Weekly Research Briefing: Frozen In and Out

January 17, 2024

I am not sure which was more extreme this holiday weekend: the volatility in the weather or on the football fields. At least the local utility did a good job in taking down all services for a few of those big upsets this weekend. The family had a much better time watching an old box of Seinfeld DVDs that we found in the basement. David Puddy remains unmatched.

While many of our lives were flipped upside down due to the storms or football loyalties, the markets continued on in their boring trending pattern. Bonds up, yields down, stocks up, GDP forecasts raised, stock market targets lifted, large M&A continues, etc. The continuing trends were helped last week by another good set of inflation data. Where the CPI was a bit stronger than expected, the PPI was much lower than expected. The net adjustments have led to a further downside outlook for the next PCE datapoint. Earnings also began last week as J.P. Morgan raised the bar with its biggest earnings print ever sending its stock to new all-time highs. The big bank stocks had little reaction to their numbers after their recent two-month gains of 20-25%. But for the market, the best news was that the consumer remains solid and credit quality continues to normalize at a slow rate.

For this week, Q4 earnings releases will continue while on the economic front we will see Retail Sales, Industrial Production, the Fed's Beige Book, several Housing data points and the UofM Consumer Sentiment index. No idea if the UofM series will have a positive researcher bias due to the Wolverines and Lions victories. Have a great week and stay warm and safe. Now let's see if these old 9-volt batteries have enough juice in them to MacGyver this note to your inbox.

The collapse in the PPI is great news for the next PCE number which is closely watched by the Fed...

@RenMacLLC: The message from PPI is that core PCE will not come in nearly as firm as core CPI did. Using the inputs from CPI/PPI, we estimate core PCE of 0.2% MoM. Over the last 12 months, it is core PCE inflation is likely to come in below 3.0%.

And as inflation surprises to the downside, forward inflation forecasts are falling for the major economies...

Goldman Sachs

Last week's inflation data sent the 2-year Treasury yield to nine-month lows...


One of the Fed's big hawks, Christopher Waller, just blessed future fed funds rate cuts...

While the bond market sold off on the total size of the cuts and the monthly vs. quarterly method, it is the acknowledgement of cuts that should be most important.

“As long as inflation doesn’t rebound and stay elevated, I believe the FOMC will be able to lower the target range for the federal funds rate this year,” Waller said at a virtual event hosted by the Brookings Institution on Tuesday.

“When the time is right to begin lowering rates, I believe it can and should be lowered methodically and carefully,” he added.

The Fed governor offered some of the most detailed remarks to date around the Fed’s intentions to ease policy this year. While Waller showed an openness to cutting rates, his comments also appeared to push back against market expectations for as many as six rate cuts this year.

“With economic activity and labor markets in good shape and inflation coming down gradually to 2%, I see no reason to move as quickly or cut as rapidly as in the past,” he said, pointing to previous economic shocks that have precipitated rapid rate cuts.


After the Waller comments, the market continued to forecast six cuts through year end...

CME Group

Barclays rate forecast cuts illustrate the post CPI/PPI mood...

Barclays revises its Fed rate cut forecast, now anticipating the first cut in March after a soft PPI report.

'With core PCE inflation projected at 1.9% in H2 2023 and 2.4% by end of 2024, we expect FOMC rate cuts every other meeting starting March,' says lead economist Marc Giannoni.

They foresee the federal funds rate dropping to 4.25%-4.50% by end of 2023 and 3.25%-3.50% by 2024's close.

This shift, rooted in lower inflation and ongoing moderation, doesn't require a significant economic or labor market downturn.


U.S. Bureau of Labor Statistics comment about shelter impacting December's CPI...

"The index for shelter continued to rise in December, contributing over half of the monthly all items increase."


The CPI numbers are still running hot due to the lagging nature of housing/shelter costs (35% of CPI)...

Here is some good context on how shelter will be like cement shoes to the future CPI.

Seeing lots of chatter about the sticky CPI Shelter/Rent pulling up headline inflation, but remember: This was entirely expected due to lagged methodology of how the CPI captures rent and OER. Furthermore: Rent/shelter IS continuing to cool off, even if not as quickly as real-life rents. AND the month-over-month change in CPI Rent came in at 24-month low (see chart in second post of thread)... which brought the YoY change to a 17-month low (first chart)... and it'll keep cooling from there.

Friendly reminders:

1) Shelter inflation is primarily driven by Owners Equivalent Rent (OER) and Rent of Primary Residence. Contrary to conventional wisdom, OER is primarily based on a survey of RENTERS (not homeowners or home prices), with differences in weighting (i.e. the infamous hypothetical survey question asked to homeowners). So shelter is all about RENT. Home prices haven't been a variable in CPI since 1981.

