The Week Behind

While Payrolls came in ghost-pepper hot, soft landing sentiment generated by the FOMC meeting and mega-cap earnings proved to be the greater force. Net-net, the FOMC meeting and mega-cap earnings earned the bulls enough credibility to award them the benefit of the doubt until data concretely supports the bear case of an earnings collapse. In a “soft landing” tape, the DOW underperformed, skimming ~0.15%; the S&P 500 gained 1.62%, and the NASDAQ outperformed, adding 3.31%. 

Highlights 

• As expected, the Fed raised 25 bps, increasing the Fed Fund Range to 4.5-4.75%.
• Mega-cap earnings, Meta aside, were predictably disappointing but did not reveal any new sources of concern.
• While Payrolls was majority bearish, there was some feed for the bulls. 

Changing of the Calendar, Changing of Market Dynamics

Following last week’s events, the burden of proof appears to now reside with the bears to make their case. Consequently, even though January has been spectacular, it feels like there is still room for equities to run. That being said, nothing goes up in a straight line. As February begins, two constructive market dynamics fade, making stock selection even more important .  

The tailwind from the tax-loss harvesting season is likely exhausted. It was a record year for tax-loss selling. As the calendar turned from 2022 to 2023, these tax-loss sellers, realizing they were too underweight stocks, became tax-loss buyers. Now that the rally has spread from the high-quality names – indicative of long-term investors rebuilding positions – to speculative, low-quality names – indicative of traders chasing a rally – I think it is safe to assume the benefit of tax-loss buying is closer to its conclusion than beginning. 

At January’s on start, the S&P 500 was ~3,800, trading at ~16.5x forward earnings. As we start February at ~4,180, the forward multiple is now ~18.5x. With the benefit of hindsight, it is clear market-multiple expansion acted as a “tide that raised all [stocks]”. Unless you believe earnings will surprise to the upside over the next 12 months, FactSet data suggests the S&P is overvalued (trading at premium to historic multiples), which suggests there is little room for further expansion in February. Furthermore, institutional managers are less willing to allocate meaningful capital at these valuations. With the tide near a peak, individual ships will need company- or industry- specific catalysts for further, meaningful upside.

The Week Ahead

Earnings season is still in full swing: 

Monday, we hear from Simon Property (SPG). They are the landlords of tenants operating retail stores in the world’s highest-class lifestyle centers. Their results will provide a read on the high-income consumer as well as commercial real-estate values.

Tuesday, Chipotle (CMG) reports. We’ll see if my burrito bull market case has legs. 

Wednesday, Uber (UBER), a company I believe is criminally undervalued, reports. It is in a rare class of growth stocks with positive free-cash-flow and positive revenue projections despite the dreary economic outlook. 

Thursday, AbbVie (ABBV) reports. Investors are struggling with their growth outlook as Humira loses exclusivity. While I am bullish on ABBV’s other treatments and pipeline, Humira is their golden goose. I understand why investors are unable to look past it. That being said, if the price falls further and management tells a good story on its future pipeline, ABBV could be an attractive opportunity.  

The macro won’t do much to take the spotlight from earnings. Aside from Thursday’s weekly jobs data, UMich consumer sentiment and inflation expectations release Friday. Otherwise, free of the blackout period, I expect Fed speakers to try and walk back some of the dovish undertones from the FOMC.  

Payrolls Fails To Derail the Rally

For my more detailed account of what I think happened, please read my full take on Payrolls here. 

Clearly, Payrolls was hot. Headline number beat by 2.75x and unemployment ticked down. A few months ago, this report would have sent the market into a panic over the Fed doing more than anticipated. While indices finished the session lower, markets pretty much hung in there. I think this resilience comes down to three factors:

1. During the FOMC Press Conference, Powell said, “I do think there are a number of dimensions through which the labor market can soften… My base case is that the economy can return to 2 percent inflation without a really significant downturn or a really big increase in unemployment.” (pg. 13-16). Prior to this meeting, the Fed seemed dead set on tightening until creating the unemployment synonymous with a recession to ensure the most dangerous inflation – wage inflation – was squashed. This quote creates a path for the Fed to declare victory without that recession.

2. There were some bullish nuggets pointing to other “dimensions” where the labor market is softening. Despite a record increase in job creation, average hourly earnings did not move much. This data suggests we can have a strong job market without strong wage pressure. It is something of economic fiction, but, if this continues, it means the Fed will not need to destroy the job market to rein in wage-inflation. 

3. This report provides indisputable evidence the U.S. economy is solid enough to endure additional rate hikes and is far stronger than bears need for an imminent earnings collapse. Without massive job losses, investors can count on U.S. households, which make up ~70% of the U.S. GDP, to spend. We have massive job creation. This damages any narrative surrounding an imminent recession or earnings catastrophe.