Is The Dow Trying To Tell Us Something?

Is the Dow’s relative underperformance versus the S&P in 2023 trying to tell us something about the viability of the rebound in US equities or, more importantly, about the economy?

Who knows. Who knows anything anymore?

One thing we do know is that the Dow is generally a cyclical index. The fact that it’s lagging the “broader” S&P during 2023’s rally might be meaningful for the macro narrative, which in turn could boomerang back to equities that’ve re-rated to a perilous 18x this year.

Do note the scare quotes around “broader.” “Broad” is still a misnomer for the S&P. Even after last year’s disastrous performance from mega-tech, Alphabet, Amazon, Apple and Microsoft still comprise 17% of the index. By comparison, Microsoft, Cisco, GE and Intel were 16% of the market at the peak in 2000.

In any case, the Dow has underperformed by more than 4pp so far this year, in stark contrast to the outperformance witnessed during the early stages of the rebound in Q4.

Of course, it’s hard to draw anything like definitive conclusions given that it’s earnings season, but outsized rallies in tech names to start 2023 have certainly helped the S&P, even as many question the sustainability of a situation that looks quite a bit like a panic chase into last year’s laggards.

“Given that the Dow was the leadership index off the October lows and representative of the China re-opening narrative to many, this more recent underperformance suggests to us that market internals are now less supportive of a cyclical rebound,” Morgan Stanley’s Mike Wilson said Monday.

He also flagged a potentially worrisome development on the earnings front, where forward EPS growth has turned negative+.

Wilson did concede that recent price action means “stocks will require more evidence that the trough is still meaningfully lower,” a process he said “may take a bit more time.” Although some evidence from earnings season is foreboding, you’d be forgiven for suggesting this is shaping up to be yet another “delayed reckoning” quarter. We’ve been kicking the can on the profit come-to-Jesus moment for three quarters running.

But the signs are there. The writing is on the wall. The YoY rate of cost growth is now completely detached from revenue growth, for example. The chart above screams margin compression. If the bottom line is shrinking but the top line is still growing (as is the case currently), that’s a bad omen.

At the end of the day, it’s difficult to countenance any version of an all-clear narrative. There’s just too much still in play, including the Fed, which investors continue to fight — historically, that’s a losing proposition.

“We find it hard to suggest last week’s meeting was overly dovish,” Wilson said, of the February FOMC statement and Jerome Powell’s press conference. “In our view, the Chair was fairly convincing that the Fed will likely hike at least one more time and that cuts will not be forthcoming anytime soon,” Wilson added.

Relatedly, he reminded market participants that during past episodes when forward earnings growth turned negative, the Fed was easing, not still hiking. “This is a big deal for equities and reinforces the point that policy is still getting more restrictive directly into an earnings recession,” he cautioned.


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