Despite Deteriorating Economics, Equity Markets At All-Time Highs

There were several important news events this week including the Fed’s January minutes. But this took a back seat to Nvidia’s blowout top and bottom-line numbers and its forward guidance which occurred after Wednesday’s (February 21^st) market close. The equity market, which had been relatively flat on Tuesday and Wednesday, advanced more than 2% on Thursday and held those numbers on Friday.

Year to date, through Friday (February 23^rd), the S&P 500 has advanced 6.69%. Most of that gain was the result of the performance of the phenomenon known as “The Magnificent 7” (MSFT, GOOG, APPL, AMZN, META, NVDA, TSLA). Year to date, their weighted average prices (weighted by market cap) have advanced 14.48%, led by Nvidia and Meta (formerly known as Facebook). The S&P 500 Index is weighted by the market capitalization of the companies in the index. That is, the larger the equity market value of the company, the more influence it has on the index’s value. The Mag 7 have a combined 30.7% weight in the index. The other 493 account for the other 69.3%. Doing some math, the “Mag 7” were responsible for 4.44 percentage points of the 6.69 percent total advance, or 66%. That’s pretty top heavy! The other 493 stocks, on average, advanced 2.24% (compared to the 14.48% of the Mag 7). We note here that 2.24% as of late February, is not that shabby; if kept up for the entire year would result in a return of approximately 15%. (On the other hand, if the Mag 7 continued their pace, that annualizes to 98%! – how likely is that?)

There have been several well-known market commentators out with cautionary advice for equity market participants, as traditional market measuring metrics, like the Price/Earnings ratio, are well above their historical averages.

The Fed

As noted, the other important news release was the Fed’s January meeting minutes. While not a market mover, it appears that those minutes sealed the market’s view that a March rate cut is off the table (market odds now under 3%). At the after-meeting press conference, Chairman Powell reiterated what his FOMC was thinking. In the minutes, we find the following:

…participants noted that the economic outlook was uncertain and they remained highly attentive to inflation risks…

Risks around the inflation forecast were seen as tilted slight to the upside…

From our perch, it would appear that the odds of a May rate reduction are also low (market odds now 8% from over 20% as a result of “hawkish” jawboning from FOMC members). Even June is getting iffy (71%). We note here that record highs in the popular equity indexes (S&P 500, Nasdaq, DJIA) are yet another reason rate cuts may be held up, as the Fed doesn’t want to encourage even more risk taking. Nonetheless, even the Fed thinks there will be three rate cuts this year, now likely in June or later.

One positive thing going in the Fed’s favor is the low level of inflation expectations, a closely watched indicator by the FOMC. The chart shows the NY Fed’s index of one year ahead inflation expectations (currently 3.0%) and the CPI. Note the strong relationship between the two. In addition, the University of Michigan’s most recent Consumer Sentiment Survey (February) pegged five-to-10-year inflation expectations at a lowly 2.9%. So as long as inflation continues to wane, as we expect, then inflation expectations are likely to be well behaved. Again, this is a positive for the Fed.

Housing

For a change, Existing Home Sales showed up with a “+” sign in January, rising +3.1% month/month. Still, sales for the month were lower by -1.7% from January ’23. These are closings of contracts signed in November and December when mortgage rates briefly dipped down to 6.6% (they have since rebounded to near 7.3%). So, it is highly likely that January’s positive month/month number won’t be repeated in February. As can be seen from the chart, despite the slight January uptick, Existing Home Sales are back at Great Recession levels.

New Home Sales, however, appear to be back to their pre-pandemic levels (see chart above). They have recently been bolstered by the slowdown in Existing Home Sales as low mortgage rates from a few years ago have kept Existing Home Inventories low, thus pushing potential home buyers towards the “New Home” market.

Housing Starts and Building Permits, both keys to future New Home Sales, both fell in January. Starts were off -14.8% from December levels and new permits were down -1.5%. The big story here is in the Multi-Family sector. In past blogs, we’ve discussed the record number of Multi-Family Units under construction (right-hand side of chart) that are now coming online.

This is not a one-off situation as new units under construction continue to come online in record numbers (left side of chart). There are still nearly one million units under construction, up 5% over the year.

According to Rosenberg Research, rental completions rose 6.3% in January, the third month in a row of large increases, and are up 54% from year earlier levels. Needless to say, this will continue to put downward pressure on rents, with its attendant (but lagged) impact on the CPI.

Commercial Real Estate

Housing isn’t the only real estate sector in disarray. Commercial Real Estate (CRE) is in even worse shape. The ability to work from…