March or May - Who Cares?

1460 words – a 4 minute read.

As we settle back into the work routine, amidst the (welcomed) snow here in NYC, the contours of what will drive markets in early 2024 become clearer. We have worked off the YE excess enthusiasm in both stocks and bonds with little ill effect with ACWI virtually flat YTD and AGG down under 1%.

We have been steadfast in our view that insofar as the Fed and rate cuts go, it’s the WHY rather than the WHEN that is crucial for investors. The historical evidence for this POV is quite clear – when the Fed cuts because inflation has fallen such that real rates are overly restrictive then stocks do quite well. When the Fed cuts because recession is imminent stocks do poorly.

Given that the Atlanta Fed’s Q4 GDP Nowcast suggests 2.4% GDP growth (1st read next week) while the gap between inflation and Fed Funds rate is roughly 200 bps vs the Fed’s real rate target of roughly 50 bps, we favor the former case.

Thus, today’s title suggests one should not care whether March or May becomes the start of the Fed’s easing cycle. We certainly don’t & yet we are squarely in the minority as the famed BofA FMS notes the Fed as the #1 driver of asset prices this year. We disagree & think the key driver will be economic and earnings growth.

We never bought into the 5, 6, 7 rate cut hysteria given our view of BTE growth (such rate cuts are much more likely in Europe). We have been on the BTE growth side since mid 2022 when we introduced our “Middle Path” thesis between deep recession and high inflation.  At that time, we focused on high nominal growth and what it would mean for earnings. Today, with consensus 2024 US GDP growth of roughly 1%, we are happy to take the over.

What really interests us about the current set up is that 2024 is likely to include two things that are rarely seen together in the wilds of Wall St, rate cuts and earnings growth. Typically, when the Fed is cutting rates, earnings are falling and vice versa. Here’s the WSJ: “Almost always in the past, when the Fed has been cutting rates, profits were faltering. The so-called soft landing that occurred in 1995 was a notable exception, when the central bank cut its target rate even as S&P 500 earnings grew. The index rose 34% that year, which remains its single best annual performance since 1958. Growing earnings and falling rates seem like a recipe for higher valuations.”

Regular readers of the Musings will recognize 1995 given that we have been talking about the 1995 analogue since well, the middle of 2022. Our view has been and remains that the coming years will see a global cap ex boom (last seen in 2H of 1990s) together with tech supported low inflation to deal with the 3 Cs of Covid, Climate & Conflict. The regionalization of global supply chains and the onshoring of key technologies (semi fab plants, AI LLF models) and key climate drivers (EVs & battery production) reinforce not only this POV but also our trusty Tri Polar World framework.

As long only, global macro investors, it all boils down to a simple question: would you rather have an extra few rate cuts or a double digit earnings outlook? We’ll take the latter thank you very much. Markets are gradually coming round to this realization as well helping explain why stocks have handled the sudden rate back up so well. The penny is starting to drop that BTE economic growth is positive for earnings and positive earnings growth is very supportive of rising stock prices.

We remain focused on our 4 for 24 global macro surprises to guide us. The evidence continues to mount for a number of them including surprise #1 - lower than expected inflation, sooner than expected (Truflation's real-time US inflation gauge has moved down to 2.1% from 6.4% a year ago), #3 the return to macro stability – notwithstanding all the Davos drone about risks here and risks there and perhaps most importantly #4, the resolution of the early cycle vs late cycle debate.

In regards to #3, we note the trillion dollar reward unlock for stability now totals almost $9T in US MMF and CDs according to the WSJ while BofA’s FMS notes $163B in cash inflows during 2024’s first 2 weeks – a record!

Regarding surprise #4, recession talk has mercifully receded (in the markets, unlike the political space, BS has to walk at some point) while signals are multiplying that we are indeed early cycle and the cycle is starting to pick up.

The earnings cycle provides one key example. As Dr. Ed Yardeni has pointed out, the earnings recession ended in Q3 of 2023 when Y/Y US EPS growth turned positive after several quarters of negative Y/Y EPS growth. Q4 is likely to sustain that positive Y/Y EPS growth; more importantly, 2024 is expected to see roughly 11% EPS growth. Extending our outlook, one notes that 2025 is forecasted to also enjoy double digit EPS growth. It’s hard to be negative on stocks with both 2024 & 2025 forecasting double digit EPS growth.

On the economics front, GS notes its financial conditions index just had its fastest two month easing in 40 years, a very conducive backdrop. Signs pointing to economic acceleration are starting to multiply. The semiconductor cycle for example is bottoming with TSMC just the latest company to state a positive growth outlook for the years ahead. Have you looked at SMH or XLK?

The US housing cycle also looks to be picking up with mortgage rates at 6 month lows,  mortgage applications rising double digits & NAHB traffic indicators picking up. US retail sales are picking up as are import prices (don’t fall for China deflation head fake, import prices up M/M after 9 down months in a row) & industrial production with Q4 electrical equipment production at the highest levels since 09.

The month to month data feeds are quite choppy but when one looks over the past year or so as our buddy Chase of PineCone Macro does, the upturn is unmistakable. But wait, there is more; RenMac notes that the latest Fed Beige Book word counts for “weak” or “slow” appeared 83 times; the lowest since April 2022. You think we are too optimistic? Here is Dr. Ed Yardeni again: “History suggests the US economic expansion may last until mid-2026.” We’re with him. Stocks have noticed; have you looked at XHB, XLI, XLF?

Sure, there is plenty to worry about if that’s what you want to do. Geopolitical risk as we wrote last week fills headline after headline. Here’s the FT on the ground in Davos: “Davos groupies have “a predominantly negative outlook for the world over the next two years that is expected to worsen over the next decade”, with 54 per cent braced for “some instability and a moderate risk of global catastrophes” in the short term — and 30 per cent predicting severe upheaval.”

Two points; first, taking the opposite of Davos speak is like doing the reverse of Economist covers – almost fool proof; 2nd, the history is quite clear – geopolitics are not risk asset drivers for any period of time. Today’s exhibit one – the Middle East and oil prices. Brent is down 10% since October 7th; Exhibit two – Taiwanese elections – EWT flat over past 5 days. We remain focused on the return to stability & the trillion dollar unlock after several years of Covid inspired upheaval.

Excited for this weekend’s NFL playoff match ups? We sure are. As we wrote in Lean Into Complexity the speed of today’s NFL motion offenses are catching much of the old guard offsides as seen in last week’s Packers – Cowboys game. Packers are the 4th youngest playoff team in the past 50 years & they made the Boys look old and slow.

We have written about speed at length over the past few years: Covid Speed & Narrative Speed to name just two. Its all about speed, reaction and being on the attack. Its not just football; its Australian Open time and a recent great article on Novak Djokovic talked about how he is beating Father Time by going on the attack – leveraging his fitness & experience, pressing his younger opponents into mistakes thereby shortening matches & keeping himself fresh for more Grand Slam Ws. It’s not just sports either – we, as investors, need to be able to handle today’s speed & be on the attack when the set up is favorable, as it is today. Enjoy that new ATH!