“The only cats worth anything are the cats that take chances.” ~ Thelonious Monk

Good evening,

For Head of Research Tom Lee and his team, the markets, year-to-date, are behaving essentially as he forecast back in December. Lee noted in mid-December that there was not a single instance where the S&P 500 fell 20% and got within 1% of an all-time high without subsequently making a new high in 20 days or sooner. This helped drive his call for “new highs in January,” which we saw last Friday (January 19).

Markets continued to climb this week. The DJIA set a new record on Monday, following in the footsteps of the S&P 500, which closed slightly down after a six-day winning streak.

After last week’s milestone, Lee asked his team to look back at what has happened in the past when stocks made an all-time high after having fallen 20% or more beforehand. They found that of the 11 precedent instances, “all 11 times, equities were higher six months later, with a median gain of 8%.” For seven of those 11 times, stocks had made strong gains 18 months later.

Other elements of Lee’s base case for 2024 continue to hold. This week, we saw the S&P Global Manufacturing PMI climb back to 50.3. As Head of Data Science Ken Xuan noted in our weekly huddle, “Because manufacturing PMI is highly correlated to EPS, this is supportive of our expectations for earnings expansion.” 

Inflation also continues to fall, as the Federal Reserve’s preferred inflation indicator, PCE, showed on Friday. Core PCE came in at 0.2% MoM and 2.9% YoY – the lowest reads since March 2021. As Lee observed, “for six out of the last 7 months, core PCE MoM annualized has been around 2%-ish. That is enough, in our view, to refer to declining inflation as a ‘trend’.”

Ahead of their release, Xuan was asked whether Friday’s PCE numbers might move markets, and he responded, “Probably not, since CPI from earlier this month had already hinted to investors how PCE will turn out.” To him, “what’s important and interesting about this number is how the FOMC will view and talk about it next week after their meeting (Jan 31.)”

Despite the positive macroeconomic news, both Lee and Head of Technical Strategy Mark Newton remain cautious in the near-term. Amidst a discussion about the markets continuing to move up during our weekly huddle, Newton interjected: “It might be helpful to add a little bit of sobriety to this discussion about rising markets and try to put things in context. Yes, it has been a wonderful lift back to all-time highs for the S&P 500 and QQQ, but we really have not seen that with other gauges.”

He continued, “The issue I have is that more than half of all sectors are down for the year. This rally has been largely led by Technology, which certainly is good for the market, but it's also really important to have those other sectors start to pick up. Along with Technology, Financials and Healthcare are the three largest sectors of the S&P, so it is positive that the latter two are also starting to show strength. Financials, to their credit, are starting to play catch-up. They continue to be an area that I think will continue to show really good performance throughout this year.”

Newton also expressed concern about small-cap stocks. “We also have a situation where small caps – the Russell 2000 – are down nearly 20% off all-time highs, which is quite unusual when the S&P [500] hits new all time highs. That’s only happened 11 times since 1950. Typically, the Russell 2000 is pretty much in lockstep with the S&P when something like this happens, but they’ve just been under a lot of pressure.” Newton continued, “I do suspect that the Russell will snap back this year, but a lot of that's going to depend on rates really rolling over. I think we’re probably looking at a March to August timeframe for when the Russell can really play catch-up.”

Lee acknowledged Newton’s concerns about breadth and with recent small-cap performance. But, in his view, the case for small-caps in 2024 remains intact, with the relative P/B ratio of Russell 2000/S&P 500 – 44% – showing what he described as “very discounted” levels.

Lee expects breadth to improve, for reasons summarized in our Chart of the Week: 

In Lee’s view, small-caps in particular should benefit from this improvement in breadth. Yet, he continued to reiterate that “we are not in a full risk-on environment,” repeating that “our base case remains that the bulk of gains for equities will come in 2H 2024. But that view could also change if the Fed establishes a clearer roadmap for cuts.”

