June saw a huge increase in bullish sentiment that carried through in July. It has been a complete turnaround since the continuously pessimistic readings throughout 2022. The about-face has been so large that an investor has to ask: Are we seeing an increase in complacency? As a contrary indicator, has it been too much too fast, indicating a slowdown for stocks ahead?
For example, CNN’s Fear and Greed index is currently in “Extreme Greed” territory. A year ago it was in “Extreme Fear” territory just as the market was bottoming. And the NAAIM Exposure index has become much more bullish. This index tracks the average equity exposure of active investment managers. Active money managers are now fully invested in stocks for the first time in over a year and a half.
When sentiment is overly optimistic, the obvious question is: ‘Who is left to buy?’ But with trillions in cash sitting in money market funds and short-term bonds, there seems to be plenty of cash available to fund further purchases of stocks.
EARNINGS RECESSION ALMOST OVER
About half of companies in the S&P 500 index have reported earnings results for this year’s second quarter. They are coming in better than the bears projected, but not quite as good as the bulls hoped for. The projection now is for profits to drop 7.3% in Q2 year-over-year; the third consecutive quarter earnings have declined year-over-year. The earnings recession may now be over as Q3 earnings are expected to rise. Earnings growth for calendar 2024 is projected to be 12.6%.
The blended profit margin for the S&P 500 for Q2 is expected to be 11.2%, only slightly down from the five-year average of 11.4%. Companies are staying very profitable in spite of inflation cooling and the freedom to raise prices going away.
We focus on bottom-up Wall Street forecasts, which are a compilation of individual analyst projections which includes talking to the companies. Top-down projections are made by Wall Street strategists after forecasting trends in macroeconomic variables (which are incredibly hard to forecast, like timing the market).
We also listen to company comments. What individual companies have to say about their business can sometimes be even more insightful than what aggregate earnings tell us. Here are a few interesting company comments from the last few weeks:
Supply Chains: Mixed results even with industries. Stellantis reports there are no weeks without supply chain issues. Volkswagen claims to be battling logistics bottlenecks in the U.S. and Europe but sees a ‘strong delivery outlook’ anyway. Boeing highlighted ‘progress driving stability in our factories and the supply chain.’
Consumer Inflation: Consumer companies (like Nestle, Unilever, and Procter and Gamble) reported the same variation on a consumer theme: volumes flat year-over-year or slightly lower while raising prices more than expected.
Energy: Exxon claims profitability ‘doubled from what we earned in a comparable industry commodity price environment just five years ago.’
EVs: Ford said that even with a 50% increase in EBIT loss for its EV division, management believes it can pay out 40-50% of free cash flow and still invest heavily in electric vehicles. GM confirmed it would double EV output in the second half of this year.
It is interesting that the earnings recession started in Q4 2022 – the same quarter the market bottomed. Now after three quarters of earnings declines, profitability is set to return which is good news for stocks.