Inflation, Earnings, and the Rally
The January Consumer Price Index (CPI) report was hotter than expected, signaling potential challenges in the path toward inflation stabilization -- and therefore challenges to the market’s now obviously incorrect anticipation of six rate cuts in 2024. (We’ve been telling you that view was too rosy for several months.)
Inflation Makes Gray Weather At the Fed
The core CPI and headline inflation rose by 0.4% and 0.3% month-over-month, respectively, surpassing the anticipated increases. Despite a slight year-over-year decrease in headline inflation to 3.1%, core inflation remained steady at 3.9%. The report highlighted a continued divergence between goods and services inflation, with core goods prices dropping, notably in used car prices, while core services inflation, especially in shelter and non-shelter services, picked up pace.
The CPI data’s implications for the Fed’s monetary policy of course suggest a reevaluation of prospective interest rate cuts, pushing the possibility of cuts further into the future, with a more cautious outlook on core services inflation due to a tight labor market. Markets reacted by (at last) rationally adjusting expectations for rate cuts, and the U.S. dollar appreciated against other major currencies, reflecting a reassessment of the Fed’s stance on inflation and interest rates.
The differentiation in goods versus services inflation, along with the market’s response, underscores the complexity of the current inflationary environment and the challenges the Fed faces in achieving its target inflation rates. The emphasis on core Personal Consumption Expenditures (PCE) inflation, which is the Fed’s preferred inflation measure, and its potential acceleration, highlights the importance of upcoming economic data in shaping monetary policy decisions. (The next release of PCE data will be on Feb 29.)
On balance, we’re glad to see a resetting of rate-cut expectations. Remember that any volatility occasioned by such shifts, in the current environment, we regard as a tactical opportunity to buy. We anticipate several such opportunities in the course of 2024.
Some Earnings Notes
Earnings are the mother’s milk of stock price appreciation… and earnings are good. But some are better than others.
The ~80% of S&P 500 companies that have reported have beaten consensus estimates by 7% on average. Year-over-year earnings themselves have increased 7%, a healthy acceleration from the previous quarter’s 4% rise. If the trend established thus far holds, the year-over-year increase will turn out to be above 9% when all is said and done. It is likely that this momentum to continue at least through the first half of 2024.
The group of stocks called the Magnificent 7 (Nvidia, Microsoft, Meta, Alphabet, Apple, Amazon, and Tesla) has been credited with much of the market’s performance over the past 12 months. Tracking their earnings reports (excluding NVDA, which reports next week) we see that this group’s EPS numbers, even though expectations were much higher, also beat EPS expectations by 7%. But this cohort has an overall earnings growth rate that stands out… at +59% YoY, vastly outpacing the rest of the market’s -3% YoY decline. Investors are paying up for the Magnificent 7 above all because of robust, visible growth. Although many expect their earnings growth to narrow compared to the rest of the market in upcoming quarters, the Magnificent 7 are still enjoying upward revisions for 2024 consensus EPS, unlike the broader market -- which has seen modest earnings expectations cuts. In our many years’ experience following companies quarterly performance, we note that company managements do not like to significantly raise next year’s earnings guidance when they report prior year data in January.
Capital expenditure (capex) for Q4 shows a modest +1% YoY growth amid interest rate pressures, but with a strong outlook for 2024, indicating a robust investment cycle ahead, much of it fueled by AI -- which is another argument favoring a lasting bolus of spending for the dominant AI hardware providers. Despite traditionally conservative guidance during Q1, corporate sentiment is improving, with indicators suggesting a continuing upcycle in earnings.
As the earnings reporting seasons wind down, the market starts to look elsewhere for inspiration. Earnings conversations give way to geopolitics, interest rates, politics, etc. We note that the market watchers at Bank of America who produce a weekly market data report called The Flow Show said that market participants entered February with bubble-ish sentiment. So, as the market participants grasp for inspiration as to the next moves, be prepared for some volatility. Still, a steep decline is hard to anticipate while global liquidity is expanding -- as we have discussed in recent notes. For traders, we note that the market tends to provide better buying opportunities near the bottom of this chart than near the top.
