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Equity Focus - January 2024

I love it when a plan comes together


I love it when a plan comes together


Key Points

The S&P 500 is now up over 15% since October 27th. A combination of strong consumer spending in stores, a rapid deceleration of inflation and a dovish tilt from the FED have all contributed to an extremely market-friendly backdrop for stocks - especially when you consider that US growth remains resilient, as per the strong November labor reports.

Markets have been increasingly pricing a US economic soft landing, while revising down the risk of a higher-for-longer rate environment. In the wake of the recent dovish tilt from the Fed, that outlook has changed quickly. While inflation decelerated at an accelerated pace, growth has remained firm (albeit no too firm), real yields receded.

This better-than-expected macro environment, which was further supported by a notable easing in financial conditions, drove a rerating of the rest of the market vs the Magnificent 7. The S&P 600 Small Cap index managed to beat the “Mag 7” by more than 5% over the last 4 weeks. The equal weighted S&P managed to beat its capital weighted counterpart by 1.2 %-points.

The January effect: Pension and other switches make January the strongest month of the year for equity inflows. On average, investors allocate ~21bps of fresh new money to equities. This would average ~USD60bn worth of equity inflows in January even without switches out of money market funds.


Main recommendations

Upgraded parts of EU Staples to neutral. A lot of headwinds from 2023 (e.g. cost of living pressures, input factor inflation, rising rates) are expected to ease in 2024, helping margins to recover.

Upgrade US Utilities to positive. Utilities continue to provide promising business updates and are working to transform their businesses towards sustainability.  Valuations are low and positioning is light. We see room for further upside, if rates continue to fall.

Stay diversified including in some cheap and solid cyclical stocks (European Financials).

Country-wise, we maintain our positive stance on the eurozone, UK, Japan and Latin America

Be cautious/selective with expensive market segments, such as Consumer Staples, some large-cap US tech stocks and some Consumer Cyclicals: pricing power is weakening and operating profits are under pressure from rising costs. Some very high P/E ratios are difficult to justify.

The key risks are that the US Federal Reserve or the ECB could keep interest rates high for longer than expected, triggering a sharper economic slowdown or even a recession. 


Q4 Earnings Season outlook 


Companies have been busy putting pressure on expectations as we approached Q4 earnings season. Both the number and the percentage of S&P 500 companies issuing negative EPS guidance for Q4 2023 is currently higher than average. 65% of companies which issued an update lowered the expectations, which is well above the longer-term averages. As a result, analysts lowered their earnings estimates for Q4 2023 by a larger margin than average during the fourth quarter. On a per-share basis, estimated earnings for the fourth quarter decreased by 6.8% from September 30 to December 31, surpassing long term averages as well.

But Q4 is already history. What matters more is the outlook for 2024. In this respect, the Q4 earnings downgrades could be seen as an attempt to lower the bar for 2024. We saw several companies which not only lowered their guidance but also depreciated their inventories. Consequently, the consensus estimate for 2023 EPS stands fell by almost USD4 to USD219.31, which let to an increased earnings growth rate for 2024 of now 11,5% vs 9,5% as per end of September.

Among the key elements to watch will be margins and factors that are likely to influence them.  Analysts have lowered their expectations of the net profit margin to 11% (was 12.2% in Q3). We feel that this pessimism could be driven too much by an extrapolation of the precautionary downgrades we saw from some companies. As revenues are still expected to grow, we expect S&P 500 firms in aggregate to have benefitted from continued strong economic growth and subsiding input cost pressures, enabling them to beat consensus forecasts.

For 2024, economic growth is one key element to watch for in respect to EPS evolution as US economic growth explains more than 50% of the variability observed in S&P 500 EPS growth. We see a higher probability that the US economy avoids recession, which would provide another tailwind to EPS growth. Inflation is another key element, albeit its impact is mixed. While a headwind for sales, it often acts as a potential tailwind for margins. Upside risks to margin forecasts exist if input costs, including wages, grow less quickly than prices charged. Finally, US financing costs eased as rates fell from their recent highs. Consequently, the cost of new debt has declined, calming previous concerns about higher interest expense and the impact on margins.


