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March 4, 2024

February 2024: Earnings matter

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The month at a glance

Investors remained focussed on the path of inflation and the question of when the Fed might begin to cut interest rates. Economic activity has been broadly strong and corporate earnings for Q4 have come in relatively solid, especially for some bellwether US tech giants. The combination of continued cooling inflation, albeit slowly, with a still robust economy has reduced expectations that the Fed will cut rates as soon as investors had hoped. The next Fed meeting is later in March, but comments from Fed governor Waller in a recent speech captures the evolving expectations for rate cuts: “with most data indicating solid economic fundamentals, the risk of waiting a little longer to ease policy is lower than the risk of acting too soon and possibly halting or reversing the progress we've made on inflation”.1

  • The core (excluding food and energy) personal consumption expenditures price index, the Fed’s preferred gauge of inflation, rose 0.4% in January from December, higher than the 0.1% monthly increase last month, but the increase from year-earlier levels continued to come down and now stands at 2.8%, down from 2.9% in December.2
  • Labor markets remain tight with a robust 353,000 jobs added and the unemployment rate holding steady at 3.9% in January.3
  • Fourth quarter 2023 earnings for S&P 500 companies have come in relatively strong, with trailing 12-month operating earnings up 7.2% from a year earlier.4
  • Longer-term interest rates rose modestly in February as investors adjusted expectations of Fed rate cuts. The 10 year treasury rate ended the month at 4.25%, up from 3.99% at the end of January and 3.88% at the end of 2023.5
  • Equity markets rose solidly while most fixed income segments posted negative returns for the month.

Solid earnings supports equity gains

Equity markets resumed their upward march after a mixed start to the year. All broad indices showed positive returns for the month, with US large cap growth stocks returning to their leadership position.6 With 92% of companies reporting, fourth quarter 2023 operating earnings growth for S&P 500 companies has come in relatively strong, with 75% of all companies and 90% of tech companies beating estimates.7

  • US large cap growth stocks led the market and are now up over 10% for the year.
  • Value stocks returned to positive returns for the month, but continue to lag the overall market.
  • Cyclical sectors (consumer discretionary, industrials, materials) posted the strongest returns for the month while utility stocks remained the weakest segment.8
  • International developed market stocks trailed US stocks, with developed market small cap stocks still negative for the year.

Equity Returns: February 2024 and year-to-date

Source: S&P Dow Jones Indices9, NASDAQ10

Rate cut uncertainty: Not if, when

While short-term policy rates have remained unchanged in recent months, longer-term rates continued to rise in February as investors adjusted to the increasing likelihood of the Fed pushing off any rate cuts until later this year. The latest Fed “dot chart” from December shows the median target range for the Fed Funds rate projected by Fed members to be 4.6%, down about 75 basis points from current levels.11 This drop is consistent with analysis by the Carlyle Group that suggests that the market has priced in three 25 basis point rate cuts this year as of the end of February, down from a high of 7 cuts priced in in early January.12

  • Rising rates dragged down returns in most fixed income categories.
  • Longer dated treasuries and corporates all fell over 1% for the month.
  • Short duration treasuries gained 36 basis points in February and are up 1.3% so far this year.
  • Equity-like preferred stocks continued to lead the market.

Fixed Income Returns: February 2024 and year-to-date

Source: S&P, JP Morgan

Mixed results in private markets

Cliffwater’s most recent alternative investments report for 2023 shows mixed results for the three main private investments categories.13 Their universe contains a sample of funds that report NAVs at least monthly. For the full year 2023, private credit sector funds, which experienced strong inflows for the year, saw an average return of 12.51%, more than twice the results of the trailing 3-year period. Private real asset funds fared poorly, falling 4.76% for the full year. Among those funds, private real estate showed the most negative returns. Private equity fund returns cooled a bit from the prior two years, but still ended 2023 up 10.39%.

Private Market Returns: February 2024 and trailing 3-years ending Dec. 2023

Source: Cliffwater Alternative Fund Report, January 202414

Earnings matter 

As stock prices have risen over the past year despite tighter monetary policy and recession concerns, a natural question is what is supporting the gains. Increasing expectations that inflation is receding and interest rates have peaked while economic activity remains generally strong has buoyed investor sentiment. In addition, company earnings have resumed growing after a short pull back in the first half of 2022. Ultimately, it is these company fundamentals, both realized and expected, that drive expansion in equity prices.

In 2023, S&P 500 company operating earnings grew 7.2% and forecasts for 2024 predict a further 13.75% gain.15 The growth in earnings underlies the gains in equity prices. The economic sectors that led the stock market in 2023 showed even larger growth in earnings. Information technology companies delivered an 11.9% growth in operating earnings in 2023 and are expected to expand earnings an additional 26.6% in 2024.16 The Magnificent 7 companies that dominated the equity market in 2023 have largely supported those gains with correspondingly strong earnings. Those seven companies have produced a 126% cumulative earnings growth since the start of 2020, over three times that of the broader market and almost five times the S&P 500, excluding the Magnificent Seven.17

Operating Earnings: S&P 500 and Information Technology Sector

Source: S&P Global, Earnings and Estimate Report18

Still, the valuations of the overall market and the technology sector specifically have expanded even more than the realized growth in earnings. As of Q4 2023, the price-to-operating earnings ratio for the S&P 500 was 22.59x, up from 19.50x at the end of 2022.19 Tech stocks were at 33.7x in Q4 compared with 22.12x in 2022.20 The high expected future growth in earnings may indeed justify these valuations, but their lofty levels makes stock prices generally, and especially for the technology sector, vulnerable to any weakness in expected earnings growth. It will be wise for investors to keep a keen eye on the evolution of company earnings for any cracks that could spell a sharp reconciliation between prices and earnings.

1 https://www.federalreserve.gov/newsevents/speech/waller20240222a.htm
2 https://www.bea.gov/news/2024/personal-income-and-outlays-january-2024
3 https://www.bls.gov/news.release/empsit.nr0.htm
4 https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx
5 https://fred.stlouisfed.org/series/DGS10
6 https://www.spglobal.com/spdji/en/index-family/equity/
7 https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx
8 https://www.spglobal.com/spdji/en/index-family/equity/us-equity/sp-sectors/#overview
9 https://www.spglobal.com/spdji/en/index-family/equity/
10 https://www.nasdaq.com/market-activity/index/comp/historical
11 https://www.federalreserve.gov/newsevents/pressreleases/monetary20231213b.htm
12 Carlyle Group, Economic Indicators 2024
13 Cliffwater, Alternative Investments Report, January 2024
14 Cliffwater, Alternative Investments Report, January 2024
15 https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx
16 https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx
17 https://www.wisdomtree.com/investments/blog/2024/02/21/magnificent-seven-earnings-mostly-impress
18 https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx
19 https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx
20 https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx

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