Early? Or A Change In Trend?
The investment media narrative on real estate in some of the country’s biggest challenged cities has been a relentlessly negative drumbeat; New York and San Francisco have been among the worst. There’s no denying that the signs, especially in San Francisco, have been almost apocalyptically bad: remote work crushing office occupancy and draining the economic life out of downtowns; feckless government aiding and abetting chaos and theft; major corporates retreating; law enforcement retreating; residents demoralized -- fleeing, contemplating flight, or battening down the hatches for a painful siege.
Downtown San Francisco Has Almost Become a No-Go Zone For Retailers
This is why it’s significant to see some first signs that experienced, aggressive speculators are making a bet in the opposite direction.
Drawing from his family’s legacy of capitalizing on distressed markets, as they did in New York City during the 1970s, Ian Jacobs, an heir to the Toronto-based Reichmann real estate dynasty, has begun securing financial commitments from relatives and other wealthy families aiming to acquire San Francisco office buildings at significantly reduced prices. Despite the prevailing pessimism surrounding the future of downtown office spaces, particularly in San Francisco, Jacobs is moving forward with plans to purchase properties, hoping to emulate his family’s historical success in real estate investment and turnaround. Buying Manhattan property at its nadir in 1973/4 turned out to be an epic win, although it took decades to come to fruition. (Those were the bad old days that were so bad they led to the post-apocalyptic urban fantasy Escape From New York, which some readers, like us, might remember with fondness. Though the film was released in 1981, director John Carpenter had written the script in the dark days of 1975.)
The new venture, dubbed “Project Uris,” references the Reichmann family’s successful investments in New York. Jacobs, who has a background in value investing and once sought mentorship from Warren Buffett, has raised $75 million for initial acquisitions and aspires to buy three million square feet of office space at about 70% below construction costs.
It might take a long time for this bet to pan out, but we suspect strongly that eventually it will -- and it’s noteworthy that someone experienced is making it.
Thanks for listening; we welcome your calls and questions.
General Disclosures About This Newsletter
The publisher of this newsletter is Guild Investment Management, Inc. (GIM or Guild), an investment advisor registered with the Securities and Exchange Commission. GIM manages the accounts of high net worth individuals, trusts and estates, pension and profit sharing plans, and corporations, among other clients.
Your receipt of this newsletter does not create a personal investment advisory relationship with GIM although some recipients may also be advisory clients of GIM. GIM has written investment advisory agreements with all its personal advisory clients, which sets forth the nature of that relationship.
The newsletter makes general observations about markets and business and financial trends and may provide advice about specific companies and specific investments. It does not give personal investment advice tailored to the needs, objectives, and circumstances of individual readers. Whether investment ideas and recommendations are suitable for individual readers depends substantially on the personal and financial situation of that reader, which GIM, as the publisher of the newsletter, makes no effort to investigate.
GIM attempts to provide accurate content in its newsletters to the extent such content is factual rather than analysis and opinion, but GIM relies primarily on information compiled or reported by third parties and does not generally attempt to independently verify or investigate such information. Moreover, some content and some of the assumptions, formulas, algorithms and other data that affect the content may be inaccurate, outdated, or otherwise flawed. GIM does not guarantee or take responsibility for the accuracy of such information.
Please note that investing in stocks, other securities, and commodities is inherently risky, and you should rely on your personal financial advisors and conduct your own due diligence in connection with any investment decision.
A Special Comment for Guild’s Clients
If you are an investment advisory client of GIM who is receiving this newsletter, please note that the fact that a general recommendation is made of a particular security, commodity, or investment area to its newsletter subscribers does not mean that investment is suitable for you or should be purchased by you. For example, GIM may already have purchased such securities on your behalf or purchased securities in the same industry (and an increase in the position for you may represent too much concentration in one security or industry), or GIM may believe the investment is not suitable for you based on your risk tolerance or other factors. If you have questions about the recommendations in this newsletter in relation to your account at GIM, please contact Tony Danaher, Rudi von Abele, or Aubrey Ford.
