April Update

April was a tough month for equities as expectations for rate cuts were pushed out of 2024. The fight against inflation also seemingly stalled across many economies over the quarter amid fears that inflation has begun to re-accelerate, leading to a higher-for-longer interest rate setting. In the US, we saw the third month in a row whereby US inflation figures came in higher than expected, constituting a trend and a subtle change of tune by central bankers who developed more patience on cutting rates. This resulted in a steady climb in US Treasury yields throughout the month, with the US 2-Year Treasury peaking at just under 5.04% and the US 10-Year Treasury following a similar trajectory, peaking at just over 4.70%—levels last seen in October and November of last year.

The Pullback Is In-Line With Recent Pullbacks

A simple rule of thumb on how rates affecting stock prices, based on last year's experience, seems to be: for every one-point increase in long bond yields, there is a 10%-12% contraction in P/E multiples (due to convexity), adding back expected EPS growth. The S&P 500 Index is up 30% since January 2023, with half of the price gains coming from P/E expansions and the other half from EPS growth. Last summer, bond yields rose from 4.0% to about 5.0%, and stock prices fell by 10%, led by a 12% drop in P/E multiples, as this Alpine Macro chart shows. Since early this year, 10 year #Treasurybond yields have risen by 80 basis points, and stocks are down by 5%. One could say that the equity market #correction has been on the lighter side, based on the previous correlation. Treasury yields on 2yr topped out recently just below 5% and 10yr around 4.67% vs 2year topping 5.2% and 10 yr topping 4.99% in October 23.

Source: CNN

The driver of this narrative is once again the inflation story, more specifically the "last mile" of getting inflation to return to the target range of 2%. We have seen headline inflation, as reflected by the US Consumer Price Index (CPI), trend higher over the last 3 months, from 3.1% year-over-year in January, 3.2% in February, to 3.5% year-over-year for March. The month-over-month gain is also painting a troubling picture, running at 0.4% from February to March. The Federal Reserve's preferred measure, the PCE index, has also seen an acceleration, from -0.1% in November to 0.3% in January and February, continuing into March.

Fading Confidence in Rate Cuts

The market has gone from pricing in 2-to-3 rate cuts by December, to 1. Investors confidence in when the Federal Reserve will start cutting rates and how many it will deliver has been shaken by sticky inflation , a strong jobs market, and hawkish commentary from central bank officials. Fed Funds Futures with December Expiry was pricing in  US Fed Funds rate at around 4%, as January, Feb and Mar inflation numbers came through the shift has been considerable, in effect shifting from an estimate of 6 cuts for 2024 in January to just the one cut in 2024.

Source: LSEG / Ophir Asset Management

Back home in Australia, retail sales growth, which has been volatile for several months, came in 0.4% lower month-on-month for March, following a 0.2% gain in February. The February data may well have been skewed by the Taylor Swift phenomenon that hit our shores through February; Melbourne alone, according to figures from NAB, was a beneficiary to the tune of a $174 million boost in spending, with national estimates ranging from a $300-$500 million boost in spending. This one-off event likely pulled the retail numbers into that positive number for February, masking the real retail numbers. Ultimately, though, retail spending is cooling but not capitulating. Australian inflation for the quarter came in higher than expected at 3.6% headline and 4% for core, with services and rents dominating pricing pressures. With Australia's current inflation setting and interest rate policy, one would expect a more gradual return to target CPI. With data pointing to slowing consumer activity and a gradual creep higher in unemployment, one might view that the current RBA Cash Rate of 4.35% is suitably restrictive for now. House prices in capital cities saw a month-on-month gain of 0.6%, delivering a year-to-date pop of 9.4%, according to CoreLogic data.

Wages growth never increased as much in Australia as it did in the US. High US wages growth is keeping US services inflation elevated.
US wage growth need to reach 3-4% annually to align with the 2% inflation target. Australian wages, have reached their highest point since 2009 due to a tight labor market. However, similar wage increases are not anticipated this year in Australia, and a rise in the unemployment rate is expected as labor demand eases. Consequently, softer wage growth in 2024 will likely lead to a decrease in services inflation.

Turning to market action as April closed out, we moved through the midpoint of the Q1’24 S&P 500 earnings season. As we have continued to see over the last few quarters, corporate earnings remain resilient, with companies performing well versus expectations. Positive earnings surprises and the size of those earnings surprises are above their 10-year average. By the end of April, approximately 80% of constituents had reported actual Q1’24 results. Of these companies, 77% have reported actual Earnings Per Share (EPS) above estimates, equaling the 5-year average of 77% but above the 10-year average of 74%. In aggregate, companies are reporting earnings that are 7.5% above estimates, which is below the 5-year average of 8.5% but above the 10-year average of 6.7%. The positive earnings picture was also broad, with eight of eleven sectors reporting year-over-year earnings growth, led by Communication Services, Utilities, Consumer Discretionary, and IT sectors. Energy, Healthcare, and Materials reported year-over-year declines in earnings.