Broker Check

Investors Looking in The Rearview Mirror Will Likely Miss Out

| March 04, 2024

The S&P 500* gained roughly 4.5% in February, bringing the 2024 total gain to about 7.5%, as of this writing. We’ve noted how January performance often predicts full-year performance. On the strength of additional February 2024 gains, the probability of a positive year jumped to 92.0%.

Thus, our initial year-end target of 5,200 for the S&P 500 is increasingly likely to undershoot actual performance. As of now, using the last 15 years of similar January-February starts, the median gain implies a year-end mark of 5,400-5,500 for the S&P 500.

That said, there’s no urgency at this moment to adjust our target. After all, there are still 10 months left in the year (and it’s an election year).

Strong Earnings, Data Discredit Negative Narratives

Now that 2023’s fourth quarter earnings season is complete, we can reflect. It’s been a good earnings season, with 78.0% of S&P 500 firms beating earnings per share estimates by a median of 7.0%, meaning the bottom-up EPS figure jumped 3.0% to $55.20, according to FactSet.

With this updated data, are earnings tracking towards our 2025 EPS target of $260.00? Let’s review some charts and simple math around recent earnings results:

  1. EPS is now $221.00 annualized.
  2. EPS is 3.0% higher than the start of earnings season.
  3. EPS growth is now 7.0%.
  4. Removing the bottom 15 stocks, EPS growth stands at 14.0%:

  1. Our 2025 target of $260.00 is 17.0% higher than the current reading.
  2. Our 2025 target still two years away, implying a per-share earnings compound annual growth rate of 8.0%.

In short, earnings are solidly tracking towards our 2025 figure, which is great. Also, S&P 500 companies added $35 billion in net income from the fourth quarter of 2022 through the fourth quarter of 2023 (7.0% EPS growth).

Artificial intelligence and its associated ecosystem efficiencies are generating business growth. This is a strong argument against claims of an AI bubble. Consider NVIDIA Corporation (NVDA)#^ and its free cash flow yield of roughly 3.0%, which is about the same as the entire S&P 500’s free cash flow yield of 3.5%.

Since when has the yield on a “bubble” been just slightly lower than the entire market’s yield? Based on the data, we think AI is not a bubble, nor is it overvalued. Regardless of what the media says, there are more tailwinds than headwinds:

Additionally, stocks are going up on good news. We worry instead when stocks fall on good news, which happened often in 2022. That’s not happening now.

Keep in mind, there are 10 months left in this presidential election year. But right now, it seems Wall Street might be as wrong about this bull market as it was about calling for a recession.

The Market is Far from Overvalued

Let's consider the narrative of the market’s supposedly high price-earnings ratio. The forward-looking 12-month P/E ratio for the S&P 500 is about 20.4-to-1, which is above the five- and 10-year averages. But it’s misleading to think this is a reason for alarm.

Removing the “Magnificent 7” stocks, the S&P 500 is trading at a 15-to-1 P/E multiple. So, the rest of the market is far from being overvalued.

The top line in the chart below represents the market-weighted S&P 500 and the bottom line is the equal-weighted S&P 500. Just two stocks comprise 14.0% of the S&P 500’s total market capitalization, but those same stocks account for only 0.4% of the equal-weight index’s market cap.

The difference is largely due to technology stocks. This exemplifies the undervalued nature of the broader market.

For those who think tech is as overextended as in 2000, think again. The value of tech stocks would essentially need to triple to be as frothy as 2000 without any further earnings increases.

Increasing Participation

Since Wall Street thought a recession was a “sure thing,” money has piled up on the sidelines at a record clip:

With the AI revolution, stocks continue to be one of the greatest wealth-building opportunities of all time. We think this will induce even more temptation to participate, which will likely lead to sidelined money flowing into stocks, especially as interest rates decrease.

Growing Economic Strength

For some global context, let’s examine the S&P Global U.S. Manufacturing Purchasing Managers Index (PMI). It’s compiled through questionnaires of around 800 manufacturers and is widely considered one of the best leading indicators of economic strength.

