The growing dissonance between tech earnings estimates and stock prices … why Luke Lango believes the Fed is about to pivot … another story for our “commercial real estate watch” segment
This week begins Q1 earnings season and it could bring some fireworks.On one hand, analysts estimate that we’re about to see the largest earnings decline since the pandemic, clocking in at -6.8%.On the other hand, we have a rather bullish stock market with the tech-heavy Nasdaq leading the charge, up 15% in 2023.Accounting for this divergence is something you’re very familiar with by now…The market doesn’t want to believe the Fed.Many tech investors on Wall Street have been front-running what they believe will be rate-cuts this year, as the Fed will be forced to prop up a deteriorating economy. Tech/growth stocks respond better in a low-interest-rate environment.But this run-up in the Nasdaq has been happening at the same time that Federal Reserve Chairman Jerome Powell and the various Fed presidents all toe the party line – there will be zero rate cuts in 2023.The Nasdaq’s gains and the Fed’s alleged interest-rate-stubbornness won’t coexist peacefully this year.Here’s Bloomberg speaking to this tension:
This year’s 20% rally in US technology stocks is decoupling from reality ahead of what’s predicted to be a gloomy reporting season, the latest MLIV Pulse survey shows.While investors have flocked to tech in the market shakeup amid recent banking turmoil, the rotation is at odds with analyst calls for the steepest drop in quarterly profits for the sector since at least 2006…“The tech outperformance is a bit overdone and we’re not chasing that indiscriminately,” Wei Li, global chief investment strategist at BlackRock Inc., said in an interview in London. “It’s being driven by expectations the Federal Reserve will start cutting rates as a recession becomes evident, and not necessarily by company fundamentals.”
To illustrate Bloomberg’s point that the Nasdaq rally isn’t based on fundamentals, let’s turn to FactSet, which is the go-to earnings data analytics groups used by the pros:From last Friday’s FactSet Earnings Insight:
The Information Technology sector is expected to report the third-largest (year-over-year) earnings decline of all eleven sectors at -15.0%…At the sector level, the Information Technology and Industrials sectors have the highest number of companies issuing negative EPS guidance for the first quarter at 27 and 16, respectively. Combined, these two sectors account for more than half (43) of all the companies in the S&P 500 issuing negative EPS guidance for the first quarter (78).
So, we have tech earnings estimates going down at the same time that tech stock prices have been headed up.What will give?
If Luke Lango is right, a Fed pivot will smooth out all of these wrinkles
Luke is our hypergrowth/tech expert, with his flagship Innovation Investor portfolio soaring more than 20% so far in 2023 thanks to the expectations of a Fed pivot.Luke notes that while investors have been anticipating this pivot for months, data finally suggest that it’s imminent.From Luke:
Seasoned investors know that short-term Treasury yields track Fed policy.That is, longer-term yields like the 10-year track a number of factors, including inflation and economic growth prospects. But shorter-term yields like the 2-year pretty much exclusively track the Fed Funds rate on a near 1-to-1 basis. Every once in a while, though, this relationship breaks. The 2-year Treasury yield starts to diverge from the Fed Funds rate. This happens when the bond market starts front-running a shift in Fed policy. One such major divergence is happening right now.
Luke highlights how over the past week weeks, the two-year Treasury yield has collapsed as fears of a recession have surged. But with the Fed hiking its Fed Funds rate even higher last month, the two-year yield plummeted more than 100 basis points beneath the Fed Funds Rate.
Back to Luke for the significance:
Historically, every time this has happened before, a Fed pivot was imminent. That is, every single time the 2-year Treasury yield has dropped more than 100 basis points below the Fed Funds rate, the Fed went from hiking rates to cutting them.
For all the talk of rate hikes from various Federal Reserve members, the bond market is telling the Fed that it has no more room to hike. It’s time to cut. The Fed will listen to the bond market. It always does, as the chart above shows.Every time the bond market tells the Fed this loudly that it needs to cut rates, the Fed ends up cutting.
If Luke is right, then the front-runners on Wall Street who have been bidding up tech prices may have bet wisely – even if tech earnings underwhelm in the next several weeks since investor will be looking forward, not backward.
So, what sort of returns could be in store if history repeats itself?
Back to Luke:
…Every single time the Fed has paused its rate-hike cycle over the past 40 years, stocks rallied over the next few months, with returns often running north of 20%.
This time will not prove different. A Fed pivot is coming. So, too, is a big stock market rally.
By the way, if you missed it, last week, Luke held a special, live event that featured his quantitative trading system in Breakout Trader. If we are on the verge of a Fed Pivot and an ensuing bull market, this trading system will help you pinpoint the fastest-moving, most explosive stocks. To learn more about it, and to get Luke’s broader macro research, just click here.
Finally, in our ongoing “commercial real estate watch” segment…
Regular Digest readers know we’re tracking developments in the commercial real estate sector. This is because the same interest rate issues that recently took down a handful of regional banks will similarly affect the commercial real estate sector. And if/when it rolls over, the economic contagion could tip the broader economy into a recession.Yesterday, Goldman Sachs downgraded real estate giant Cushman & Wakefield. While we’re not as interested in Cushman & Wakefield specifically, the issues that Goldman cites are landmines for the broader sector.High leverage… problems with free-cash-flow… climbing interest expense… a tightening of overall sector liquidity…On that last note, even if we do see rate-cuts from the Fed as Luke forecasts, Goldman questions whether it will save commercial real estate. Here’s CNBC:
Meanwhile, a tightening of liquidity will continue to pose a challenge to real estate investors, Goldman estimates, which “more than offsets any tailwinds from potentially lower rates.”“As such, we are cautious on CRE transaction and the lending market in 2023…”
Remember, nearly $1.5 trillion of U.S. commercial real estate loans will come due before the end of 2025. As rate climbs, banks tighten lending requirements, and commercial real estate companies suffer lower revenues, liquidity challenges have the potential do inflict all sorts of damage. The dynamic is similar to draining a gas-powered engine of oil – it’s only a matter of time before the pistons lock up.Returning to Cushman & Wakefield, its stock price has lost more than 35% since early-February. Just a reminder to keep an eye on any exposure to commercial real estate in your portfolio.We’ll keep you updated on all these stories here in the Digest.Have a good evening,Jeff Remsburg
