Straight Talk

April 29, 2024

Five Things You Missed This Week

1. It’s not about CPI and PCE, but EBITDA.

That’s a cheeky way of saying that the market’s less focused on inflation and more focused on corporate earnings growth. The consumer price index (CPI) and core Personal Consumption Expenditure deflator (PCE) both recently showed higher-than-expected inflation in March, but the market reaction has so far been muted. Instead, investors hope that corporate earnings (earnings before interest, taxes, depreciation and amortization, or EBITDA) can justify a continued rally. To this point, almost half of the companies in the S&P500^® Index have reported first-quarter 2024 results. The numbers are decent, but not overwhelmingly strong. According to FactSet, on average we’ve seen 3.5% earnings growth and 4% top-line (sales) growth. A handful of sectors, including basic materials, energy and health care have reported earnings declines. Our take is that it’s hard to see how the current level of earnings growth is capable of sustaining a market P/E that’s currently hovering around 23 with interest rates hitting levels we haven’t seen in months.

2. Sticky inflation and weak growth have investors uttering the “S” word—stagflation.

Our longer-term base case is for growth around 2% or so. We see inflation running a bit higher, at around 2.25% to 2.75%. If we’re right, that’s hardly stagflationary territory. But of course, short-term economic variation around that long-run view is inevitable. Last week, first-quarter GDP was 1.6%, down from 3.4% the prior quarter. Meanwhile, the annualized run rate on core PCE last month was 3.6%. One month or even one-quarter of data does not make a trend. But if those numbers were to be sustained for some time or worsen, then we’d begin to consider whether it’s appropriate to utter the dreaded “S” word.

3. Economic growth remains dependent upon consumer spending.

It’s worth pointing out that the miss on economic growth this quarter came from trade and inventories—not from consumer spending, which remained strong. On average, consumer outlays account for two-thirds of economic growth. That’s why the March personal income and spending data are so important. The report showed robust spending in both February and March. The question everyone’s asking is, how much longer can American consumers keep opening their wallets?

We found an interesting take on this in a recent presentation by BCA research. They note that consumers can spend from one of three places:

• Past income (the notorious “excess savings”);

• Present income (wages and investments returns. This is why the current state of the labor market is so important); or

• Future income (borrowing).

All three sources of spending are problematic at present. We don’t believe they can continue to fund the consumer at these levels indefinitely.

4. Explaining “p-hacking” and the replication crisis in financial research.

Two weeks ago, I talked about the crisis around the ability of academic research findings to be replicated. Replication is crucial because the cornerstone of the scientific method is that research methods should be clear and findings repeatable. Good reading on the subject can be found in two studies. One was published by Banque de France titled “The Reproducibility of Economics Research: A Case Study”. The authors succeeded in replicating only 38% of the 162 papers they evaluated.

A second paper, an NBER working paper titled “Replicating Anomalies” is arguably more damning. They declare, right up front, that the literature on stock factors or what is known as “anomalies literature” is “infested with widespread p-hacking.” P-hacking is less affectionately known as data mining, data dredging, data fishing, data snooping or data butchery. P-hacking is essentially the relentless analysis of data with the intent to obtain a statistically significant result to support the researcher's hypothesis. The authors found that roughly two-thirds of 286 identified anomalies failed to reach conventional levels of statistical significance. This is important to get right because investors and practitioners should have the highest confidence in the research on which investment decisions are made.

5. Crypto as “digital gold”?

The remarkable run-up in Bitcoin and other cryptocurrencies in 2023 has investors looking for reasons to jump on the crypto bandwagon. One argument we’ve heard is that crypto can function like “digital gold” as a portfolio diversifier. We just don’t believe that Bitcoin’s supposed ability to diversify equity exposure is well founded. Bitcoin completely dropped the ball as a diversifier in 2020 and 2022. And crypto’s utility as a store of value? Unproven and way, way too early to make that determination. While we do believe that the adoption of the emergent blockchain technology will be key to the long-term utility of Bitcoin and other cryptocurrencies, we just aren’t there yet. What’s more, there are literally thousands of cryptocurrencies in existence and the major central banks around the world haven’t even entered the market yet. But if and when they do, there’s little doubt that central bank digital currencies will elbow out most, if not all, of the individual crypto players in the field. So, again, we aren’t ready to jump on the crypto bandwagon, despite its recent remarkable returns.