2) The CPI Rent survey will lag headline asking rents because asking rents are what a renter signing a new lease would pay-- whereas CPI is attempting to measure the net change in ALL active leases... the vast majority of which do not change month-to-month... which creates the well-established 12-month lag effect

3) Additionally, renters included in the CPI Rent survey are contacted once every SIX months, so if their rent changed in Month 2, it wouldn't be captured until 5 months later. More lag effect.

4) New lease asking rents are the front-runner for "contract rents" (i.e. in-place rents) measured by CPI.

I've used this analogy before and I'll use it again: CPI Shelter is like an 18-wheeler riding its brakes down a mountain. We know where this is going (downhill). It's just gonna take some time to get there.

After the Waller comments, the market continued to forecast six cuts through year end...


The hard economic data remains up and to the right versus the soft survey data which remains a hot mess...

Tuesday's Empire Fed Manufacturing print of -43.7 is just difficult to even try to explain as it was even lower than during the GFC. Do New York manufacturing companies truly believe that the world is worse off today than when the banking and auto industries were going under?


Onto last week's earnings. Some solid comments from Wells Fargo, Bank of America and KB Home...

"Debit card spend increased 2% from a year ago, with both discretionary and non-discretionary spend up 2%, with growth in most categories except for home improvement, fuel, and travel. Credit card spending continued to be strong was up 15% from a year ago. All categories grew with double-digit growth rates in every category except fuel, home improvement, and apartment apparel." - Wells Fargo CFO Michael Santomassimo

"...the year-over-year growth rate and spending from the beginning of '23 started declining. And it went from in the early part of '23 over the early part of '22 from a 9% to 10% growth rate to this quarter's 4% to 5% growth rate and that's where it stands here early in 2024...That growth rate, 4% to 5% is more consistent with the 2% GDP environment in a lower inflation environment." - Bank of America CEO Brian Moynihan

"As interest rates have now declined since the end of our fiscal year, demand has improved significantly. For the first five weeks of our first quarter, our net orders are 904 as compared to 403 in the comparable period of the prior year. Our orders in December were higher than in November which is unusual given that December is typically a slower sales month. To us, this speaks to the pent-up demand for homeownership." - KB Home CEO Jeff Mezger

The Transcript

And if you really want a thermometer of the economy, look no further than the maker of that little blue and yellow can...

[WDFC] Reports Q1 $1.28 v $1.02 y/y, Rev $140.4M v $124.9M y/y

  • Affirms FY24 $4.78-5.15 v $5.10e; Net sales $570-600M v $576Me; Gross Margin 51-53% (prior: $4.78-5.15; Net sales $570-600M; Gross Margin 51-53%)
  • Gross margin 53.8% v 51.4% y/y
  • CEO: On a constant currency basis, global net sales were up 9 percent in the first quarter which is in line with both our fiscal 2024 guidance and our long-term growth projections. We are also pleased that gross margin improved 240 basis points over the prior year representing the highest level since the second quarter of fiscal year 2021. Overall, we are incredibly pleased with our solid first quarter performance and it provides us confidence that we will achieve our 2024 financial goals.


@TheTranscript_: The WD-40 Company CEO: "We have started FY2024 firing on all cylinders, with significant volume-related sales growth across all three trade blocs"

Intuitive Surgical reported that hospital procedures are back on track which should be good news for anyone selling into an operating room in the Q4...

[ISRG] Reports prelim Q4 Rev $1.93B v $1.86Be; da Vinci procedures +21% y/y - filing

  • During early 2023, COVID-19 resurgences in China continued to negatively impact our procedure volumes; however, as infections and hospitalization started to decrease, we saw a recovery of procedure volumes. During the remainder of 2023, we did not experience significant disruptions from COVID-19.
  • Financial and Operational Highlights Fourth quarter 2023 worldwide da Vinci procedures grew approximately 21% compared with the fourth quarter of 2022. The comparative fourth quarter of 2022 reflected a resurgence of COVID-19 in China, which negatively impacted procedure volumes in the region. Full year 2023 worldwide da Vinci procedures grew approximately 22% compared with 2022. The Company expects worldwide da Vinci procedures to increase approximately 13% to 16% in 2024 as compared to 2023.The Company placed 415 da Vinci surgical systems in the fourth quarter of 2023, an increase of 12% compared with 369 in the fourth quarter of 2022. The Company placed 1,370 da Vinci surgical systems in 2023, an increase of 8% compared with 1,264 systems in 2022.Preliminary fourth quarter 2023 revenue of approximately $1.93 billion increased 17% compared with $1.66 billion in the fourth quarter of 2022. Preliminary 2023 revenue of approximately $7.12 billion increased 14% compared with $6.22 billion in 2022.


