by Jurrien Timmer, Director of Global Macro for Fidelity Management & Research Company
The news flow has been fast and furious so far this year, and frankly it’s becoming hard to keep track of all the moving parts. Whenever the news flow reaches escape velocity like this (whether in the markets or in life), I find it useful to take a breath, zoom out, and focus on what we know, or what we think we know.
What We Know
Despite a solid January, during which every asset class I track went up, the past 8 weeks or so have had a “churning” feel to them. The Mag 7 has been consolidating, Bitcoin seems stuck at $100k, the banks are on fire, and both the dollar and Treasuries have corrected some of their initial “Trump Trade” reaction. The Fed may well be done easing, but nobody seems to care, as all eyes are fixed on the long end of the yield curve.
Maturing Bull
Overall, the trend remains up for US equities, which leads me to conclude that this cyclical bull market remains in place at 28 months old. Yet only 62% of stocks are above their 200-day moving average, and the chart below shows a series of negative divergences, the likes of which have tended to happen in the more mature stages of bull markets. It feels like late innings to me.
Breadth
Furthermore, the S&P 500 equal-weight index remains below its all-time high, and only 53% of stocks are above their 50-day moving average. It’s a rather weak recovery from the recent 5% pullback, during which only 17% of stocks were above their moving average. Strong bull markets tend to roar back to life after corrections, so this is something that bears watching.
Sentiment
Sentiment remains quite constructive, at least as far as equity flows are concerned. The sentiment surveys are more two-sided, but investors seem to remain poised for a good year in the markets.
Q4 Earnings Season
Earnings are doing their heavy lifting, and then some. With 308 companies reporting, 4th quarter earnings season has been a good one, with 77% of companies beating estimates by 655 bps. That’s fairly typical, but the chart below shows that the growth rate has now jumped to 13%. It was at 8% at the start of earnings season.
A Solid 2024
This strong bounce has lifted the 2024 estimate from 10.1% to 11.4%. It’s a great result following the modest 2.6% decline in 2023. The past four years have posted growth rates of +48% (2021), +8.5% (2022), -2.6% (2023), and now +11.4% (2024). Impressive.
Squiggles
While the outlying estimates tend to start too high and work their way down, the squiggles chart below shows that expectations remain quite robust for 2025, 2026, and 2027. If correct, this should provide a solid underpinning for the market, valuations and interest rates notwithstanding.
The Fed is Done
Speaking of rates, the Fed seems to be done with their efforts to recalibrate their policy to reflect the moderation in the inflation rate and the labor market. At 4.25-4.50%, they are only a smidge above my estimate of neutral (4.0%), so all appears good here.
QT
The Fed is still shrinking its balance sheet, however, and we have reached the point at which the Fed’s reverse repo program (RRP) has been all but depleted. That means that any further reductions in assets will likely start shrinking bank reserves (which would constitute a proper tightening of policy). However, with the Treasury’s cash balance at the Fed (TGA) at a robust $830 billion, any spending down of that TGA balance during the “extraordinary measures” phase of the debt ceiling process could neutralize that tightening.
The long-term chart below shows that the Fed’s balance sheet still has a long way to go before reaching more normal levels. At 23% of GDP, it is well below the 36% extreme set during Covid, but well above where it was during the pre-QE (pre ’08) days.
Bonds
As mentioned, no one seems bothered by the potential end of the Fed easing cycle (not even the White House, apparently), as all eyes are on the bear-steepening long end. Here too, things have moderated in recent weeks, and we no longer seem to be on the brink of a 5-handle. That’s good news for equity valuations, but the big question remains as to what the proper level of the term premium is in an era of ongoing fiscal expansion.
Competitive Alternatives
History shows us that when the risk-free asset (Treasuries, supposedly) becomes competitive with equities, stocks have to work harder to compete. This dynamic is explained by the Fed model, which compares the equity “P/E” to the bond P/E (below). Investors have to pay 22x the coupon stream to own a 10-year Treasury, equal to the 22x they have to pay for a year of earnings. Stocks are supposed to yield more than Government bonds, so the valuation question for stocks is not just one of absolute levels but also relative to bonds and cash.
Rising Correlation
History clearly shows that as bond yields rise, so does the correlation with stocks. It makes perfect sense, based on the above approach to relative value. If bonds yield 1% and going to 2%, while stocks are yielding 5%, it matters in terms of discounted cash flows, but stocks are still the superior yielding asset by far. But if bonds are yielding 5% and going to 6%, while stocks are at 5%, valuations need to adjust lower. This is classic late cycle behavior, in which robust earnings growth is offset by rate pressures.
Secular Context
The above dynamic may well play a role in what is now a mature secular bull market. History shows that secular bulls die in one of two ways (or both): inflation and valuation. While valuations are not quite at the extremes seen in 2000, 1973, or 1929, they are elevated at a time when bond yields have become competitive again.
Therefore, I could easily see this super-cycle’s “golden years” be a phase in which valuations go from amplifying earnings gains (as they did in 2023 and 2024) to offsetting them. It doesn’t mean the end of the bull market, but it would mark the peak of double-digit returns, which is exactly what the CAPE model (above) says.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
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