/ July 24 / Weekly Preview
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Monday:
N/A
Tuesday:
Consumer Confidence (111 exp.)
Wednesday:
Fed Interest Rate Decision (0.25% hike exp.)
Thursday:
Durable Goods Orders MoM (0.6% exp.)
GDP Growth Rate QoQ (1.8% exp.)
Friday:
Core PCE Price Index MoM (0.2% exp.)
Personal Spending MoM (0.3% exp.)
Personal Income MoM (0.4% exp.)
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Monday:
Cadence Design CDNS
Domino's Pizza DPZ
Logitech International LOGI
NXP Semiconductors NXPI
Range Resources RRC
Tuesday:
Alphabet GOOGL
Microsoft MSFT
3M MMM
General Electric GE
MSCI MSCI
NextEra Energy NEE
Snap SNAP
Spotify SPOT
Texas Instruments TXN
Visa V
Wednesday:
Align Technology ALGN
Automatic Data Processing ADP
Boeing BA
CME Group CME
Coca-Cola KO
eBay EBAY
Edwards Lifesciences EW
Hilton Worldwide Holdings HLT
IDEX Corp IEX
Lam Research LRCX
O'Reilly Automotive ORLY
Quest Diagnostics DGX
ServiceNow NOW
Thursday:
Amazon.com AMZN
AbbVie ABBV
Enphase Energy ENPH
Ford Motor F
Intel INTC
Mastercard MA
McDonald's MCD
Northrop Grumman NOC
Roku ROKU
Royal Caribbean RCL
S&P Global SPGI
Valero Energy VLO
Friday:
AstraZeneca AZN
Chevron CVX
Exxon Mobil XOM
Procter & Gamble PG
Earnings: So far, so good (except Tesla & Netflix)
With Q2 Earnings Season underway, corporate results and outlooks remain relatively upbeat. Market pricing suggests the economic cycle might fundamentally improve. While it’s a bit early to confidently make this assertion, it does look like we’ll get new all-time-highs in the market sometime early next year.
Technically, SPY is holding above the R2 level at $449. Historically, when trading out of an established down-trend (like the case is today), and clearing the R2 level, the studied instrument is highly likely to reach all-time-highs. While slightly illogical from an “economist’s” standpoint, the strong bullish technicals suggest this is the coming reality.
However, pay attention to the fact that market advances have their “gravitational” limits. A bull run that goes too far, too fast, will eventually revert and re-test previously established levels of support, before resuming. Look no further than the results of Tesla and Netflix to understand that when technicals are pushed to the limits, fundamentals DO matter - and they matter a lot.
We have created a video that should be especially helpful to stock-pickers in explaining how to adjust a technical chart in order to correctly account for fundamental assumptions about the business. This process is the cornerstone to our fundamental - technical valuation insight.
SPY Analysis
As the MACD has triggered a BUY from a highly elevated level, advances don’t “stick” - we immediately notice another loss of momentum forming
As noted above, there are limits to any advance. As a consequence, there are limits to technical price signals as well. The previous MACD BUY signal that we got on 07/13 has only managed to produce a 0.64% gain so far - and it’s already looking like transitioning to a SELL.
With sentiment amongst retail and professional investors sitting at “Extreme Greed” levels, we see a correction as more likely to occur than usual. The R1 Level (at $431), coinciding with the 50-DMA, would be a fine place to add exposure. This retracement would not fully resolve the overbought condition of the market, but a lot of short-term risk would be priced out. Currently, a correction to the 50-DMA would imply a -4.83% drop, while the downside to the 200-DMA is -10.5% (see the Risk Explorer for more statistical metrics).
These conditions often alight with short-term peaks in the market. Remaining patient and opportunistic with your allocation is likely to be rewarded, as there’s an increased chance we’ll get a better opportunity to “get on board”.
The good news is that this advance has also started to “lift more boats” - we’ve got much better participation in terms of market breadth. While the divergence in Z-Scores between SPY and “the rest of the market” is still extreme, note that a breakout has occurred for “the market” (yellow dashed lines). This is another clue that suggests a new bull market is dawning.
We expect that a correction in the S&P500 would compress the Z-Score divergence. The heavy reliance on Tech and Large Caps of the index will sink the SPY when a correction / rotation finally arrives. Since “the market” is computed from the top 1000 stocks by volume, equally weighted, they are less likely to suffer a drawdown of the same magnitude (hence, the divergence would resolve).
