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Softer Nowcast Data and Price Cuts

Thought to ponder …

“The time we spend worrying is actually time we’re spending trying to control something that is out of our control. Time invested in something that is within our control is called work. That’s where our most productive focus lies. Worrying isn’t productive because it doesn’t produce confidence, and even if it did, the confidence wouldn’t last.

— Seth Godin, “The Practice”

The View from 30,000 feet

With quarterly corporate earnings reports for Q1 firmly in the rearview mirror, markets have rotated to macro, specifically interest rates, being the key driver of daily undulations. Notable events for the week included Trump entering the record books for being the first President to wear the badge of being a convicted felon. Financial markets took the news in stride, with a fair amount uncertainty about what the conviction will mean for his election chances. Exit polls during primary season indicated that as many as 25% of Independents may be influenced negatively by the ruling. However, more recent polls, conducted in the two days after the court ruling, indicated that 35% of Republicans were more likely to vote for Trump after the conviction. More notable for the financial markets last week were streams of economic data that are beginning to paint a picture of deteriorating economic growth in the US, with only marginal signs that inflation is cooling, putting the Fed in a complicated position because they would like to get out in front of the slowdown in growth, but are being forced to sidelines because inflation remains uncomfortably high. Key data for the week included a softening of Q1 economic data, as the second estimate of Q1 GDP ticked lower to 1.3%, while Nowcast estimates the current quarter’s GDP estimates continue to erode. On an encouraging note, the monthly PCE data release showed that the recent resurgence inflation felt since the beginning of the year is subsiding, but the cooling trend didn’t have enough umph to convince anyone that inflation would be moving towards the Fed’s targeted range anytime soon. This leaves the markets in a trading range driven by rate cut expectations influenced by the daily whims of data releases and Fed press coverage. For the time being this includes the 10-year Treasury stuck in the danger zone between 440 and 450, with equity strength perking up as rates show signs of falling below 440 and weakness tied to anything that signals that rates may push above 450. For the Fed’s part, they continue to utilize a barbell rhetoric approach, splitting mouth pieces between doves and hawks, managing an optimistic message of rate cuts in 2024 from the doves, matched with a pragmatic view of vigilance from the hawks.

  • The Focus Point Leading Market Indicator continues in Neutral Conditions with help from loosening financial conditions
  • Magnificent 6 not expensive by post-pandemic standards
  • Retailers play to consumer strain with PR campaigns about price cuts
  • Nowcast GDP models for Q2 are diving
  • Focus Point Sector Rotation Update: Deterioration in breadth shines through in sector work

The Focus Point Leading Market Indicator: Neutral Conditions with help from financial conditions

  • The Focus Point Leading Market Indicator continued the 15th consecutive month of Neutral Conditions, indicating that risks are balanced and the probability, as calculated by the model, of a severe and prolonged market downturn in next 30 to 90 days is low.
  • Over the course of May financial conditions loosened marginally, with credit spreads narrowing and equity markets rising creating a market friendly environment for risk assets.
  • Separately, private lending continued to expand, despite higher interest rates and tightening lending standard environment, signaling stable liquidity conditions.

Financial conditions loosening and bank lending expanding

HY CDX Spread vs BBB 10-Yr Treasury Spread

Bank Credit All Commercial Banks Annual Percent Change

  • The average forward price-to-earnings of the Magnificent 6 (Apple, Amazon, Google, Meta, Microsoft, Nvidia) as of the close of May, stood at 30.4x.
  • Although this is comparatively expensive to the S&P500, which stood at 3x at the end of May, it is actually only in the 30th percentile of the period beginning 1/1/2020 to 5/31/2024, in which time the range has been between 27.4x and 41.0x.
  • In the time frame of 1/1/2020 to 5/31/2024 the average return of these six stocks was 6%, heavily weighted by Nvidia, which was up 739.8%.
  • Performance for these six stocks has been about each of the companies effectively exploiting their competitive advantages. As an example of their effectiveness, free cash flow of these six companies increased on average 282.9%, with projections for the next 12 months to end at $419b.

