This is a peak earnings reporting week, and it will include results from a number of FAANG components. Many third quarter results have been excellent including Google’s parent Alphabet Inc. A (GOOGL – $169.68) which beat on the top and bottom line. These results were helped by a 35% increase in its cloud business and a rise in digital advertising revenue. But note, digital advertising results were boosted by both the 2024 Paris Olympics in August and political spending ahead of the presidential election. These are one-time events. Visa Inc. (V – $281.88) reported a fourth-quarter profit that beat expectations, and it showed that consumer spending continues to be resilient. Payments volume rose 8% in the quarter. Visa also noted that it plans to lay off about 1400 employees and contractors by the end of the year and expects profit growth per share to be “at the high end of low double digits” for 2025.

But as much as we believe corporate earnings and earnings growth are the most important events of the current week, it is clear that investors are fully focused on the presidential election. And according to the pundits, markets are in the process of discounting a Trump re-election even though the polls suggest it is too close to call. In particular, the benchmark 10-year US Treasury yield has jumped from 3.6% in mid-September to a four-month high of nearly 4.3% recently. Bond gurus are indicating that investors are wary to buy debt before next week’s elections due to fears that a Trump win would increase the deficit and inflation. Nonetheless, yields did ease after a strong seven-year note auction this week.

Stocks and Elections

Historically, the stock market has had a decent record of predicting the results of presidential elections. The presidential election year has traditionally been the second-best performing year of the four-year cycle with gains averaging 6% in the Dow Jones Industrial Average. Normally, the first half of the year is lackluster, the third quarter is the weakest, and the last two months of the year tend to produce solid gains. The month of October is the most telling because weakness just ahead of the election suggests an incumbent loss whereas strength in October is indicative of an incumbent win. See page 5.

However, 2024 has not been a typical year and the DJIA has already generated a 12% gain year-to-date. And while to date the DJIA is down slightly in October, this index is widely underperforming the S&P 500 which is up 1.2% in the same time frame. The Nasdaq Composite is now up 2.9% in October and even the Russell 2000 index has eked out a 1.4% gain. In short, the market is sending a mixed message to investors.

What we found interesting was a Bloomberg poll that indicated that nearly 40% of investors polled felt a Trump victory would be good for stock prices and that the gains of 2% per month seen in 2024 to date, would accelerate should he win the White House. See page 5. This is the opposite of comments from most economists who indicate that both deficits and inflation would be worse under Trump and stock prices could fall. But as we noted last week, the most important elections on November 5^th will be the Congressional races. A president can be a major force in foreign relations and on the border, but Congress controls the purse strings, which includes spending and taxation.

Economic data is mixed

Final numbers for October’s University of Michigan consumer sentiment survey were revised upward and this added slightly to September’s gains. Still, the University of Michigan sentiment readings for headline, present, and expected, remain low and at recessionary levels. The Conference Board’s consumer confidence index increased more than expected in October, from the upwardly revised 99.2 (previously 98.7) in September to 108.7, the strongest monthly gain since March 2021. Nevertheless, October’s headline sentiment reading remains stuck in the narrow range it has held for the last three years. The good news in the Conference Board report is that the expectations index remained above 80, because readings below this level tend to correspond with recessions. See page 3.

Existing home sales dipped lower in September to 3.84 million units, down from the 3.88 million units reported in August. This was down 3.5% YOY. The months of supply of homes rose from 4.2 to 4.3. The median price of a single-family home was $404,500, down for the month but still up 3% YOY. New home sales were 738,000 in September, up slightly from August, and up 6.3% YOY. The months of supply fell from 7.9 to 7.6. The price of a single-family new home jumped from $405,600 in August to $426,600 in September, but this was relatively unchanged on a year-over-year basis. See page 4.

Dichotomies and Disparities

Politics has been impacting a number of commodities recently. Crude oil prices fell sharply on news that Israel would not bomb Iranian oil facilities, and that Saudi Arabia was committed to crude capacity of 12.3 million barrels per day. Prices are also weaker due to expectations of slower global growth. This decline should be favorable for future inflation reports. However, gold futures and derivatives continue to set new record highs. Gold has not been a good indicator of inflation in recent years, and we attribute the recent surge in gold to tensions in the Middle East and Europe which is driving countries and investors toward gold as a safe haven investment. Turkey (in the Middle East) and Poland (which borders Ukraine) have been large buyers of gold recently. As noted, the 10-year Treasury yield continues to climb. In normal times this would be the result or anticipation of stronger economic growth and/or inflation. However, the current rise in rates is most likely a fear of rising deficits. It is an interesting dichotomy of trends. See page 8.  

