Last week’s headline event was Nvidia’s quarterly earnings release, which investors treated as a measuring stick for the strength and durability of the boom in generative A/I. The company didn’t disappoint. Revenue and EPS growth far exceeded consensus estimates as Wall Street analysts struggle to keep up with Nvidia’s hockey-stick growth trajectory. Q1 revenue guidance of $24.0 billion also exceeded consensus estimates by nearly 10%, resulting in further revision of expectations and yet another re-rating of the stock. NVDA finished 8.5% higher on the week, despite slumping in the days prior to Wednesday’s release.
Reassurance that A/I growth continues unabated plus a benign week for rates allowed US stocks across all industries to push higher. The S&P 500 and the Dow Jones Industrial Average closed the week at fresh all-time highs, while the Nasdaq eased back just slightly on Friday after reaching a new high on Thursday.
The picture remains mixed on the macro front. On the plus side, jobless claims fell sequentially and continue to indicate a strong labor market, S&P’s US Manufacturing (51.5) and Services PMIs (51.3) printed in expansion territory in the preliminary February reading, and existing home sales ticked higher in January thanks to some moderation in mortgage rates around year-end.
However, the Conference Board’s Leading Economic Index (LEI) painted a different picture, falling for the 22nd month in a row. The index is down 7.0% on a y/y basis, and has fallen 13.4% from its peak in December of 2021. In the past, declines of that magnitude have always been followed by a US recession (see Chart of the Week).
Albion’s “Four Pillars”:
Economy & Earnings
The US economy was resilient last year, and Wall Street analysts expect full-year 2023 corporate earnings to be roughly flat y/y versus 2022. Analysts are forecasting low double digit EPS growth in 2024; growth of that magnitude will depend on the economy avoiding recession.
The S&P 500’s forward P/E of 20x is above the long run average, so valuation could be a headwind to future returns. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Eq Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.
Futures markets imply that the Fed will cut overnight interest rates several times in 2024, most likely beginning mid-year. The belly and long end of the curve have already priced in a rate cutting cycle, with yields falling more than 100bp in November/December of 2023.
After reaching 40yr highs in mid-2022, inflation has moderated significantly over the past 18 months. Goods inflation has fallen due to softening demand and supply chain normalization, while services inflation remains somewhat elevated, in part due to heavily lagged shelter costs.