Are Fundamentals Supporting the Bulls?
While short-term supply and demand are influenced by investor psychology and professional manager’s need to deliver returns - longer term, it’s fundamental earnings growth that dictates the trend of the market. Ed Yardeni made a bold prediction that the S&P 500 index could hit a high of 5400 in 2024:
“Market veteran Ed Yardeni predicts that the S&P 500 could reach a record high of 5,400 within the next 18 months. Yardeni, the head of Yardeni Research, believes that the current bull market, which began on October 12, 2022, will continue until at least the end of 2024. He expects the equity benchmark to make significant gains, with a target range representing an increase of 6.5% to 19.9% from its current level.”
This kind of prediction might seem unsubstantiated, until we check on our Market Fundamentals instrument. Since 2011, the last 3 major contractions in P/E Ratio for the S&P500 have taken the measure lower by -25% to -30%. The period which followed saw valuations recover to previous peaks. Such a contraction has also occurred now, reaching a bottom in October 2022. There is “fuel in the tank” to reach previous highs, crediting Yardeni to his view.
The normalization of Revenue Growth is also a factor that supports the bullish thesis. Right now, the average Revenue Growth reported by S&P500 companies sits at the cycle median of 6.3%. Note on the chart below that the market (being forward-looking in nature), was on its way to recovery once the revenue slowdown was “in the books” - entirely accounted for and properly discounted. We can’t know when the eventual revenue growth slowdown will be complete, until after the fact - but the market’s recovery tells us that participants are expecting this measure to perk up again.
In any case, the revenue growth slowdown is close to being properly priced in, for the average stock, leaving more upside for the future.
The Risk / Reward setup for Earnings Headliners
Microsoft (MSFT) - Price Target $350 / 10.5% EPS Growth
Our DCF Model works with the following assumptions:
Revenue Growth: 11%
Gross Margin: 67%
Operating Expenses % of Sales: 27%
Share Count Growth: -1%
EV / EBITDA Multiple: 22
WACC: 9.8%
Tax Rate: 21%
Fundamental Risk / Reward for MSFT: not great, nearly fully priced in
Google (GOOG) - Price Target $140 / 11% EPS Growth
Our DCF Model works with the following assumptions:
Revenue Growth: 11%
Gross Margin: 55%
Operating Expenses % of Sales: 28%
Share Count Growth: 0%
EV / EBITDA Multiple: 15
WACC: 10.70%
Tax Rate: 21%
Investors can find a much better Risk / Reward in Google than Microsoft ahead of earnings at the moment.
Amazon (AMZN) - Price Target $130 / 12% EPS Growth
Our DCF Model works with the following assumptions:
Revenue Growth: 12%
Gross Margin: 43%
Operating Expenses % of Sales: 39%
Share Count Growth: 0%
EV / EBITDA Multiple: 21
WACC: 11%
Tax Rate: 21%
Our Price Target for Amazon is a bit lower than the street’s due to structural margin concerns; in this scenario, AMZN has limited upside.
Our Trading Strategy
With AMZN and MSFT needing to prove themselves during their respective earnings announcements, upside appears limited if we count on them as positive catalysts. Google is much better positioned in terms of providing a nice upside surprise. A.I will be front and center on investors minds during these calls and we suspect they will push for proof that the emerging technology actually impacts the bottom line.
For a hardware infrastructure provider, like NVDA or AMD, surging interest in A.I. is a huge net positive. That has us thinking on who exactly is on the other side of this transaction, providing the capital expenditure for these new chips. And we suspect that software developers like MSFT, GOOG and AMZN are the big spenders, as they are in a position to dominate the field and assure their leadership in the future.
In the short term, A.I. development is a zero-sum game, squeezing developer’s margins. As a consequence, software developers will need to provide investors with a roadmap to profitability. MSFT has already taken the first step in this direction, announcing future charges for its A.I. products. We suspect AMZN and GOOG will step up, and provide shareholders with proper guidance.
On our radar is the Fed interest rate decision on Wednesday, where a 0.25% rate hike is all but assured. Following that, market participants are broadly expecting a pause.
We’re keeping a more defensive profile for the moment, having added to financial small caps last week. In order to add exposure to more risky areas of the market, we’d like to see a pullback first. We’ll keep you in the loop with our trading in the Sigma Portfolio.