Opportunities at Cedears for the second half of the year

The beginning of the 2024 He presented us with arguments to keep us aggressive in our portfolio of Cedearsafter a 2023 where The S&P500 closed almost 27% higher than at the beginning of the year. The arguments were confirmed, and the index reached a high last week of over 5,660 points, representing an increase of around 19%. In the meantime, a new season of balances where companies report their results in response to the expectations of investors and analysts. The focus is on meeting expectations by the so-called “Magnificent Seven” (7M).

But before we get into the micro, let’s look at the macro. The environment remains challenging from a macroeconomic perspective, but it also presents opportunities. The challenges that began the year are still in force, but are more geared towards economic policy objectives.

Inflation appears to be under control and approaching The Federal Reserve’s goals The economy was on the downside for the third consecutive month. This was coupled with the slight deterioration in the labour market, which is seeking a healthy balance in light of the objectives of the monetary authority, which also ensures full employment. This deepened the drop in rates due to a better balance of risks between the two mandates of the FED, that of “full employment” and that of “low inflation.” In this “data-dependent” mode in which the monetary authority is, further declines in inflation rates and/or a further deterioration in labor market indicators could push the FED to initiate its rate-cutting cycle, which the market is discounting, perhaps hastily, with increasing probability starting with the September meeting.

The market is testing companies: a new season of financial statements

In the midst of a new season of financial statements, the main indices of the American stock market have registered strong corrections during these weeks. The Russell 2000, which represents smaller-cap companies, rose 9%, while the Nasdaq fell -4.2%, and the S&P 500 “Equal Weight” which gives equal weighting to all stocks in the indexhad an increase greater than the S&P 500 by 4.3%, giving signs of a healthy correction, which shows a rotation towards sectors that were lagging in their valuations.

However, the positive GDP data released today, driven mainly by consumer spending and private investment due to inventory accumulation, seem to reverse these movements. These activity data are consistent with a weakening economy, although they do not show concerns of a recession. Scenario that was already in prices.

This raises questions in the search for new opportunities in the face of the scenario of rate cuts by the FED starting in September, without losing sight of our main objective: generating value with long-term opportunities.

At this initial stage, The second-quarter earnings season for the S&P 500 is off to a mixed start. On the one hand, the percentage of S&P 500 companies reporting positive earnings surprises is above average levels. On the other hand, the magnitude of those surprises is below. At the sector level, A significant increase in earnings for the financial sector is being partially offset by a substantial decrease in earnings for the energy sector. As a result, the index as a whole is reporting higher earnings for the second quarter, which if closing at these levels would represent its highest earnings growth rate since the fourth quarter of 2021.

If the current 9.7% is the quarterly growth rate, with the data from companies reporting as of last Friday, it will mark the highest year-over-year earnings growth rate since the fourth quarter of 2021 and the fourth consecutive quarter of year-over-year earnings growth for the index.

The contribution of the “Magnificent Seven”

Several of the “7M” companies saw their share prices rise during the second quarter, helping to boost the value of the S&P 500. The question amid the earnings season is whether these companies are also expected to boost S&P 500 earnings in the second quarter. The report by FacSet is expected to report: Four of the “7M” are among the top five contributors to S&P 500 year-over-year earnings growth for the second quarter of 2024. Among them: Alphabet.

Analysts predict that these companies together will report year-over-year earnings growth of more than 25% for the remaining two quarters of 2024. However, It is interesting to note that analysts believe the other 496 companies in the index will report double-digit year-over-year earnings growth starting in the fourth quarter of 2024.

Visa and Google exam evaluations

Alphabet (Google) reported strong second-quarter results on July 23, beating expectations on revenue and profit. In summary, it delivered a solid performance across all of its operating segments during the second quarter. While Google Cloud beat expectations, YouTube ads fell short and the market was punished. The company continues to pay dividends and aggressively repurchase shares. Although free cash flow faced pressure due to investments in AI innovation, Alphabet remains an attractive investment option. However, The market reaction was not good, the shares plummeted 5% due to higher spending on AI and lower advertising revenue from YouTube.

The same day he also reported Visawith mixed results. Revenue was below expectations, although earnings per share were in line with consensus. Payments volume was up 7%, cross-border volumes were up 14%, and processed transactions were up 10%. Cash flow from operations and free cash flow were down slightly, while it paid a healthy dividend and repurchased $4.8 billion in stock. All in all, the market caused its share price to fall by almost 4% at the time of the rating. This brought the company’s lowest level since December, mainly due to the volume of payments and processed transactions. However, despite the mixed results of the quarter, Visa continues to show solid growth and maintains a healthy financial position, which reinforces its competitiveness and attractiveness as a long-term investment.

Cedears: the long-term momentum continues

Let’s review two of the most important reasons that, while still present, convinced us to be aggressive in 2024, to analyze how to position ourselves for the rest of the year with a focus on the long term:

1. The Federal Reserve considers initiating rate cuts with inflation slightly above 2%, allowing it to take preemptive action. This benefits stocks whose cash flows are expected to be long-term, especially large-cap technology and large-cap growth stocks.

2. The artificial intelligence [IA] remains a huge potential source of growth. Microsoft has already begun monetizing AI in Copilot, and while Nvidia and AMD will benefit by providing the computing power behind the AI ​​revolution, many more companies will tangibly monetize AI starting in 2024.

So, keeping an eye on the long term, The AI ​​revolution could create a favorable scenario for the economy for the rest of the decade. Despite a higher interest rate environment, if AI investment improves productivity, inflation could be kept under control. This is similar to the period between 1994 and 2000 for the American economy, when productivity increased thanks to the Internet and stocks prospered.

The Artificial Intelligence boom continues to significantly boost large-cap tech companies. Although there is speculation surrounding this new technology, which brings healthy short-term corrections to the markets, AI is improving labor productivity after years of stagnation. In addition, the increase in the valuation of AI companies is supported, as we pointed out, by expectations of improvements in future earnings, differentiating itself from the “dotcom” bubble, thus showing a more solid business foundation.

Cedears Criteria Recommended Portfolio

We are awaiting the final results of the balance sheet season and the possible start of a rate cut cycle by the Fed, which if it occurs would begin in September. This reduction would mainly boost the valuations of stocks whose cash flow is expected to be long-term, such as growth and large-cap technology companies. In the long term, by managing the risks of our investment portfolios, this sector would also benefit from the boost that AI could generate in its valuations. These companies are most likely to be able to monetize the impact of greater productivity on the economy. Therefore, this is how our Cedears portfolio is composed.