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The Weekend Edition # 122 - Shelter Inflation and Earnings Themes

Markets take a breather; Shelter inflation HOT; Earnings Themes; Financial

Welcome to another issue of the Weekend Edition!

Thank you to all who’ve read and welcome to all the new subscribers this week!

Here's what we cover

Market takes a breather on Inflation worries

February 12 - February 16, 2024

This week was all about the macro data. Inflation is starting to look like a concern again. While several Fed speakers tried to downplay the inflation narrative and yes, this may not be the start of a trend, we can’t help but wonder whether the concerns are valid.

PC: Trading Economics

We ended the week with hotter PPI data which signifies that prices at the producer levels (not just end consumers) are going up, and quite a bit if I may add. Not just that, the PPI data also feeds into what the Fed likes to measure - that is the PCE data. We also got the preliminary University of Michigan sentiment data that showed that inflation expectations for the year ahead have gone up.

All things considered, there are reasons to be worried because where we are seeing the spike in inflation is in services, more specifically core services, which is what the Fed is also worried about.

Having said that, food inflation also increased and we’re seeing spikes in food prices across the board. Egg prices have gone up significantly, with prices up close to +75% for the month!

PC: Trading Economics

The market’s reaction to these numbers, however, is that they are adjusting to reality. Traders had gotten too ahead of themselves with 6 rate cuts priced in for the year starting in March (at some point even January was in question). But, we’re seeing this normalize more towards June - July and 4 rates. I still see the first cut in July.

With that, we’ve had yields increase and markets pull back. This has been the first red week for the S&P 500 since the first week of January. Yields have been increasing for the past two weeks but, the market was content to ignore it, driven partly by earnings and partly by euphoria. This correction was perhaps healthy, in a sense and we’re likely to have more corrections along the way, but the path of least resistance is probably higher.

S&P 500 vs. 10Y Yield

Some of the charts in the recap section have been sponsored by Koyfin. We have a special discount of 15% for MacroVisor readers for any new sign-ups to Koyfin. To take advantage of this promo please sign up here - Koyfin MacroVisor Discount

Macro - Shelter Inflation and Housing

The most glaring number in the CPI report was the increase in Shelter Inflation. Now, we’ve all been keeping an eye on the shelter component because it constitutes such a large proportion of the CPI (36%). But, something seems amiss here.

Let’s look at the Year-on-Year data first:

  • CPI = 3.1%

  • Core CPI (ex-food and energy) = 3.9%

  • CPI ex-shelter = 1.5%

  • Shelter Inflation = 6% (down from 6.2%)

Last year, we looked at the correlation between Shelter CPI and the S&P Case-Shiller Home Price Index, and what we found was a 12 - 15 month lag between home prices and inflation. The Home Price Index peaked in March 2022, which ideally would suggest that Shelter Inflation should also have peaked, which it has.

CPI Shelter Components vs. Case Shiller Home Price Index lagged 14 months (PC: Apollo)

The chart above also suggests that Home Prices have put in a recent bottom as well in May 2023, which means that we just may start seeing shelter inflation pick up again towards mid-2024, something we have already started to see in this month’s release, and therein lies the problem.

The second issue is rent. We know that almost 27% of Shelter CPI is made up of Owner’s Equivalent Rent (OER) which is an odd indicator that tracks what homeowners would charge to rent their homes. Regardless of the oddity, the bigger problem is that the indicator tends to lag real-time data by about 6 months. So when we look at leading indicators of rent from various other measures, we should be seeing the OER come down far more drastically. Nevertheless, the rent measures now seem to be bottoming and if we look at this with the comparative lag to OER, we could see a rebound in OER between April and July.

Leading indicators of rent (with a lead) vs. OER (PC: Apollo)

We know the issue here. Firstly, home inventory is low, i.e., the US doesn’t have enough homes.

Housing Inventory per Household (PC: Apollo)

Secondly, people are not moving out of their existing homes, because they have locked in low mortgage rates.

It would seem that higher mortgage rates have had some of a contradictory effect on the housing market in terms of second-hand homes (existing inventory) but, this is gradually changing and the inventory of existing homes is starting to increase again. As the idea of rate cuts becomes more widespread, we’re seeing some cooling in mortgage rates, which is causing mortgage applications to rise.

But the fact remains, that more housing is required. This is why the homebuilders have been on fire because there continues to be a shortage of homes and plenty of business for them. Yesterday’s housing starts data was down 14% which was a big disappointment and probably added to market worries. However, this could be a seasonal issue because of winter weather conditions, and watching this data for the next few months would be important to gauge whether the housing market is coming back into balance.

Earnings Season - Q4 Themes

Earnings have improved.

From the last quarter of 2022 to the second quarter of 2023, the S&P 500 experienced a decline in earnings for three consecutive quarters. However, there was a 5.3% increase in earnings year-over-year in the third quarter of 2023, as reported by FactSet. Furthermore, the estimated earnings growth for the fourth quarter is 3.1%.

Additionally, earnings for the first quarter of 2024 are expected to increase by 3.7%, with a forecasted 10.9% rise in earnings for the entire year of 2024.

Goldman Sachs does a fascinating study on earnings call transcripts, called the S&P 500 Beige Book. This quarter (Q4, 2023) they have identified three key themes that companies are talking about (1) AI; (2) Supply Chains (3) Labor Market

Here’s a summary of their findings:

Finally, Nvidia’s Q4 earnings is on Wed Feb 21, 2024 at 4:20 pm ET and it is arguably the most watched earnings in recent memory. According to GS, options are pricing in an implied move of ~11% which translates to a market cap gain or loss of about $200B.

The biggest issue with these earnings is that they are priced to perfection and that simply means that if the analysts & traders don’t see exactly what the are hoping for, or better… the stock price may pull back. The company has been delivering over the past few quarters, beating revenues by about ~$2B and the stock has been pricing in significant levels of growth in earnings over the last few months. Year-to-Date, NVDA is up +50.75%.

  • Q4 EPS Estimate: 4.59

  • Q4 Revenue Estimate: $20.369 billion

  • Previous Q3 EPS: 4.02 (est. 3.37)

  • Previous Q3 Revenue: $ 18.12B (est. $16.19B)

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The Week Ahead - Calendars - Monday is a holiday in the US

US Earnings

US Economic Calendar in Eastern Time (Source: Trading Economics)

Closing Thoughts - Financial stress declined

Last week, I talked about taking some profits ahead of the CPI data print. Next week will be relatively quiet on the Macro front, with no shortage of Fed Speakers, however. Next week’s key highlight will be Nvidia earnings but, we also have Walmart and Home Depot on Tuesday before the open.

Over the past few weeks, we saw some concerns about distress, particularly in commercial real estate, which ideally could lead to the Fed cutting sooner but, with the inflation narrative overtaking that issue, we’re seeing rate cuts being pushed back. In fact, BofA’s financial stress indicator has fallen to its lowest level since 2021!

Have a great week ahead!

Sincerely yours,

Ayesha Tariq, CFA

There’s always a story behind the numbers.

None of the above is Investment Advice. I may or may not have positions in any of the stocks or asset classes mentioned. I have no affiliation with any of the companies other than explicitly mentioned.

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