No Stag, No Flation

By Hightower Omaha on May 7, 2024

Week of May 6, 2024

1. FOMC Maintains Its Policy Rate. Last Wednesday the Federal Reserve kept the fed funds rate steady at 5.25-5.50%. ­The current Fed pause is now the second longest on record, coming in at 285 days since the last hike on July 26, 2023. Historically speaking, a long pause has been positive for equity markets. The three longest pauses recorded an average market return of 11.3% during the period from the last rate hike to the first rate cut. During the longest Fed pause, July 2006 to September of 2007, the S&P rallied 22%. In the current Fed pause, the market is up nearly 12%. It can be noted that markets enjoy clarity, and investors welcome the idea that interest rates are likely at their peak for this cycle.

Our opinion is that Fed Chair Powell’s commentary was dovish, and the fact that quantitative tightening (QT) was reduced speaks volumes on this front. Powell discussed the tight monetary conditions and expectation for lower growth and inflation ahead; as a result, we believe rate cuts will eventually come. Our base case is for one or no rate cuts this year. Inflation has made progress (from the 9.1% peak levels two years ago), but that last mile to get the current 3% level to the 2% target is mainly a function of better growth in the U.S. – where GDP has been running at 2.5% to 3%.

Not only is the U.S. seeing above trend growth, but global economies are also experiencing improved results, with the IMF targeting 3.2% for 2024 in world growth and the OECD revising global estimates to 3.1% for the year. Higher growth with slightly higher inflation has been and will continue to be positive for earnings – which are currently beating expectations by 7.5% and are up 7.1% for Q1. Excluding Bristol Myers’ (BMY) $12 billion charge, earnings are up 10%. We expect this trend to continue for 2024 – with 8-10% growth. 

Chart 1: Inflation’s Peak Coincided With the Bottom in Stocks[1]

2. 175,000 New Jobs in April. April’s non-farm payrolls came in below expectations at an increase of 175,000 relative to the estimate of 240,000. Importantly, the three- and six-month average for non-farm payrolls stands at 242,000 – still a healthy amount. To put this in perspective, the 10-year average for monthly job gains is 166,000. There are 1.3 jobs available per one unemployed person. 

The unemployment rate increased 0.1% to 3.9%, and although higher, it is important to note that the unemployment rate has been below 4% for 27 consecutive months, tied with 1967-1970 for the longest streak ever. Average hourly earnings rose 0.2% m/m and are up 3.9% y/y, still showing strong earnings growth consistent with the 4-5% wage growth seen in other reports.

Chart 2: Job Gains Hover Around 200,000 per Month With Wage Growth Near 4%[2]

3. Apple Reports Better-Than-Expected Earnings. Apple (AAPL), which represents 6.2% of the S&P 500 weighting, reported after the bell last Thursday. The company beat EPS and revenue estimates against low expectations. Declines in China were less than expected at -8% versus the consensus -12% q/q. Investors were worried about market share losses and the earnings results showed less deterioration in this geography, which is 20% of total revenues. The other highlight was services, which grew 14%, also ahead of consensus. The mix was quite bullish as services now make up 26.3% of total revenues versus 19% q/q. Margins for services came in at 74.3%, compared to product margins at 36.6%. 

We expected a new buyback announcement, and this too did not disappoint as the new amount was larger than expected at $110 billion – the largest stock buyback in history. Apple maintains the top six largest buybacks ever, and the $110 billion dollar plan beats its $100 billion buyback announcement from May 2018. To put this into perspective, the buyback is larger than the size of Bulgaria’s GDP. A dividend increase was also initiated, bumping to $0.25/share from $0.24/share.

With the second quarter behind us, easy comparisons ahead, the Worldwide Developers Conference in June (which should highlight new AI initiatives) along with a new iPhone 16 cycle ahead, we believe there are many reasons to be upbeat on the company. 

4. Fixed Income. U.S. Treasury yields fell last week when May’s FOMC meeting concluded with a decision to hold rates steady. Powell stated that the next policy rate move will not be a hike, avoiding the hawkish pivot that for which the bond market was largely positioned. U.S. 2, 10- and 30-year Treasury yields fell 17, 12 and 8 bps, respectively. High yield spreads tightened by 9 bps to +336 bps. Muni yields decreased 7-9 bps across the curve.

5. The Week Ahead.

Earnings – Monday: TSN, MCHP, WMB; Tuesday: DIS, EA, MTCH; Wednesday: EMR, UBER, ABNB, TTD; Thursday: WBD, AKAM.

Economics – Friday: Michigan Consumer Sentiment.

[1] Source: FactSet (Chart). As of May 3, 2024.

[2] Source: FactSet (Chart). As of May 5, 2024.