Weekly Market Update: The Bull Market has yet to show us its legs. Does it matter?

Last week the US equities reached new highs. To be sure, the usual contra-arguments are there.

The rally is mostly led by the usual narrow band of stocks, the so-called Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla). From these, it was really Meta’s decision to pay a dividend that spurred the latest leg of the rally.

Most indices, including US equally-weighted and Ex Tech and Comms, are significantly lower than the headline index performance.

When so few stocks have such a grip over an index, then we can’t really call the index rally a market rally as such. The winners are the index trackers and those who join the bandwagon of technology. The losers are those who expect the fundamentals to play out over the medium term.

Yet, the market rallied. Bulls simply point to the resilience of the index.

Earnings are not that supportive. US large-cap bottom-line earnings have grown a paltry 2.9% for the year to December. For Q4, companies are reporting earnings 3.8% above expectations, below their 1-year (5.7%), 5-year (8.5%) and 10-year average (6.7%), according to Factset. Not exactly the stuff of bull markets.

Much like the Fed’s balance sheet, earnings growth has decoupled with market growth.

Yet, the market rallied. Bulls suggest that 2.9% is still better than 1.6% expected at the beginning of the earnings season. A diversified portfolio of energy, consumer discretionary and industrials led the pack, not tech.

The Fed isn’t supportive either. Last week was littered with statements from Fed officials singing a very similar tune: Inflation isn’t beat yet. “More evidence needed that inflation is cooling”, and “rate cuts are coming later in the year”. “Too soon to consider rate cuts”. The OECD’s outlook also suggested that, although inflation will eventually come down, it’s too soon to cry victory. And of course, the Fed has said very little about when it plans to stop quantitative tightening, which removes c.$100bn per month from financial markets. The notion of quantitative tightening is not compatible with a sustainable bull market.

As a result of the Fed’s hawkishness, rate cut expectations have been coming down. Bond markets are pricing in 4.5x 25bp rate cuts, down from nearly 7x in December.

Additionally, PMI services surveys suggest that input prices are rising and that employment conditions remain tight. And growth projections continue to improve. Both the IMF and the OECD, as well as Bloomberg surveys, have all upgraded their forecasts on global and US growth. Growth can support inflation, and higher inflation does not help with rate cuts.

Yet, the market rallied. Bulls are simply shrugging off the Fed’s comments, suggesting that hawkish talk is necessary to prevent a downward shift of the yield curve which would lower borrowing costs way ahead of when the Fed is comfortable with. As for inflation, they point to deflation exported from China and lower energy prices.

The deflation narrative has been picking up steam, to be sure. On some level, it makes even long-term sense, if consumers haven’t broken from the 14-year paradigm of secular stagnation.

But it’s not enough. When all is said and done, this bull market has yet to show us it has legs. Yet this doesn’t seem to matter. Markets are in a bullish mood and are likely to focus on the sunny side of every argument. Long-term fundamentals don’t apply for the medium and short term. Investors have been bullish since October when they realised that inflation was finally coming down, and bullishness has been breeding bullishness.

What this means for portfolios

For traders, it’s back to the age-old question: does one ride the wave, investing in what is popular (remember, not all assets rally), do they try to find value, or do they reduce risk exposure, acknowledging the headwinds against a sustainable bull market?

But for asset allocators, things are much simpler. We can’t afford to ignore the bullishness, so we need to at least keep with our benchmarks in terms of risk exposure. We can’t take sides on the growth tech—value debate, simply because the tech side is driven purely by sentiment and wild speculation as to what Artificial Intelligence will be able to do (hint: we don’t know, any more than we knew how the internet was going to change the world in 1994). But in a market not run by fundamentals, what will the catalyst be for value to catch up to growth? In essence, we need a balanced approach.

As we have said so often, in this non-QE market, it will be security selection, industry focus and even geographical selection that will make a difference, more than top-line asset allocation. Managers need to think in all four of those dimensions to position properly.

George Lagarias – Chief Economist

Market update

Last week, global stocks delivered positive returns, with US and European equities leading the way. US stocks gained +1.6%, outperforming all other regions, while European stocks advanced +1.5% despite the hawkish narrative adopted by ECB official Isabel Schnabel in an interview with the Financial Times. UK stocks, however, declined -0.6%, lagging their developed market peers. Meanwhile both Japanese and emerging market equities also posted modest gains, with Japanese stocks rising +0.2% and Emerging Market stocks increasing +0.9%.

The bond market witnessed a rise in yields across the board. The US 10-year treasury yield climbed 14 basis points to 4.17%, while the UK 10-year gilt yield also jumped 18 basis points to 4.16% as bond markets retraced following the significant risk-on rally in bond markets in Q4 2023.

Commodity markets were mixed. Oil soared +6.5%, as worries about supply resulting from the conflict in the Middle East unnerved market participants. Gold, on the other hand, dipped -0.3%, as rising bond yields and the stronger US Dollar reduced the appeal of the precious metal.

Macro news

The US non-manufacturing PMI survey pointed to strong growth in the services sector in January. The PMI figure, based on surveys of purchasing managers, registered at 53.4, above forecasts of 52, where values of above 50 indicate expansion. The value marks the thirteenth consecutive month of growth in the US services sector according to this index and showed growth in employment and new orders, but also a sharp increase in prices paid for materials. The services index stands in stark contrast with the manufacturing index, which has sustained a value of below 50 for more than a year.

Data from China’s National Bureau of Statistics showed consumer prices in China falling at their fastest pace since the global financial crisis. The consumer price index fell by 0.8% in the year to January, beating economist expectations for a smaller 0.5% decline. The producer price index, a measure of factory-gate costs, also fell by 2.5%, marking the sixteenth consecutive month of decline. The news compounds existing concerns for the Chinese economy, including struggling domestic demand, low consumer confidence and a falling stock market, and has raised calls for China to do more to stimulate its economy.

The week ahead

GDP data released by the ONS this week will reveal whether the UK slipped into a technical recession last year. GDP in the third quarter of 2023 shrank by 0.1%, while growth over October and November was 0% on aggregate, meaning that the month of December will be decisive in determining if two consecutive quarters of negative growth have occurred. Aside from this, investors will also be paying attention to inflation figures, which will be released for both the US and UK this week.