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Valuation could be issue if earnings don't live up to H2 hype

Market indices (^DJI, ^IXIC, ^GSPC) are hovering around their flatlines this morning after last week's whirlwind of consecutive highs from the S&P 500 and Nasdaq Composite. Evercore ISI and Goldman Sachs strategists have both raised their year-end targets on the S&P 500.

Miller Tabak Managing Director and Chief Market Strategist Matt Maley sits down with the Morning Brief team to talk about the market rally, where investors should be looking, and the outlook on the Federal Reserve's late-2024 interest rate cuts.

"You never like to see a narrow rally, having said that this time last year we had a very similar, narrow rally, and yet it kept going for another month and a half, and it really didn't see a pullback until we got to August," Maley says. "But, one of the things it does tell us is that investors aren't all that confident about anything outside of the AI phenomenon. And we haven't seen the big broadening out of earnings outside of the AI phenomenon."

He also comments on how markets are expected to react to the 2024 presidential election — following France's own market reaction to the country's snap election — and geopolitical tensions in the Middle East.

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For more expert insight and the latest market action, click here to watch this full episode of Morning Brief.

This post was written by Luke Carberry Mogan.

Video transcript

Let's talk about that concentration that we certainly have seen play out here in the markets.

We are initially, we're talking about some concerns, some risk that, that might uh signal here for the broader market.

What do you think just about where we are the current valuations and whether or not, maybe there is too much worry about that narrow concentration.

Well, you know, you never like to see a narrow rally having said that uh you know, this time last year, we had a very similar narrow rally and yet it kept going for another month and a half and it really didn't see a pullback until we got to August.

Um But, you know, it, it, one of the things that does tell us is that, you know, investors aren't all that confident about anything outside of the A I uh phenomenon.

And we haven't seen the big uh broadening out of earnings outside of the A I phenomenon.

We have this, you know, the people are making the chips, the picks and the shovels are doing well.

But it's not, you know, it's, we're not seeing the end users of these uh uh chips, uh really you know, seeing a big increase in earnings.

So that's gonna be a big concern.

I mean, the, the S and P weight index that you guys were talking about, it's down four weeks in a row while, while the SNP has been rallying uh quite nicely.

So this divergence is something we do need to be concerned about, you know.

Uh Yes, maybe it does need to fall a little bit further before it creates some problems.

But um whenever you see a, a narrow market, especially when it's incredibly narrow as this one is, uh it does raise some questions.

So Matt, what does that tell us about the 6440 portfolio?

And I ask because I'm on the phone with my mom over the weekend talking to her about what she should be, she should be doing with her retirement funds.

And I know you're not gonna give us investment advice.

But when you do have that level of concentration, should you be pouring in more, doubling down, getting in on just tech or should you be hedging your risks a little bit because concentration could go bad really quickly.

Yeah.

And one of the things right, right now, uh Mat is, is that we have this, this situation where uh it's interesting at least in the last week or so.

So we heard some people talk about, you know, using a barbell strategy, which is something we've heard a lot in the past.

But this seems to make a little bit of sense.

I mean, these, these companies that are, you know, out performing so well are making money.

I mean, NVIDIA, uh it is not an expensive stock if you look at it on a, on a long term basis, but you getting 5% in, in cash right now, which is outperforming, as I mentioned, I mean, you know, the S and P equal weight, uh index of Russell 2000 is down on the year.

Uh, you know, a lot of this stuff in the middle is not acting very well.

So why not have, if you're going to be overweight in those, those and those big caps that are doing so well and are, uh, are getting some, some nice earnings.

Uh, why not have a little bit in cash on the other side uh for protection if the thing does start to turn down?

Well, when you take a look at what the fed is going to do next, it's, it's too much influence being placed or too much emphasis, I should say being placed on the exact timing from of a, of a fed rate cut.

And ultimately, we don't get one this year.

What's that going to do to investor sentiment, do you think?

Well, yeah, that's certainly gonna be, I mean, let's say we went to what, expecting seven rate cuts then down to three.

Now we're down to one and, you know, we couldn't even get zero.

that would certainly throw a wrench into the works because, I mean, let's face it.

The market is trading at 22 times, uh, forward earnings for, well, for 2024 and 21 or more than 21 times the next 12 months.

So the, um, you know, so now we have a situation where the markets principle, we don't have ultra low interest rates to kind of, uh, justify that big high valuation.

So that does create problems.

And then the other side, we also have to worry about what happens if they, if they suddenly start to cut rates in a meaningful way.

Uh you know, that, you know, in other words, what reason would they have to cut rates more, uh more quickly?

And that would be, of course, that the economy is slowing down and that's not what we want.

Uh because that there would be a negative impact for earnings and an expensive market.

That's not a, that's not a big thing.

So we, you know, we're definitely as we move into the summer months, we are, uh you know, have some concerns out there.

And that's why I think some, a little bit more cash on hand is not a bad, is not a bad investment idea.

How high does that put the bar then for the next earnings cycle?

And is that bar so high that at a certain point, these tech companies are not going to be able to keep up with the amount of growth that the street is looking for.

That's the big concern.

I mean, it is an election year.

We know we've got a lot of fiscal, uh, uh, stimulus in, in the marketplace and it's gonna be there.

It's not like Congress has to pass anything more.

They've already, they passed a long time ago and the administration back and loaded it.

So, so, uh, into this year.

So we, we, we get some nice, uh, liquidity but earnings, you know, remember last year, the stock market rallied 25% on zero earnings growth.

So, I mean, you know, if, if we're, and we're already up, you know, so since the beginning of two, 2023 we've had a 38 39% rally in the S and P 500 yet the earnings have only grown are expected to grow over the two years.

Uh, you know, 23 and 24 12% at some point.

Uh, we have to get a big increase in se in the second half.

We are looking for, you know, a nice increase in 3rd, 3rd quarter or fourth quarter, but it's gonna have to be even better than the expectations are right now or, or it's just, I just think this evaluation thing is, is going to become a problem.

Matt le le let's talk about what's going on in the rest of the world here.

And the impact that that could ultimately have on the US markets and, and investors watching this show when you take a look at what is playing out right now in France, when you take a look, even from a geopolitical risk perspective, the latest on the war in Israel, uh Israel's war with Hamas, what should investors keep in mind here just in terms of the risk that that could ultimately pose here to the global markets and what that could mean to the US?

Yeah, I, you know, II I sh I just really think that the, the the situation is the complacency surrounding these uh uh uh geopolitical risk is, is awfully high.

Again, some of that has to do with the, the liquidity in the marketplace and the market keeps going higher.

I I can't worry about these things.

I mean, let's face it.

Uh The, the situation in the Middle East has been going on for 778 months now and it hasn't had an impact, but you know, that issue has not stopped escalating.

It's only been escalating very gradually, but it keeps escalating.

And now we start thinking, I think with uh in the north of Israel and Hezbollah and the conflicts there, if this becomes a wider, you know, a wider war and that impacts the stock price, you know, with the Straights war move shutting down or something like that, you got a big problem and uh it's, it's, I just that.

And of course, with the thing with France, everybody is saying, don't worry about it, but we've seen what sovereign debt crisis have done in the past.

So again, with 5% cash, I'm not saying, oh jeez, you should suddenly go to 50% cash or even 20% cash.

But you know, it, it gives you a little bit easier to sleep at night when you have some of these things going on over there and you're actually paid to wait and actually paid, uh, to have a little bit of cash.

So, raising that level a little bit, I think is a good idea.