June 25, 2024 - What Are the Fundamental Factors Impacting the Market?

Transcript

Introduction: In today's video Observations and Expectations, Virtus Senior Managing Director and Chief Market Strategist, Joe Terranova, addresses the catalysts that are driving the overall positive environment for risk assets.

Joe Terranova: Here we are, [and] moving towards the last week of the first half of 2024. The S&P 500 enjoying about a 14.5% gain. And I think we could define the overall environment for risk assets is a very favorable one, both domestically, internationally, both for equity and credit itself. I think it's important to understand the macro environment, the reasoning behind it, the fundamental conditions, what is acting as a catalyst that's allowing for a favorable investment environment for investors.

And as we turn the page into the second half of the year, [there] is the expectation that there can be some form of a reversal. Well, let's remember something. When you have very strong fundamental conditions, they must be defeated for there to be a significant inflection point, a reversal of the current bullish trend. Let's identify what these catalysts are.

First and foremost, it begins with the Federal Reserve. The Federal Reserve is no longer in an adversarial position. In fact, you could make the argument that the put is back underneath the market once again. The Federal Reserve in a 16-month period, beginning in March of 2022 and ending at the end of July in 2023, through 11 rate hikes, raised rates 525 basis points. Four 75-basis point rate hikes from June of 2022 to November of 2022. That's an adversarial Federal Reserve. A Federal Reserve that's no longer adversarial is messaging to the markets that the potential is there, that they're looking for the reason to begin to adjust monetary policy from what they believe is restrictive territory.

Now, let's keep something in mind. It's not just what they're communicating, it's actually their action. What have they done here in 2024? They've moderated the pace of quantitative tightening, taken down the runoff of $60 Billion worth of Treasuries on a monthly basis, now down to $25 Billion.

The second catalyst [that] the fundamental condition [is] very supportive for markets is there's a clear disinflationary trend that is in place and I'll tell you it is actually stronger, the disinflationary trend, outside the U.S. If you look into Europe, you have inflation reading with a two handle on it. Look at the Asia, inflation readings with a one-handle on it. And China, you have the concern surrounding outright deflation itself. It's not that the inflation that we're seeing is wage inflation, it is actual rent inflation. June of 2022, we reached that high point for CPI on a year-on- year basis of 9% that has come down very quickly, not at the Fed's target yet, but we have the disinflationary trade in place.

The third catalyst and fundamental condition is we've recovered from an earnings recession. Yes, we entered an earnings recession in the fourth quarter of 2022. S&P, Nasdaq, and the Russell 2000 all experiencing that earnings recession. Where are we now?

[Image: SPX Index Earnings Analysis, Source - Bloomberg]

S&P 500 in the most recent quarter, we've got earnings growth of 8%. We've got revenue growth of 4%.

[Image: NDX Index Earnings Analysis, Source - Bloomberg]

How about the Nasdaq? Remarkable earnings growth of 30% revenue growth of 9%.

[Image: RTY Index Earnings Analysis, Source - Bloomberg]

And then lastly, the Russell 2000 struggling to come out of that earnings recession. Expectation consensus estimates are it will do it in the coming quarters here. Earnings growth from the last quarter, still contracting 12%. That puts the Russell still in that earnings recession.

 And then the last catalyst, and arguably the most important one, surrounds the innovation for artificial intelligence and the halo [of] artificial intelligence, advancing it to generative AI and the exciting part of it is that it's being funded, I often say, by the world's financially strongest corporations. They have over $600 billion worth of free cash flow generation to pour into the R&D. It makes the environment so remarkably different than what we witnessed in the innovation surrounding the late nineties, when that was all funded by debt. Very similar analogy when I look at ‘95 and ‘96 to what we're experiencing in ‘23 and ‘24. Move the calendar into the second half of the year, tell me that you're going to defeat these very strong four fundamental catalysts, and then we can have the conversation about an inflection point in markets. But until we do that, we've got a very strong secular bull trend in place for equities and credit.

Recorded June 25, 2024.
Edited from the original.