There is also a disparity in the performance of the popular indices. The year-to-date gains of 22.3% in the S&P 500 index, 12.1% in the Dow Jones Industrial Average, 24.7% in the Nasdaq Composite Index, and 10.4% in the Russell 2000 index are similar to the performances seen in the month of October. But a lot of this can be explained by a recent post from FactSet that indicated that as of October 21^st, the Magnificent 7 companies were reporting third quarter earnings growth of 18.1% YOY, whereas the remaining 493 companies in the S&P 500 were reporting earnings growth of 0.1% YOY. Much like the US economy, corporate America is a story of the haves and the have-nots.

Technical Indicators

The 25-day up/down volume oscillator is 0.22 and neutral after spending five consecutive days in overbought territory earlier in the month. This oscillator was also in overbought territory for seven of eight days ending September 19, the last six of these sessions were consecutive. In short, recent readings have been good enough to confirm the new highs in the averages. Nevertheless, this indicator suggests the rally is a continuation, not the beginning, of a bull cycle. See page 10. The 10-day average of daily new highs fell to 258 this week and new lows are slightly higher at 49. This combination of new highs above 100 and new lows below 100 remains positive but the trends in both are deteriorating. The NYSE advance/decline line made a new record high on October 18, 2024. Overall, breadth indicators are positive, but volume has been declining and there are signs of deceleration in recent days.

Gail Dudack

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As the presidential election nears, we would normally review the economic platforms of both presidential candidates and try to determine how election results might impact the economy and the stock market. However, this year both platforms seem more conceptual than concrete and both candidates have indicated they would cut taxes and spend federal money at a time when the budget deficit is at an all-time high. This is worrisome.

Platforms

In brief, Harris is targeting small businesses by proposing an increase in small business tax deductions and stimulating small business formation. She is also stating she wants to provide tax credits to middle- and lower-income families to make housing, groceries, child rearing and prescription drugs more affordable to all. To offset this, Harris plans to raise the corporate tax rate to 28%, raise the capital gains tax rate, and would likely let the 2017 Tax Cuts and Jobs Act expire.

Trump has implied he would eliminate taxes on tips, social security, and overtime pay, and keep the 2017 Tax Cuts and Jobs Act permanent. His campaign has focused on stimulating the economy as a way to raise revenue and a big part of this is to make the US an energy independent country by removing the current Biden/Harris restrictions and red tape on energy production. But most economists have focused on Trump’s talk of imposing tariffs on imports to the US, which nearly all economists indicate would be detrimental and inflationary.

To all this we can only state that any US President can suggest tax policy but only Congress can pass and enforce it. Therefore, the odds that any of these ideas will come to fruition are nil which makes most of this meaningless political rhetoric. But in terms of Trump’s tariff talk, it is a fact that Presidents can impose tariffs, and Trump did impose punitive tariffs early in his first administration. Nevertheless, inflation at the end of Trump’s term was 1.9% YOY, which economists appear to have overlooked. Most have analyzed Trump’s tariff rhetoric in terms of a static economy, while we live in a dynamic economy. Moreover, we think Mike Gallagher (former House Representative from Wisconsin from 2018 to 2024 and currently head of defense for Palantir Technologies Inc. [PLTR – $42.94]) said it best in an interview on CNBC’s Squawk Box this week, that Trump used the threat of tariffs as a negotiating tactic in his first administration and only imposed tariffs selectively to change behavior and improve the trade balance of the US. This reminds us of President Teddy Roosevelt’s foreign policy of “speak softly and carry a big stick.” In terms of increasing energy production, this can be done by a President by removing current restrictions on energy producers and it does not require Congressional approval.

All in all, this does not make analyzing the economic impact of the election any easier. In our view, whoever wins the election may not have the luxury of passing any bill in the current emotionally charged environment. From this perspective, the results of the Congressional elections could prove to be more important to the overall economy than who sits in the White House.

