AGG - So Many Market Narratives Don't Forget Price

2023-05-01 11:20:00 ET

Summary

• After the gradual erosion in S&P 500 EPS and revenue “upside surprises” in 2022, Q1 ’23 is breaking the trend and EPS has come in much stronger than expected.
• If you simply watched “price action” you’d think all was well with the world. Everything is up this year in terms of YTD returns.
• And yet, sentiment is so bearish.

Promised readers in this weekend’s S&P 500 earnings comments that a quick history of the “upside surprise” for S&P 500 revenue and EPS would be forthcoming:

• Q1 ’23: +7.7% EPS, +1.5% revenue
• Q4 ’22: +1% EPS, +1.6% revenue
• Q3 ’22: +3.4% EPS, +2.3% revenue
• Q2 ’22: +5.5% EPS, +2.5% revenue
• Q1 ’22: +7% EPS, +2.6% revenue
• Q4 ’21: +5.1% EPS, +2.7% revenue
• Q3 ’21: +10.2% EPS, +2.9% revenue
• Q2 ’21: +15.7% EPS, +5.2% revenue
• Q1 ’21: +22.3% EPS, +4.0% revenue
• Q4 ’20: +15.7% EPS, +3.7% revenue

Last weekend, this blog previewed the mega-cap companies reporting earnings last week , and the title referenced the post-Covid hangover, and that’s exactly what’s happening.

Readers can see that after the gradual erosion in S&P 500 EPS and revenue “upside surprises” in 2022, Q1 ’23 is breaking the trend.

Personally, I’d rather see stronger beat rates coming from revenue, but it’s clear corporate management are much more disciplined around expense management than the last 2 years.

No question, Q1 ’23 S&P 500 EPS has come in much stronger than expected.

The various market narratives or “fears” that constantly arise in the financial media:

• Recession: The jobs market needs to crack. Corporate CEOs have been fearing recession for 15 months now. You have to assume it will happen at some point;
• Inflation: Services inflation is turning out to be “stickier” than expected. The majority of the inflation indices have rolled over;
• The Fed and FOMC: Will do another 25 bps this week. The question is, “When does the FOMC stop hiking fed funds?”
• S&P 500 earnings and revenue weakness: Not so much, at least so far in Q1 ’23;
• Credit spread weakness: None really to speak of, certainly nothing like 2001-2002 or 2008. (More on this later in the blog);
• Banking “crisis”: Now contained, although First Republic Bank ( FRC ) will be taken over. No systemic risk in evidence;
• The debt limit battle: Needs to be addressed, still in front of us. Could get ugly;
• “The 60/40 portfolio is dead” per BlackRock this week. Doubtful...

Other narratives:

• Market weight is outperforming equal weight, the opposite of last year. The S&P 500 and QQQ are up 9% and 21% respectively, while the RSP (S&P 500 equal weight) and QQQE are up 3% and 11% respectively.
• The 60% / 40% benchmark portfolio is up 7% YTD as of 4/28/23.
• Market breadth isn’t great - it’s a big peg in the bear case.

Credit Spreads Have Been a Pleasant Surprise

Good graph cut-and-pasted from John Silvia’s column on LinkedIn.com. John was a former economist at Kemper in Chicago and Wells Fargo in the 1990s. I knew him from his time in Chicago in the early 1990s.

Here’s a quick run-down of YTD returns of credit-related ETFs and mutual funds so far in 2023:

• Investment-grade corporate: +4.29% (Bloomberg source)
• iShares Investment Grade ETF ( LQD ): +5.28%
• PIMCO Corporate ETF ( CORP ): +4.85%
• High-yield corporate: +4.60% (Bloomberg source)
• Barclays Aggregate ( AGG ): +3.92%
• iShares High Yield ETF ( HYG ): +3.94%
• iShares Short-Duration High Yield ETF ( SHYG ): +3.42%
• PIMCO Corporate High Yield ( PHDAX ): +4.59%
• Invesco Financial Preferred ETF ( PGF ): +5.10%
• iShares Preferred and Income Securities ETF ( PFF ): +4.54%
• SPDR Bloomberg Convertible Bond ( CWB ): +3.13%

You heard a lot of talk by corporate bond fund managers about “upgrading credit quality” after Silicon Valley Bank collapsed, and yet, most of the corporate credit ETFs and funds are still trading at or near YTD highs. Many of these funds and asset classes rallied sharply in January ’23, sold off in February ’23 on higher inflation worries, and then again in March ’23 with regional bank and credit constriction concerns, but have rallied back again.

The interesting vehicles to me are iShares' LQD and PIMCO’s CORP, which are both primarily BBB-rated ETFs, which is probably not a bad place to be on the capital stack (to borrow a Rick Rieder term), to sit between the “better economic growth ahead” and “it’s going to be an ugly recession” dynamic.

There is no question that corporate credit and corporate high yield spreads have held up much better over the last 16 months than many anticipated in early 2022. I’d get nervous about corporate high yield if the monthly jobs report started losing 200,000-300,000 jobs per month. That would be the first sign of potentially deeper credit trouble.

FOMC meeting May 3rd, 2023

According to CME’s FedWatch tool, there is an 84% chance of the FOMC raising the fed funds rate to 5-5.25% Wednesday evening, May 3rd. The future rate hikes look somewhat less “robust” right now, but that will change based on Jay Powell’s press release and presser. The next FOMC meeting is on June 14th, 2023.

Personally, the core inflation rates - particularly services inflation - are still too high. We’re still a long way from 2%.

There is no question that the majority of inflation indices have rolled over and are headed south, but they remain above the FOMC’s desired target range, and there seems to be little reason for Jay Powell to turn “dovish”.

The only question is whether the asset-liability or “duration mismatch” within the banking system is thought to be enough of an issue at the Fed to try and return the Treasury yield curve to its normal, positive slope.

Apple ( AAPL ) reports Thursday night, a day after the FOMC announcement.

Summary / conclusion

If readers turned off CNBC, Bloomberg and Fox and simply watched “price action”, you’d think all was well with the world. Even international markets are having a good year, and 2022’s so-called “bear market” wasn’t that bad. 2022 was simply a correction from the overheated Covid stimulus.

Everything is up this year in terms of YTD returns, i.e., Treasuries, corporate credit, municipal credit, mortgages, even emerging market credit, not to mention large, mid- and small-cap stock indices and international. Like a mirror image of 2022, the only asset that is down in 2023 which was up in 2022 is the US dollar.

And yet, sentiment is so bearish.

Maybe this week is the week that the bottoms falls out.

None of this is advice, or a recommendation to buy or sell, and past performance is no guarantee of future results. Add S&P 500 EPS and revenue data is sourced from IBES data by Refinitiv. More importantly, any information may or may not be updated in a timely fashion, if at all. Capital markets can change quickly for both the positive and negative (depending on how you are positioned).

Thanks for reading.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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