Weekly Wisdom – February 15, 2024

By Hightower Great Lakes on February 15, 2024

Better Than Expected

Thus far, 67% of S&P 500 companies have reported earnings, and we’ve seen more earnings per share surprise than average (see chart 1). Currently, 78% of S&P 500 companies are beating earnings estimates, and the long-term historical average is 73%.

The total S&P 500 earnings growth rate is at 5.3% for the fourth quarter. Importantly, 2024 is on track for double-digit growth, one of the key reasons the equity markets have had a strong start in performance year to date.

Surprisingly, the energy sector continues to lead the earnings beat rate at 91% but earnings growth shrunk -27% year over year. The communication services sector has the highest miss rate at 37.5% but grew earnings 44% year over year.

Outside of earnings, the economy continues to chug along with growth running close to 3.5%. Jobs remain strong, and the four-week moving average of initial unemployment insurance claims is at 212,000, down 17% from highs and nowhere near the recessionary levels of 350,000-375,000.

Inflation is making progress, but the January CPI was hotter than expected with a headline figure of 3.1%. Keep in mind that we are down from 9.1% in June of 2022, but 3.1% missed the mark and expectations of 2.9%.

The figure was disappointing but shows progress, and with the stronger GDP, it’s not too surprising to see inflation remain stickier. If given the choice, we’d choose faster growth and a little hotter inflation.

One interesting observation: U.S. companies are using their strong free cash flow to return that cash to shareholders. S&P 500 companies have already returned over $58 billion to shareholders through share buybacks year to date.[1]

Interestingly, the first week of February showed that U.S. companies declared $105 billion of share repurchases, which already surpassed the January total, making this February the strongest month for buybacks of all time.

For the rest of the year, analysts project S&P 500 constituents to buy back $855 billion worth of stock, which would be a 10% increase from the year prior.[2] Dividends, another form of shareholder returns, are also growing. 68 U.S. companies increased dividends during the week ending February 9.[3]

Chart 1: EPS Surprise Historically Strong[4]

More M&A, More Energy

Another week, another big deal within the energy sector. U.S. oil producer Diamondback Energy (FANG) announced the acquisition of Endeavor Energy Partners in a $26 billion cash and stock deal. With this acquisition, Diamondback will be the number three Permian producer, behind the juggernauts of Exxon Mobil (XOM) and Chevron (CVX).

This is a huge strategic announcement for the company. Endeavor Energy is a private energy company that has an operation stretching over 350,000 acres in the Midland section of the Permian Basin. Located in Texas and New Mexico, the Permian Basin is the most productive field in the U.S. by far and is expected to be the key source of growth for domestic oil in the coming decade.

Not only does this deal immediately put Diamondback Energy in the top three producers, but it will also accumulate $550 million of annual synergies for the two companies. It is expecting 10% FCF per share accretion in 2025.

This merger adds Diamondback Energy to a long line of companies that are not afraid to pay to expand their businesses. More important is the fact that in the past year, energy companies have made over $468.8 billion in deals, showing the importance of cheap valuations seen in the industry. The sector remains out of favor, but we see long-term value and confidence in the industry deal activity as confirmation.

Chart 2: Oil Producer Rankings[5]

Pent-Up Demand

Although it seems generative AI has been around for years, the $40 billion industry in 2022 will expand to $1.3 trillion by 2030 with a CAGR of 42%.[6] Driven by training infrastructure in the near term, it will gradually switch to inference devices for large language models (LLMs) in the longer term.

This will benefit companies like Google (GOOGL), Microsoft (MSFT) and Amazon (AMZN), as all three have been developing their LLM models for years. Amazon’s LLM Bedrock platform makes it easier for smaller companies to build generative AI products, giving them the same scale that Amazon uses.

Chart 3: Generative AI Revenue[7]

Generative AI can dramatically increase the productivity of everyone in the world; PWC views the AI transformation as possibly contributing $15 trillion to the global economy by 2030, more than the current output of China and India combined.[8]

Production will increase, and consumption will become more personalized, enhancing products and stimulating more consumer demand. This comes at a price as it will have to command a larger budget from companies. Spending on AI can help productivity across businesses, in turn, growing margins and earnings.

An interesting quote from CDW corporation (CDW): “What we are seeing and hearing is that budgets are coming from elsewhere in the organization, the functional areas that are going to be improved through AI are innovation in HR, finance and marketing.” We find it telling that CDW is hearing this, as it specializes in providing information technology to small, medium and large businesses.

NYCB Turmoil Update

New York Community Bank (NYCB) resurfaced banking sector fears due to a downbeat earnings report on January 31. The bank caught investors by surprise, cutting its dividend by 70% in order to strengthen its balance sheet.

The added assets that NYCB took on from acquiring Flagstar Bank back in 2022 as well as its purchases of Signature Bank assets subjected the bank to tougher regulatory requirements. The dollar amount for these stricter Category IV regulatory requirements is $100 billion in assets, and NYCB sat at $116.3 billion as of December.[9]

Along with the dividend cut, the company’s loan losses rose 345% from the year prior, and its loss per share missed consensus estimates by nearly 200%. These shortcomings resulted in the stock falling as much as -46%, also pulling its peers down in sympathy.[10] NYCB’s credit rating suffered as well with Moody’s downgrading it to Ba2.[11]

After the downgrade, NYCB was able to gain back some ground in its stock price after promoting Alessandro DiNello to executive chairman to aid with the repair of the company’s operations.[12]

Aside from the increased regulatory requirements, the main issue with NYCB stems from its outsized position in commercial and multi-family real estate. These real estate positions were two times as large as the bank’s most similar peer bank.[13]

These assets have struggled during the past year due to the work-from-home phenomenon that has left many office buildings nearly vacant, and this has been reflected in the properties’ valuations. Increased interest rates have also played a role here.

It is now more expensive compared to the past decade for families to obtain a mortgage. Additionally, families with low mortgages have little incentive to move and trade their low-rate mortgage for a most likely higher one.

While this is worth watching, it is important to note that the “big 6” banks are well-capitalized and have been since 2008. Smaller, regional banks account for nearly 70% of all commercial real estate loans outstanding.

Banks with between $1-10 billion in assets are the most exposed to these commercial real estate loans, followed by banks that have $100 million to $1 billion in assets. As for asset mix, commercial real estate loans only make up about 6% of large money center banks’ assets, whereas the figure is at 30% for small regionals.[14]

Click here to read last week’s Weekly Wisdom (2/8).

Disclosures

Investment Solutions is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors.

All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Investment Solutions and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Investment Solutions and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice.

This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

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[1] Source: Bloomberg. As of February 13, 2024.

[2] Source: Bloomberg. As of February 8, 2024.

[3] Source: Dividend Growth Investor. As of February 12, 2024.

[4] Source: Piper Sandler & Co. As Of February 8, 2024.

[5] Source: Bloomberg. As of February 12, 2024.

[6] Source: Bloomberg. As of June 1, 2023.

[7] Source: Bloomberg. As of June 1, 2023.

[8] Source: PWC. As of August 2017.

[9] Source: Euro Money. As of February 2, 2024.

[10] Source: Reuters. As of January 31, 2024.

[11] Source: Bloomberg. As of February 6, 2024.

[12] Source: CNBC. As of February 7, 2024.

[13] Source: Axios. As of February 8, 2024.

[14] Source: Apollo Global Management. As of February 9, 2024.