Money Market Funds – the 6 trillion dollar gorilla?

Driven by climbing interest rates, investors have put USD1.35 trillion into money market funds (MMF) in 2023 which pushed Assets managed by MMFs to a new high. This marks higher inflows than  in the prior 3 years combined. On the other hand, global equities logged +USD172bn of inflows in 2023. This represents the weakest inflows in the past 4 years. This comes despite the recent rally and is especially remarkable as  even the down-year 2022 saw larger inflows.

The market (via the yield curve) is still pricing in a 60% probability of a recession next year. We see chances for this number to fall during 2024. It is worth noting that there have been several instances over the last 10 years when investors have aggressively rotated out of money market funds as the probability of a recession dropped. While a large amount if such flows would likely move into bonds, even a small fraction could already have an impact on equities, given the total size of the money that may be moving.


Japan - Beware the Ides of January

While January is broadly considered a good month for equities from a seasonal perspective, Japan is an excemption to this rule. Based on 20-year seasonality, January does tend to be one of the worst months for performance in the Japanese equities market. The 20-year average for TOPIX is -0.65%, while the average for Nikkei is -1.45%.

Investors should be aware of this effect to not get spooked by a relative underperformance of Japan vs other markets during January. We stick to our positive stance and would see any weakness as opportunity to increase positions.


Sector Allocations – Overview

  • We downgrade Energy to neutral
  • We upgrade US Utilities to positive
  • We upgraded parts of the EU Staples complex to neutral
  • Gold Miners are still substantially lagging the price evolution of the underlying commodity and offer interesting opportunities (see the last edition for more details)
  • Please refer to the Thoughts and Convictions section on the next page for brief comments on our key convictions


Upgrading US Utilities to positive

Valuations are close to Covid lows while increasing capex increases the prospects of solid EPS growth

We see signs of US Utilities entering a new a spending cycle, driven by significant needs to maintain, harden, and expand the grid in order to support reliability as we continue to progress on the Energy transition. Those investments should support an average of 6% earnings growth for the sector, according to Goldman Sachs. As relative valuations vs the S&P 500 valuations remain close to COVID-19 era lows, we do not see this reflected in current prices. Falling yields should provide further support to valuations.


Upgrades in the staples sector

EU Food & Beverages as well as EU Food retail are upgraded to neutral on valuations and an improved margin outlook

Several headwinds from 2023 (e.g. cost of living pressures, input factor inflation, rising rates) are expected to ease in 2024. While  there  are  some  notable  exceptions  (robusta  coffee,  cocoa,  sugar),  it  is  generally  the  case  that  most  relevant  commodity  inputs  have  been  either  stable or declining as of late, which should help margins. Looking at  key macro indicators (consumer confidence, unemployment,  GDP),  they  suggest  that  the  average  consumer  should  be  stable  and  arguably  improved  compared  with  2023, helping volumes. Based on the recent valuation normalization, we upgrade EU Food & Beverages (Ingredients are our most favored sub-sector) & EU Food Retail to Neutral. Personal & Household Goods (PHG) remain on Underweight due to expensive valuations.


Downgrading Energy to neutral 

The fundamentals of the market will be less supportive going forward

While we still expect oil prices to recover during the next 12 months, interest rates and inflation expectations are unlikely to provide the tailwinds they did in 2023. Also, we see rising risks of modest negative revisions to consensus estimates for earnings and shareholder distributions. Geopolitical risk events will provide less support going forward. Thanks to ample OPEC spare capacity, oil prices (and hence Energy equities) have become less sensitive to geopolitics. The sector is still highly cash-generative and valuations are not demanding. However, we see less room for outperformance against this backdrop. We do still like MLPs in the US as US energy infrastructure benefits from increasing exports which lead to more oil & gas being transported toward export hubs along the costal line.