over-year) earnings growth rate for the S&P 500 is 2.9%. If 2.9% is the actual growth rate for the quarter, it will mark the second-straight quarter that the index has reported earnings growth.

65% of S&P 500 companies have reported a positive revenue surprise, which is below the 5-year average of 68% but above the 10-year average of 64%.

In aggregate, companies are reporting revenues that are 1.2% above the estimates, which is below the 5-year average of 2.0% and below the 10-year average of 1.3%.  

If 3.9% is the actual revenue growth rate for the quarter, it will mark the 13th consecutive quarter of revenue growth for the index.

It is interesting to note that analysts were projecting record-high EPS for the S&P 500 of $243.41 in CY 2024 and $275.34 in CY 2025 on February 8. 

On February 8, the forward 12-month P/E ratio for the S&P 500 was 20.3, which marked the seventh time in the past nine trading days in which the P/E ratio for the index was above 20.0. How does this 20.3 P/E ratio compare to historical averages? 

Here is the chart for the historical PE, we have been above the 10 year average of around 18 for a while, and are now above the 5-year average of 19 as well.