The preliminary February 2024 composite global PMI reading increased to 51.5 from January’s reading of 50.7 (over 50.0 connotates expansion):

This indicator includes information related to business output, new orders, employment costs, selling prices, exports, supplier performance, and more. Its rising nature is undoubtedly bullish.

Moderate Use of Leverage

Margin debt stands around just $771 billion. We say “just” because it’s nowhere near the all-time high of more than $935 billion in 2021.

Why does this matter?

This indicates stocks are hitting all-time highs without excessive leverage. In other words, this bull market run is natural. There are no leverage games being played by investors.

Market Broadening

Even though bond yields have backed up across the curve, equities have shown resilience. All 11 S&P 500 industrial sectors have continued trading higher over the past few weeks.

This evidence further debunks the claim of markets moving higher solely on the strength of a handful of huge tech stocks. Conversely, there is strong participation in the industrial sector, non-bank financial technology stocks, and large health care companies, which all signals market broadening.

Thawing Capital Markets

Merger and acquisition activity froze in 2022 and 2023. It’s thawing this year as sizable deals come across the wire, including:

  • Capital One buying Discover for $35 Billion.
  • Diamondback Energy acquiring Endeavor Energy for $26 billion.
  • Owens Corning buying Masonite for $3.9 billion.

Fresh M&A deals are almost always bullish markets. It makes us wonder what’s next.

“Big Money”

Readers know about our most trusted data set – “big money” professional investor activity. That includes the Big Money Index (BMI), a 25-day moving average of “big money” investor netted buys and sells, from our friends at MAPsignals.

A falling BMI is a risk reduction signal. That said, there must be accompanying selling pressure to cause true concern. The chart below shows a falling BMI, yet there isn’t notable selling pressure (yellow arrow). Rather, the dip is due to huge December 2023 buying rolling out of the 25-day average (red X).

This provides comfort. While there may be some natural consolidation ahead, underlying data holds longer-term promise because there’s been steady buying after a minor drop off.

Thanks goes to the NVIDIA’s earnings blowout. It caused buying across the market and stabilized the BMI:

We need to see obvious, significant selling to derail this bull market and it’s not happening yet. Recent buying outweighs selling by over a three-to-one ratio:

What could spoil this run is if the market climbs were what we call a “ghost action,” meaning the rises were not joined by significant volumes. The below chart reflects unusually large trades based on volume and volatility alone. It’s trending up:

As we sit here today, this rally is intact and only strong contradictory evidence will change that view. For now, there isn’t much of it.

Ride the Wave

In closing, investors looking in the rearview mirror will likely miss out on further gains. Transformational catalysts are here (e.g., AI), there’s record cash on the sidelines, and the horizon shows lower interest rates ahead. We’re also seeing heavy volumes, buying strength across the market, growth sectors leading the way, and rock-solid earnings.

This all opposes negative narratives.

Of course, it wouldn’t surprise us to see some consolidation over the next month or so as markets digest earnings reports and economic data like inflation, employment, retail sales, consumer sentiment, and more. But that doesn't change the full-year outlook.

Still, there is another potentially big risk worth mentioning. The upcoming two-to-four-week period gives investors an opportunity to see how the bond market reacts to more hefty Treasury auctions. Our $34 trillion (and climbing) federal debt can derail any good equity market. The debt’s size and questions around who will buy it all merit attention.

But as we've said numerous times, we’ll ride the wave until the data says otherwise. Data is the edge.

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* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.

# Cornerstone Financial Services, LLC owns NVDA directly in managed client accounts.

# Daniel Milan and Cornerstone Financial Services, LLC does not own COF, DFS, FANG, OC, DOOR personally or in managed client accounts.

^ Daniel Milan personally owns NVDA.

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC.  Cornerstone Financial and CoreCap are separate and unaffiliated entities.