Financial company earners will concentrate the reports during this holiday shortened week...

@eWhispers: earnings for the week of January 15, 2024

I am happy to see another global financial firm write about the weakness in using P/E multiples to measure the value of small cap indexes...

As we wrote in our November note, with 40% of the Russell 2000 companies losing money and excluded from the P/E calculation, there is less use in comparing the P/E valuation metric from today to that of years past. 10 years ago, only about 27% of Russell 2000 components were losing money on a 12-month trailing basis. 30 years ago, this figure was in the teens. Goldman Sachs's work last week analyzes forward returns with similar results. On a 12-month forward earnings basis, they arrive at the Russell 2000 trading at a 29x P/E, which is nearly twice the P/E if all money losing companies are excluded. Keep this valuation in mind as you wonder why you are not crushing it in your passive small cap positioning this year.

Goldman still stands up for small cap stock attractiveness as they feel the key driver of small cap stock performance is U.S. economic growth (which they are favorable towards). They also show that historically, price to book values are a better metric for small cap relative measurement. This makes sense given the higher weight of financial stocks in the small cap indexes which more often than other stocks trade on a P/B basis.

While many investors prefer P/E valuations to P/B multiples, earnings-based valuations measures are less useful for the Russell 2000. Roughly a third of Russell 2000 constituents are unprofitable. In addition, only 5 sell-side analysts cover the median Russell 2000 stock, compared with 18 analysts covering the median S&P 500 stock. 13% of Russell 2000 constituents currently have no estimates or just one estimate for 2024 EPS. Nonetheless, looking only at profitable Russell 2000 stocks with forward analyst EPS estimates, small-cap P/E multiples also register below historical averages.

Goldman Sachs

Speaking of the high P/E multiple small cap index, what do you think about the Mag 7?

@dailychartbook: "The market cap of the Magnificent Seven is now four times the market cap of the entire Russell 2000." - Torsten Sløk

Something to keep in the back of your mind is that the S&P 500 index of companies is not representative of the U.S. economy...

SPX earnings are half geared toward goods production, much of which is big ticket, less than frequent sales. Think Boeing airplanes, Caterpillar heavy duty equipment and F-150 pickup trucks. The total economy is much more services based like accounting and consulting firms, retailers and restaurants and healthcare professionals. The private markets are typically more focused on owning companies with recurring sales that have more consistent cash flow like you would find in the everyday U.S. economy. So, if you are looking for another reason to expand into more private market investing, consider shifting your portfolio from the bar on the left to the bar on the right.

BofA Global

A couple of big deals announced last week which will erase the tickers of two S&P 500 components...

[JNPR] HPE confirms to buy Juniper Networks for $40.00/shr in all-cash, for EV ~$14B; Expected to be accretive to non-GAAP EPS and FCF in the first year post close.

[ANSS] Ansys confirms to be acquired by Synopsys in $35B cash-stock deal; Ansys shareholders to receive $197.00 in cash and 0.3450 shares of Synopsys common stock.


The head of the Nasdaq sees the IPO dam breaking open in 2024...

Nasdaq Inc. has more than 80 companies ready to go public in what is expected to be a busier year for initial public offerings, according to Chief Executive Officer Adena Friedman.

“We have about 85 companies that have filed to go public on Nasdaq, so it means they are ready for the markets to be open,” Friedman said in an interview with Bloomberg TV from Davos on Tuesday.


Maybe the craziest reason that I have ever heard for remaining a private company...

"We are aware of a scenario where an investor approached one of our customers and had some conversation related to, we believe it was a hedge fund that had our -- short our stock, we had like a 20% short position, approached one of our customers and was complaining to them about how much money we're making. They clearly had a vested interest to try and get the customer to try and negotiate our prices down. And I think that's garbage, but it's not against the law." - Aehr Test Systems CEO Gaun Erickson

The Transcript

Speaking of the weather, while inflation is falling everywhere, it is unlikely to fall for your future property insurance costs...

Billion-dollar disasters are increasing in number

NOAA’s 1980-2023 annual inflation-adjusted average is 8.5 billion-dollar events, but over the past five years (2019-2023), the annual average has more than doubled, to 20.4 events. In a blog post, NOAA said: “The number and cost of weather and climate disasters are increasing in the United States due to a combination of increased exposure (i.e., more assets at risk), vulnerability (i.e., how much damage a hazard of given intensity—wind speed, or flood depth, for example—causes at a location), and the fact that climate change is increasing the frequency of some types of extremes that lead to billion-dollar disasters (Fifth U.S. National Climate Assessment (2023).”

Yale Climate Connections

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