Higher Rates Imply Strong Profits

In 2022, the Federal Reserve found itself grappling with the highest inflation rates seen in 40 years. This led to a selloff of overvalued stocks, driven by concerns that the impending tighter monetary policy would usher in an economic recession. A multitude of indicators with impeccable pedigrees, including Leading Indicators, Purchasing Managers, and Inverted Yield Curves, stoked these fears. Despite faltering earnings, a spending surge fueled by substantial government stimulus, even in the face of full employment, prevented the fear from escalating into a hyperbolic panic. Blue chip tech leaders lost 25 to 60% of their value, yet consumer demand and underlying business profits were much better than feared. Corporate earnings later surged to record highs in 2023 and 2024, surpassing consensus estimates. 

The consumption boom, exceeding the norm, resulted in unprecedented demand for workers, leading to robust wage growth and multi-decade high worker participation rates.

 Notably, corporate payrolls consistently added over 100,000 jobs per month for a record 40 consecutive months, while job openings remain far above pre-COVID highs at 8.5 million. This labor market dynamism might be shifting from red-hot to merely hot as the search for trainable workers becomes increasingly challenging.

Continued fiscal stimulus, coupled with record personal spending, has bolstered company coffers, enabling them to enhance shareholder value through anticipated record stock buybacks in 2024. Companies typically repurchase their own stock when they perceive it to be undervalued and are experiencing robust free cash flows. Should stocks undergo a substantial correction of 10% or more this year, companies are likely to ramp up their share buybacks, providing a boon for investors as the available shares for purchase dwindle

 While April witnessed a modest 5 to 7% dip in stock prices, aligning with our anticipated pullback for March, Federal Reserve commentary has once again propped up prices in May. Despite the prevailing consensus of enduring higher inflation and interest rates, investors have displayed resilient purchasing power, largely disregarding these concerns. Federal Reserve Chair Powell’s recent remarks assuaged anxieties, asserting that there is no imminent economic stagnation or alarming inflation, and that the next move by the Fed will not be a rate hike but rather a postponed rate cut later in the year as inflation trends recede.

Although stock indices can viewed in a several month trading range today, a move in the SP to the major resitance zone of the 5270’s to 5330’s would remove the chance for a deeper oversold conditon in Q2 and encourage even greater equity exposure.

From a technical standpoint, the market exhibited oversold conditions in April/May, yet a drop below the April low is necessary for our composite indicator to turn on the gren light for additonal buying. In ongoing bull markets, oversold corrections are not obligatory, suggesting a trading range with an upward bias before the conclusion of Q2. The symmetry in duration is noteworthy, with the most recent upswing lasting 21 weeks, nearly identical to the previous surge ending last July. Both major advances were interrupted only when the 10-year yield began surpassing new multi-week highs above 4%. Thus far, the ensuing correction has involved 3-wek pullbacks and roughly 6% declines followed by 2-week recoveries. If this pattern persists, we could anticipate another month of consolidation, but further advances to the 4270’s resistance in the S&P would need to be respected as a sign of continued bullish momentum ahead.

As always, interest rates remain pivotal. Yields are hovering close to the dreaded 5% threshold, a level not seen in decades. The initial weeks of May present seasonal headwinds, so any 10-year yield movement beyond 4.7% will likely trigger concerns about an imminent ascent to 5%, prompting a temporary exodus from equity markets. The Fed’s calm messaging is encouraging, and we would adopt a bullish stance on the 10-year should it test 5% (near 106 in price) or if we move through the month without new lows in bond prices. As we progress through May and early June, accumulated buying power for stocks and bonds is expected to materialize.

 

 

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