Weekly Investment Update (01/19/2024)

This Week’s Positioning and Views

In our final Weekly Investment Update of 2023, we highlighted a potential shift in investors’ reactions to incoming economic data, noting that with expectations reset, slower growth forecasts for 2024 may not be necessary to convince investors that inflation will be less problematic going forward. We maintain this view at the start of 2024 as good news for the economy is not automatically bad news for the market, as was the case for much of 2023.

Although a pause in the recent market rally has been the dominant narrative thus far in 2024, we are encouraged by the way equity markets have behaved. This week, the 10-year Treasury rate increased from 4.06% to 4.18%. We also received data on retail sales, housing, and consumer confidence, all of which exceeded expectations. At the same time, the S&P 500 rose about 1%. Looking ahead, given the recent strength in the economy, we believe investors will be increasingly sensitive to incoming inflation data, which could lead to near-term market volatility. However, we are also comfortable with the idea that in the coming quarters, inflation can ease alongside an economy that continues to grow. This should allow the Federal Reserve to ease monetary policy in the second quarter, and non-recessionary rate cuts have historically been a tailwind to stocks.

Fourth Quarter U.S. Earnings Season Off to a Steady Start

What is happening: In the past week just over 10% of companies in the S&P 500 reported their fourth quarter earnings. Results have so far beaten reduced expectations, with 62% of companies beating estimates. Overall expectations are for a 4.4% year-over-year increase in earnings. Particular focus will be on the Magnificent Seven mega-cap technology stocks set to begin reporting earnings next week, as they are collectively expected to grow earnings by 46% YoY, which will be key for the overall level of earnings for the market.

Why it matters: This earnings season will be important for the short-term direction of the S&P 500. Earnings estimates had been reduced in the past three months, setting a lower bar to beat, so investors will be paying particularly close attention to earnings commentary for signs of whether the reduction in estimates is due to conservative management teams' setting a low bar for a greater upside surprise, or a sign of weakness in the economy. The mixed picture of the economy can be seen by the banks that have reported earnings, some of which mentioned the continued strength of consumer spending over the holiday period; however, there have also been announcements of layoffs from companies such as Macy’s, Google, and Amazon that will likely pressure overall consumer spending in 2024. After the strong rally in markets toward the end of last year, the tone of company outlook statements made by management teams will be key to the market's near-term direction.

Pro-Independence Party Retains Presidency in Taiwan Election

What is happening: Last weekend, Taiwanese voters elected the current ruling Democratic Progressive Party (DPP) for an unprecedented third presidential term. The DPP has traditionally supported formal independence from China more than other political parties. While the DPP failed to maintain control of parliament, President-elect Lai Ching-Te's victory will likely result in a continuation of a more outwardly confrontational position toward China while seeking closer ties with the U.S. and other democratic allies.

Why it matters: The importance of Taiwan both to the global technology supply chain as well as to broader geopolitics cannot be overstated. Taiwan retains the most cutting-edge semiconductor manufacturing capabilities in the world, making the technologically advanced island nation of strategic importance to the U.S. and its allies. Chips made in Taiwan are present in everything from kitchen appliances to U.S. military hardware. Meanwhile, Beijing views the island as part of its territory even though Taiwan has governed independently since 1949. China has ramped up routine incursions into Taiwanese airspace and maritime borders in recent years. If China were to assume control of Taiwan, either peacefully or by force, it would signify not only a loss of a key Asian democracy but also Beijing's expanded control of critical technology supply lines.

While the DPP victory is unlikely to ease tensions between Taiwan and China, we assign a low probability to any serious near-term military confrontation given China’s stated timeline for military readiness for a Taiwan operation isn’t until at least 2027. While the outcome of the Taiwanese election is important to the geopolitical landscape, our primary focus remains the economic picture within mainland China, which continues to lack meaningful improvement. Bessemer portfolios remain underweight Chinese equities versus respective benchmarks.