Strength in labor data, upward revisions to GDI and continuation in strong services activity along with a successful defence of 5700 retest on SPX, all support a broader growth narrative and support a "risk-on" view. In addition to the positive view on China, growth equities are now even more favored, particularly given these have lagged and under-performed in a rising market.
Economic Growth Begets Growth Equities.
Of the three keenly watched variables (labor, 5700 on SPX and earnings), two are now positive with the third to be played out over coming weeks as earnings kick-off. While no doubt earnings season will come with its own volatility (previous two quarters have seen an asymmetric response to earnings misses), the current forecasts for a deceleration into 3Q (consensus 4.6% y/y for 3Q vs. 11% delivered in 2Q) appear somewhat pessimistic with likely upward revisions.
We cannot over-emphasize the importance of earnings delivery - given the elevated valuations, price appreciation is likely to be earnings led rather than multiple expansion.
How To Position
- Overweight US Growth Equities - We expect our macro nowcaster to turn positive, led by strengthening labor data and a likely resumption in consumption trends. More importantly, the market signals model is clearly positively aligned. A further reduction in hedges in our model portfolio along with a bias in positioning in favor of growth equities are the strongest opportunities.
- Overweight China Equities - Expectations of a cumulative stimulus kick-starting growth, along with favorable price action, support the case for being overweight China equities (see note Irrigating Flooded Farms...30 Sep 2024), especially in tech, domestic consumption and selected exporters. A near vertical rally is likely to pause for consolidation, providing renewed entry opportunities.
- Tactically Underweight India - We see structural/secular opportunities in India, BUT, for now, we see downside risk in absolute and particularly in relative terms for India. Long China/ Short India is a preferred Trade.
- Fixed Income - The case for extending duration is further weakened with stronger economic growth. Although spreads remain compressed near historic lows, there appear to be limited catalysts for widening, in aggregate terms. There are however relative opportunities (see note Finding Value in Bonds by Joydeb Chatterjee, 30 Sep 2024).
- Commodities - In the short-term, industrial commodities, Copper and Iron-ore are likely beneficiaries of the growth trade, especially in China. Gold continues to remain in a solid uptrend, BUT, is likely to consolidate. Long Gold/ Short Bonds (TLT) is an attractive tactical trade opportunity.
Risks to Views
- Geopolitics - There are a number of flash points in addition to upcoming US elections in Nov - these are likely to elevate volatility. That said, geopolitical events tend to have a short lived impact with economic and corporate fundamentals more critical driver of share prices.
- Another false dawn in China remains a risk to the bullish call. Ultimately, consumption and demand need to respond to stimulus measures.
- Price Action - SPX fails to hold the breakout - While the successful retest and defence of 5700 levels for the SPX are a clear positive, any reversal below this will weaken the bullish case.
Positives from Recent Economic Data
A slew of recent macro data, ranging from upward revisions to income and savings suggests a further support for consumption trends. Labor data, despite some lingering concerns, has continued to show sequential improvements in recent weeks, capped by yet another strong payrolls report. This is further supported by financial conditions that have remained easy and abundant liquidity supporting the risk-on trend. Overall, even as the current cycle appears long in the tooth, data does not show a major turn just as yet.
- More Consumption Firepower - With the BEA revising GDI figures, aside from resolving the disconnect between GDP and GDI data, the elevated income and savings suggests a greater than previously expected consumption firepower. This is likely to support consumption and broader economic growth.
- Stronger Payrolls - Sep payroll data surprised to the upside with now a 4th month back-to-back gain in payrolls. Do note this data series has been subject to substantial revisions.
- Lower Jobless Claims - While both initial jobless claims and continuing claims remain elevated, these have now been improving for 9 weeks.
- Strength in Services PMI - Service activity has continued to be elevated and in positive territory. While manufacturing activity has been weak, aggregate PMIs continue to be growth supportive. Of note, the US economy remains services dominated.
- Easy Money Conditions - Despite what has been a "restrictive" monetary policy backdrop, both M2 growth and aggregate financial conditions have continued to remain easy and also continue to get easier.