Forward price-to-earnings multiples not historically expensive and free cash flow booming

Mag 6 Avg. Forward PE Multiple in 30th Percentile

Magnificent 6 combined free cash flow up 283 Percent

  • A slew of headlines crossed the wires last week, with major retailers announcing price
    • Target -1,500 items (with plans to cut prices on 3,500 additional items this summer)
    • Walmart – 7,000 items
    • Amazon Fresh – 4,000 items
    • Walgreens – 1,500 items
    • Aldi – 250 items
    • McDonalds – limited $5 happy meal
    • Akro Corp (operator of convenience stores in rural areas) – most aggressive deals in 20 years
    • Other major companies included in price cutting headlines – Ikea, Michaels, Kroger
  • Following comments from major retailers including Walmart, Starbucks and Home Depot indicating that consumers are becoming more and more price conscious.
  • According to Adobe data, the market share for the least expensive groceries grew from 38% to 48% between April 2019 and 2024, while the most expensive groceries market share declined from 22% to 9% in the same period.
  • Price cuts at the register are positive trend for consumers but not a The Atlanta Fed has a time series that divides inflation between Sticky CPI and Flexible CPI. Nearly all the items associated with these news stories fall in the Flexible CPI basket, which is rising at 0.6% annually according to the latest reading, compared to Sticky CPI, which remains higher at 4.4%.

Source: AP News


Atlanta Fed Sticky CPI vs Flexible CPI

CPI - All items less shelter

Nowcast GDP models for Q2 are diving

  • All three of the GDP Nowcast models produced by different Federal Reserve Banks are showing a similar trend of falling.
  • Last week’s Q1 2024 GDP estimate fell to 1.3%, taking the economy into territory of growing below trend, which is 1.8% to 2.0%.
  • An economy growing below trend is not necessarily a problem and should provide the Fed comfort that higher rates are being transmitted through the economy, reducing the chances that the Fed would lean toward tightening rates, even if inflation were to remain persistent.

Nowcast GDP Models from Fed Reserve Banks of Altanta, NY & St. Louis

Focus Point Sector Rotation Update: Deterioration in breadth shines through in sector work

  • The Focus Point Sector Rotation Model is a combined trend following and mean reversion model that utilizes seven factors to analyze daily price data on sectors to determine the strength of upward trends.
  • The percentage of member of the S&P500 trading above their 50-day moving average ended the month of May at 51.3%. Historically, in the range of 30% to 60%, is associated with market churn and range bound markets.
  • Sectors have been plagued by a similar pattern, with only three sectors exhibiting strong trending patterns based on the percentage of members within the sector trading above their 50- day moving Although, this is only one indicator used in the trend following model, it is emblematic of larger picture for both the broad indices and sectors.

Focus Point Sector Rotation - Relative Weights

Putting it all together

  • The markets are in range bound doldrums sandwiched between earnings seasons with a lack of corporate catalysts, creating a vacuum where attention is focused on economic data releases and geopolitical developments.
  • The latest developments include slowing growth, a softening of inflation data and anecdotal evidence that retailers are being pressured by consumers to lower prices.
  • Although goods prices falling is a welcome sign for consumers, shelter remains the main culprit in CPI calculations causing inflation to be sticky. As we’ve pointed out previously, there are trends unfolding indicating a pocket of softness forming in housing, including:
    • An increase of active listings
    • A decrease in pending sales
    • An increase in time to sell
    • An increase in listing price drops
  • The equity markets are being driven by six stocks (Apple, Amazon, Google, Meta, Microsoft and Nvidia). Although these six stocks are expensive relative to the rest of the S&P500, the are actually relatively cheap compared to their relative pricing over the last four years.
  • We continue to have a positive view on risk assets contingent on the employment and housing markets remaining resilient and driving consumer spending and corporate earnings, but we are cautious because we see weakness developing in each of these key areas that bare watching very closely.

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