Conflicts of Interest
As of the date of this newsletter, GIM’s investment advisory clients or GIM’s principals owned positions in areas that are the subject of current recommendations, commentary, analysis, opinions, or advice, contained in this newsletter.
GIM and its principals have certain conflicts of interest in its relations with its investment advisory clients and its newsletter subscribers resulting from GIM or its principals holding positions for its clients or themselves which are also recommended to its clients. GIM may change the positions of its clients or GIM’s principals may change their positions (increasing, decreasing, and eliminating them) based on GIM’s best judgment at any given time, including the time of publication of the newsletter. Factors that lead GIM to change or eliminate its positions may include general market developments, factors specific to the issuer, or the needs of GIM or its advisory clients. From time to time GIM’s investing goals on behalf of its investment advisory clients or the personal investing goals of GIM’s principals and their risk tolerance may be different from those discussed in the newsletter, and the investment decisions made by GIM for its advisory clients or the investment decisions of its principals may vary from (and may even be contrary to) the advice and recommendations in the newsletter.
In addition, GIM or its principals may reduce or eliminate their positions in an investment that is recommended in the newsletter prior to notifying the newsletter subscribers of such a reduction or elimination. The publication by GIM of a “target price” or “stop loss” for a particular security or other asset does not necessarily represent the price at which GIM intends to sell or will sell any such assets for its advisory clients or the price at which GIM’s principals intend to sell any such assets.
As a consequence of the conflict of interest, GIM’s clients or principals may benefit if newsletter subscribers purchase assets recommended by GIM since it could increase the value of the assets already held by GIM’s investment advisory clients or GIM’s principals. On the other hand, GIM’s principals and clients may suffer a detriment if they seek to acquire additional shares in securities that have been recommended and the price of the securities has increased as a result of purchases by newsletter subscribers.
To help mitigate these conflicts, GIM seeks to avoid recommending the securities of individual companies where GIM or its principals have an ownership position and where the issuer is small or its securities are thinly traded. That way sales by GIM in advance of possible sales by newsletter subscribers would not be likely to cause any significant decrease in the sale price to newsletter subscribers. GIM has a fiduciary relationship with its investment advisory clients and cannot agree on behalf of such clients to refrain from purchases or sales of a security mentioned in the newsletter for a period of time before or after recommendations for purchases or sales are made to its newsletter subscribers.
GIM encourages you to do independent research on the securities or other assets discussed or recommended in the newsletter prior to making any investment decisions and to be especially cautious of investments in small, thinly-traded companies, which are usually the most risky investments that you can make.
Disclaimer of Liability
GIM disclaims any liability for investment decisions based upon recommendations, information, or opinions in its newsletters. GIM is not soliciting you to execute any trade. Nothing contained in GIM’s newsletters is intended to be, nor shall it be construed as an offer to buy or sell securities or to give individual investment advice. The information in the newsletter is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation, or which would subject GIM to any registration requirement within such jurisdiction or country.
COPYRIGHT NOTICE
Guild’s current and past market commentaries are protected by U.S. and International copyright laws. All rights reserved. You must not copy, frame, modify, transmit, further distribute, or use the market commentaries, without the prior written consent of Guild. This email or any download from a secure website is meant for only the intended recipient of the transmission, and may be a communication privileged by law. If you received this email in error, any use, dissemination, distribution, or copying of this email is similarly prohibited. Please notify us immediately of the error by return email and please delete this message from your system. Although this email and any attachments are believed to be free of any virus or other defect that might affect any computer system into which it is received and opened it is the responsibility of the recipient to ensure that it is virus free and no responsibility is accepted by Guild Investment Management for any loss or damage arising in any way from its use.