Newton also remains somewhat optimistic. “It’s still a pretty good situation for the U.S. economy right now, I think. The data continues to suggest that we're in sort of a Goldilocks scenario. The consumption data cooled off much less than expected,” he pointed out. “It came from 3.1, everyone expected it to slip to 2.5, but it instead came in at 2.8%. So the economy's strong and people are spending, but without a pickup in inflation.” Data released this week showed that U.S. GDP grew 3.3% annualized in Q4 2023, easily topping expectations of 1.7%. For 2023 as a whole, real GDP rose 2.5%, above 2.4% expectations. 

On Tesla (TSLA 6.71% ) 

Tesla (TSLA 6.71% ) sank more than 13% this week after the company missed earnings expectations and reported a troubling outlook for the rest of the year. In the face of Tesla’s sharp decline, Lee saw encouraging signs of resilience in the stock market: “It’s a sign of market strength when the market is holding up even when the eighth-largest stock drops [this much,]” he asserted.

Tesla has been a Granny Shot since the list’s inception, but on January 17, Lee and Newton flagged it as a “Sleeping Granny”. As a reminder, a company’s status as a “Sleeping  Granny” indicates that while Lee still believes in the company’s long-term potential, there is a strong probability of near-term underperformance. 

Is this a “buy the dip” situation? Newton is doubtful. From a purely technical standpoint, he allows for the possibility of a brief bounce from current levels, but he wrote that “while price might be at important areas and momentum might be a bit oversold, it would be premature to signal a low. Furthermore, my cycle composite shows further weakness in February.” In his view, “One might hold out until more evidence of stabilization occurs.” 

Elsewhere 

The U.S. will suspend the approval of permits for new liquified natural gas (LNG) export terminals, citing a need to give regulators more time to consider the potential environmental risks of each project. The decision will affect Gulf Shore communities, energy security in Western Europe, and obviously, the energy sector.

The People’s Bank of China announced a reduction in bank-reserve requirements, hoping to stimulate the stock market with a move that could release as much as CNY 1 trillion (USD $140 billion) in cash into the economy. Chinese authorities hope this will boost lending, support the ailing stock market, and reverse its nascent deflationary trend.

Less than half – 45% to be precise – of young adults aged 18-34 are financially independent from their parents, according to a new Pew Research study. The figure is 67% for those in their early 30s and 44% for those aged 25-29. 

Sweden is nearly a member of NATO after potential opposition from Turkey and Hungary receded this week. The Turkish parliament at last voted to approve the Scandinavian country’s entry into the alliance, paving the way for Turkish President Recep Erdogan to sign the legislation (which he has said he will do once the U.S. agrees to sell his country F-16 fighter jets). Hungarian Prime Minister Viktor Orban also signaled that his country would support Sweden’s bid, with a vote by the Hungarian Parliament to take place “at the first possible opportunity” – likely mid February. Sweden sought entry into NATO in response to Russia’s invasion of Ukraine.

Apple will comply with EU orders to allow users to install applications from rival app stores, slightly opening its “walled garden” to allow for more competition. This applies only to iPhone/iPad users in the EU and is a result of the EU’s Digital Markets Act.

The European Central Bank announced it would leave rates unchanged, leaving them at the highest in ECB history. The decision comes despite declining inflation and a weakening economy. ECB President Christine Lagarde said it needs to see more before bank officials can be confident that the inflation battle has been won.

Swiss authorities appointed Stefan Walter as the new head of the country’s markets regulator, almost a year after a banking scandal that required an emergency takeover of Credit Suisse by UBS. Walker, formerly director-general of the European Central bank, will take over FINMA on April 1, as Swiss authorities continue to respond to the aftermath of the CS collapse.

Germany saw some of the largest mass protests in recent decades spread across the country this week, as hundreds of thousands gathered to protest the extreme-right’s reported proposal for the mass deportation of immigrants and “non-assimilated citizens.” The proposal, which has not been confirmed, reportedly arose after German lawmakers agreed to ease the immigration/citizenship process in response to a familiar demographic trend: an aging population and shrinking workforce.

And finally: Dwayne Johnson has long been known as “The Rock,” but he has never owned the rights to the moniker he used as a performer with World Wrestling Entertainment (WWE) – until now. Johnson got those rights as part of a deal in which he joined the board of WWE’s parent company, TKO Group (TKO).