- Are There Any Weak Spots - Yes - The gap between unemployed and job offers has continued to narrow and job quits trending down. These remain a lingering concern suggesting a still soft labor market.
Earnings - 3Q Estimates Appear Too Conservative; 2025 too Optimistic?
Following a stellar 2Q'24 earnings season, 3Q estimates show a substantial deceleration, probably impacted by corporate guidance. Given the larger than average intra-quarter downward revision, there is a distinct possibility that 3Q earnings surprise on the upside. We do remain skeptical of the 15% earnings growth currently forecast for 2025 (up from 10% in 2024), but this is unlikely to have a major bearing on near-term market direction.
- 3Q 4.6% EPS growth vs. 11.2% in 2Q - 2Q, fastest earnings growth since 4Q'21, saw a significant beat. However, analysts have been lowering estimates for 3Q - down from a 7.8% growth expectation to 4.6%.
- 2025 estimates too rich? - The case for a substantial acceleration in 2025 appears less convincing - but as we note, the market is unlikely to focus on these estimates until we've seen 2024 play-out.
source: Factset.com
source: Factset.com
Four-Pillars Summary
Our proprietary four-pillars model suggests a neutral rating for equities with strength in earnings and price signals offset by expensive valuations and deceleration in economic trends. Given recent economic data upward surprises, the economic nowcaster is likely to turn positive, supporting the case for being overweight equities.
We should also emphasize that aside from being a critical component of our four-pillars model, market signals are being leveraged to dynamically hedge our model portfolios.
source: Lighthouse Canton
SPX - Successful Retest of 5700
Following a 3rd attempt breakout (after 2 attempts in July and early Sep, SPX broke out new high ground late Sep) and a classic retest, price action suggests a successful negotiation of the critical 5700 level. A further clear close above 5750 will further solidify the up-move. Momentum indicators remain in positive territory and a likely reversal up on the MACD indicator will further strengthen the uptrend.
source: Tradingview.com
Tech and Growth Need to Participate
Even as the SPX tested (and broke-out) of previous highs, tech heavy Nasdaq 100 has struggled - both in absolute and relative terms. Leadership, with defensives, financials and industrials, over the last two months, appears to be shifting back towards growth sectors, especially technology. For SPX to continue the uptrend, we see it imperative that growth sectors not just participate, but lead the next leg up. Given recent under-performance, we see tech as a clear opportunity.
source: Tradingview.com
source: Stockcharts.com
China - If It's Real, It Ain't Late
Our recent note on the China opportunity (Irrigating Flooded Farms...30 Sep 2024) highlighted the possibility of resumption in economic activity, led by cumulative stimuli. While there is no dearth of reasons to be negative on China Equities, marginal change can be a powerful driver. Given a substantial absolute and relative under-performance over the last 4 years, we believe there is plenty of headroom for China equities, especially in technology, domestic consumption and EV export oriented sectors.
source: Tradingview.com
India - A Tactical Take Profits
We remain positive on India equities from a secular growth perspective. However, price action and lack of incremental catalysts in the short-term, suggest a tactical profit taking opportunity in Indian equities.
We also see opportunities in funding China longs through India shorts. While recent moves have been sharp, in the context of a long standing under-performance by China equities, the upside can be substantial.
source: Tradingview.com
What About Bonds and Gold
Following strength in Sep payrolls, probability of another double-barrel rate cut in Nov have dissipated rapidly (now over a 90% probability of a 25bp rate cut in Nov). Arguably, the strength in bonds (lower yields) and gold, have likely priced in the rate cuts and short-term moves are likely to see, at the minimum, a consolidation, if not a reversal. With treasury yields spiking to 3.97% (vs. 3.6% in mid-Sep), the case for extending duration becomes further weaker, at least for now. Equally, we expect a pause in gold's meteoric rally ytd.
There is however, in our view, an interesting opportunity in a Long Gold/ Short Bonds (TLT) trade. After a near 6-month consolidation, the Gold/TLT ratio is breaking out suggesting the possibility of a rapid move up.
source: Tradingview.com
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