S&P 7 vs S&P 493

Market Insights

This is a S&P 7 vs S&P 493 market.

The Top 7 large cap tech stocks contributed 99% (not a typo) of the entire S&P 500 gains in the 1st half of 2023:

This has never happened since S&P 500 index was incepted in 1957.

In fact, I am still surprised $NVDA is currently the largest position in my portfolio due to its massive run.

Will this extreme dominance continue moving into the 2nd half of the year?

Here are some of my concerns I am watching closely right now and wanna share with you guys:

#1 — S&P 500 earnings estimates have not bottomed yet

Q2 earnings season is coming!

Based on how much high expectations have been baked into the stock price, this coming earnings season could be the “make it or break it” one.

Unfortunately, we still don’t see the earnings estimates have reached the bottom yet:

Two main takeaways from this data:

Takeaway #1 — S&P 500 earnings estimates have decline by 4.7% for 2023 and 2.5% for 2024 since the start of the year

• Yes, S&P 500 up is up around 16%, which means price to earnings multiples have expanded by 3.6 points (16.6X at beginning of the year to 20.2X now)

• But that is mainly due to US large cap tech stocks have lifted the total S&P 500 valuation, even as overall earnings estimates have actually declined

Takeaway #2 — Earnings estimates have dipped lower again in the last 4 weeks, and look like they will continue to decline during Q3

•  Right now, the estimates are at $220.68/share for 2023 and $246.37/share for 2024

• After a brief uptick in estimates during May, right now we are back down again close to the April lows

My base case — I expect 2023 and 2024 earnings estimates will continue to decline modestly in Q3, simply because that’s the way the Wall Street makes projections, which can be worrisome for the 2H momentum.

However, as long as the current expected growth between 2023 and 2024 (the gap between those two lines) can hold up, I believe the current YTD gains are reasonably priced and can be held.

#2 — The 2Y Yield made a (very briefly) new high this week

This is huge! As I’ve highlighted in my previous newsletter, the US 2-Year Treasury Yield is the most important indicator right now to navigate the short term stock market.

Right after the ADP report on July 6th, this is what happened during intraday:

• first, 2Y yield quickly moved up and broke out to a new high (5.12%), S&P 500 immediately plummeted to 4385

• then the 2Y yield breakout attempt failed and come back down to settle around 5% (previous high), S&P 500 immediately recovered to 4411

Just as market was having “recession scares”, the current setup is more like a “growth scares”: investors worry the US economy is so strong that the Fed will be forced to resume raising rates aggressively.

Also, this price action showed us again how sensitive the current market is right now to the Fed’s next moves, because there have been too much overly-optimistic expectations already priced into the stocks.

Although it’s still premature to call what the Fed will do, the 2Y yield is by far the best indicator to track wall street’s expectations on Fed’s next move, which will directly impact the stock market.

My base case — The 2Y yield has a higher probability to come back down slowly in the weeks ahead.

#3 — S&P 500 vs EU & EM is reaching a critical high

Here is the chart that shows how S&P 500 has performed (on a 50d rolling basis) against European and Emerging Markets since 2012:

The orange line is the long run average value (1.6%), which means, on average, the S&P 500 has outperformed EU + EM by 1.6% on any given 50-day period.

Right now, S&P’s dominance (outperform 8.1%) is reaching the two standard deviation level (9.4%), which is historically a dangerous level to hit.

Because this is the level where the institutional investors’ market psychology will start shifting:

• more long/short hedge funds start moving capitals away from US and moving into other markets

• increasing short selling pressure to capitalise the potential downward trend on the US outperformance

Well, this is not saying the S&P 500 will crash. There could also be scenarios that the EU and EM play the catch up game while the US is taking a breather and act as a “sleepy bull” for the entire Q3.

Key Data to Watch (July)

✅ July 3, June ISM Manufacturing — BULLISH

✅ July 6, June ISM Services — BULLISH

✅ July 6, May JOLTS — BULLISH

✅ July 6, June ADP Employment — BEARISH

✅ July 7, June Jobs Report — NEUTRAL

👀 July 10, June Manheim Used Vehicle Value Index

👀 July 12, June CPI

Chart of the Week

The labor market has never been this “strong” since late 1990s:

From December 2000 through 2017, there were always more people looking for jobs than jobs available.

The opposite happened from March 2018 to Feb 2020, but openings only outnumbered unemployed workers by an average of 1.1 million over that period.

Right now, there are 3.7 million MORE jobs openings than unemployed workers. That is a 1.6X now vs 1.2X in Feb 2020.

Why this matters? — Chair Powell sees the historically large difference between openings and unemployed workers as driving wage inflation that feeds into the overall price inflation. Fighting inflation is the Fed’s number one priority right now, so J Powell will most likely stay hawkish until this gap narrows closer to pre-pandemic level.

And yes, you guess it, the 2Y yield is telling us exactly the same story, while the stock market is on the optimism side.

That’s it for today.

See you next week!

Vic