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Monthly Market Commentary

| February 01, 2024

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Normalization is the key theme for 2024.  For much of the past four years we have had a highly uncertain environment.  2024 is the year we get back to a more normal environment.  Growth looks to be settling into a steady 2.0-2.5% range, after a volatile few years.  The important hard data releases during the month, non-farm payrolls, initial jobless claims, personal income and spending, and retail sales all came in better than expected.  The consumer remains in good shape.  With a strong job market and falling inflation, real disposable income will continue to grow across all income segments.  It will be difficult to have a recession when the labor market is strong and real incomes are rising.  Inflation remains the key for monetary policy.  This is a unique cycle, in traditional business cycles the Fed cuts because growth is weakening and they need to stimulate the economy.  In this cycle, the Fed will cut for a good reason, inflation is falling and they need to get real rates to a neutral stance.  The Fed’s preferred measure, core PCE, is at the Fed’s target over the past six months.  As inflation is coming down, real rates will start to get onerous.  While the Fed is unlikely to cut as much as the market is pricing, it is likely to cut to prevent real rates from becoming onerous.  The Fed simply shifting from a hiking bias to an easing bias will go a long way to improve sentiment.  The yield-curve (10s/2s) is within basis points of inflecting positive.  A positively sloped yield curve signals a positive economic outlook and a more normal economy. 


79% of companies have beat this earnings season by an average of 6%.  AI as a mega-investing theme has been evident this earnings cycle.  This was most evident in earnings from Taiwan Semiconductor (TSMC), which helped drive technology stocks across mega-cap, semis, and software.   TSMC raised its revenue growth forecast to 20-25%, driven by sales related to AI.  TSMC is arguably the most important company in the world, essentially driving the entire tech supply chain.  When it guides up as much as it did, it can drive the entire sector.  Super Micro Computer’s (SMCI) shares were up nearly 35% after it reported numbers.  SMCI guided up its revenue and profit expectations, driven by "strong market and end customer demand for its artificial intelligence servers.”  ASML (makes advanced semiconductor equipment) reported revenue growth of 30%, saying orders more than tripled.  Meta announced during the month that they plan to buy 350 thousand GPU chips from Nvidia and almost 600 thousand equivalent chips for its AI ambitions.  Many view semiconductors as the new transports, an industry that is often a leading economic indicator.  Both Microsoft and Google reported growth north of 25% in their cloud business.  On the enterprise software side, ServiceNow reported growth of 26%, driven by AI.   AI even helped IBM report strong growth.  These types of orders and corporate commentary indicate that we are in a new capex cycle for technology driven by AI that will lead to earnings growth for the coming quarters.  Earnings revisions for tech for are up 7%, compared to down 7% for the S&P.  Dips in tech are likely to get bought with nearly $9 trillion of cash on the sidelines and under-positioning from hedge funds.              

One of the major benefits of GAI is productivity that drives margin expansion.  Goldman estimates GAI will lift productivity by 1.5% driving margins by 4%.  Healthcare stands to be a major beneficiary of margin expansion.  McKinsey estimates that just elimination of waste and fraud within healthcare could save the industry 5-10% annually.  Harvard estimates that GAI could save the industry $360bn annually.  Drug discovery is often trial and error.  Citi estimates that 92% of candidate drugs fail.  AI will help increase the hit rate.  More near-term, healthcare is expected to have the highest earnings growth in the S&P at 18.1%.  Pharma’s price-to-forward-earnings ratio of 16.7 is about a 15% discount to the S&P.  The industry looks to recover from a multi-year COVID hangover.  We are starting to see the recovery as many insurers reported high medical loss ratios indicating an increased demand for healthcare.  There is a ton of disruption in the industry from policy changes, regulation, patent cliffs, to innovation in weight loss, cancer, and Alzheimer’s that has led to M&A.  Healthcare M&A was up over 20% last year, while overall deal volume was down.  Just in recent weeks we have seen significant deals from AbbVie, Bristol-Myers, and Sanofi.  The industry is a blend of growth, value, and defense.  Finally, positioning, which is only in the 20th percentile, has plenty of room to grow.  The combination of low positioning, high earnings growth, cheap valuation, and disruption could make healthcare an attractive place to be.   

Looking forward, the market will continue to focus on the Fed, earnings, geopolitics, and the election.