Please see below March’s Investment Outlook from Evelyn Partners, which was received late yesterday (12/03/2024) afternoon:
Balancing growth and inflation
Global economic growth continues to be resilient, providing a backbone of support for companies to deliver on analysts’ earnings expectations. The J.P. Morgan Global Composite Purchasing Managers’ Index, a lead indicator for Gross Domestic Product (GDP), covering both manufacturing and services, shows evidence of gathering steam in January. It reached a level that is consistent with global real GDP growth of 2.8% and has steadily improved over the last few months.
In short, economies have been able to defy the pessimistic expectations from a year ago due largely to healthy job creation as firms continue to replace workers that left the workforce during the Covid pandemic. US demand for available workers (employed plus job openings) is running around 2 million higher than the supply of workers (employed plus unemployed). This points to a healthy jobs market and increases the likelihood that the US can avoid a recession.
A key risk for financial markets is that rapid growth rekindles inflationary pressure and central bankers reconsider their intentions to cut interest rates. Although in the Monetary Policy Committee’s (MPC) last interest rate setting meeting, some Bank of England (BoE) observers noted that inflation could drop below 2% in spring, enough to warrant an interest rate cut. Indeed, the BoE removed its tightening bias and shifted to a more neutral setting by arguing that risks were “more evenly balanced”.
However, elevated wage growth is still a concern for the hawks on the MPC. The Bank’s annual Agents Survey expects wages to expand by 5.4% in 2024, which is above the latest 4% rate of consumer price inflation in January. Should wage data come in stronger than expected it could lead to upward, cost-push pressure on prices. Under that scenario investors could have to wait until later in the year for interest rate cuts.
Wage inflation is less of a problem for the US central bank. The comprehensive Employment Cost Index (ECI), which includes wages, bonuses, and benefits for US civilian workers, grew 4.2% in the fourth quarter of 2023 from a year ago. This is down from a peak of 5.1% in the second quarter of 2022. Importantly, the number of workers quitting their jobs to look for better paid opportunities has steadily fallen over the past year. As a lead indicator for the ECI, the quit rate suggests that the risk of an upward spiral in overall compensation rates has likely eased. Given that consumer inflation is getting close to its 2% target rate, the Federal Reserve will probably feel confident to begin an interest rate cutting cycle in the coming months.
Overall, investors are becoming a little more comfortable that central banks can balance growth and inflation. Given the economic backdrop is relatively benign, the pressure could be on firms to exceed, or at least meet, market expectations for company earnings, and particularly for large-cap stocks.
Size matters for earnings delivery
The Magnificent Seven companies (i.e. Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) have become a dominant proportion of equity benchmarks. This group currently accounts for 29% of the S&P 500 by market capitalisation and were responsible for around 60% of the returns achieved by the index in 2023.
These Magnificent Seven stocks generated significant net income to enable them to outperform the equity benchmark last year. However, this year has been a different story, as only four of the seven names are currently outperforming the S&P 500. This recent earnings season could hold some clues as to why. Nvidia and Meta have been the biggest drivers of returns so far in 2024, as both companies beat analysts’ estimates and posted strong earnings figures for the fourth quarter of 2023. Take Nvidia, a company that is best known for designing some of the world’s most advanced computing chips. It has seen its earnings for the most recent quarter increase by over 450% compared to 12 months prior.
This rapidly increasing demand for chips is due to firms implementing Artificial Intelligence (AI) into their businesses, as advanced chips are essential to accelerating AI-led processes. This bumper earnings report saw Nvidia’s market capitalisation increase by over $275 billion on the day following its latest earnings announcement, the largest daily increase in market value for any listed company ever.
In contrast, Tesla has been the worst performer of the group this year. It was the only member of the Magnificent Seven to miss on analyst earnings expectations in the fourth quarter and has since seen large downward revisions to its earnings growth outlook. Falling profit margins have hindered the electric vehicle maker’s profitability. This could be in part due to recent price cuts implemented to stay competitive against rival Chinese electric vehicle manufacturers. With this constrained earnings outlook and considering that they’re the only member with a market value below $1 trillion, it might be time to reassess their membership of this exclusive club.
To summarise, the macro environment remains supportive for company earnings, and particularly for large cap stocks to drive the overall market. However, there are still risks. Analysts have already forecast strong earnings outlooks for most of these Magnificent Seven companies over the next five years and valuations have been bid up. The risk is this group of stocks fail to achieve these elevated expectations. Given the Magnificent Seven make up a decent chunk of the US (and global) stock markets, should they miss their earnings forecasts it would likely prove a headwind for stocks overall. Nevertheless, on balance, solid economic growth and lower inflation means this risk is probably manageable.
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Carl Mitchell – DipPFS
Independent Financial Adviser
13/03/2024