Deficits and Bond Yields

Whoever does win the presidential election may find their ability to tax and spend curtailed by an unforgiving bond market. There is a sense of this in the financial markets this week as the 10-year Treasury bond yield advanced from the 3.6% seen in mid-September to 4.2% currently. Bond yields jumped from 4% to 4.2% after the US Treasury announced that as of October 18, 2024, the US national deficit for fiscal year ending September 2024 was $1.83 trillion, the third highest on record. The 2024 deficit was $138 billion higher than the previous year’s deficit and represented 6.4% of the GDP. Total federal debt is now approaching $36 trillion and debt held by the public is close to $28 trillion, as compared to US GDP of $27.8 trillion. See page 5. White House estimates show deficits coming down in future years, but this seems unlikely given the current political environment. There is little doubt that the debt burden and high interest rates will be a problem going forward; and for this reason, the rise in long-term interest rates is disturbing. It is worth noting that the 10-year Treasury bond yield at 4.2%, is now trading above all its moving averages and broke above a downtrend line at 4.1%. In short, the technical pattern for yields is positive. See page 8.

The Consumer and Retail Sales

Retail sales beat expectations in September and grew 1.7% YOY from an upwardly revised 2.2% rise in August. Excluding autos and gas, retail sales grew 3.7%, which beat inflation. However, if we take a long-term view of retail sales it shows that on a seasonally adjusted basis, total retail and food services sales have only increased a total of 13% since the end of 2021. Moreover, using the Federal Reserve Bank of St. Louis series of retail sales based on 1982 dollars (adjusted for inflation), total retail sales have grown a mere 0.8% since the end of 2021. See page 3. Not surprisingly, real retail sales have been negative for 20 of the 33 months during the same period.

Negative real retail sales are one of many indicators that have been signaling a recession over the last two years, but retail sales growth has not been uniform among sectors. The big gainers since the end of 2021 have been food services and drinking places up a total of nearly 30%, nonstore retailers up 28%, health and personal care up 16.3%, miscellaneous merchandise stores up 12.4%, and general merchandise stores up 11.8%. Sales for motor vehicles and parts dealers have grown a total of 10% from the end of 2021, even though the longer-term sales trend has been decelerating since the end of 2019. Since the end of 2021 total retail sales have declined for gas stations, sporting goods/hobby/book and music stores, furniture and home furnishing stores, and building materials and garden equipment and supply stores. See page 4.

Technicals versus Valuation

The S&P Composite and Dow Jones Industrial Average have been setting a string of record highs in October and despite several days of weakness, all three major indices remain less than 1% away from their all-time highs. Even the Russell 2000 index has now gained 10% year-to-date and is less than 9% from its all-time high. By all technical measures, including our 25-day up/down volume oscillator, the equity market is demonstrating positive momentum as it approaches what is typically the best three performing months of the year (November, December, and January). See pages 9-12.

Unfortunately, valuation does not support equities at this juncture, but if this market is a melt-up or bubble, valuation will not matter in the short run. The SPX trailing 4-quarter operating multiple is 24.9 times and well above all long- and short-term averages. The 12-month forward PE multiple is 21.4 times and when added to inflation of 2.4%, sums to 23.8, which is at the top of the normal range of 14.8 to 23.8. By all measures, the equity market remains richly valued. And while LSEG IBES reports that 83% of companies are beating consensus estimates in this earnings season, it is worth noting that this week the LSEG IBES estimate for 2024 is $241.42, down $0.69, the estimate for 2025 is $275.62, down $0.48, and the guesstimate for 2026 EPS is $311.58, down $0.58. In short, equity prices have been rising, but in recent weeks earnings estimates have been falling for 2024, 2025, and 2026. This combination is unsustainable in the long run.

Gail Dudack

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The current advance in US equity prices may have as much to do with what is happening outside of the US as it does with what is happening domestically. And we are not talking about the escalating conflict in the Middle East and Ukraine, but rather the easing bias of central banks around the world.

Cutting Rates Around the World

The Bank of Canada lowered interest rates 25 basis points at each of its last three policy meetings and is expected to cut rates another 50 basis points at next week’s meeting. Plus, Canada’s last inflation report showed prices rising a mere 1.6% YOY which gives the Bank the ability to continue to lower rates. China is planning to raise an additional $850 billion from special treasury bonds over the next three years in order to stimulate its weakening economy. This amount is up from the $250 billion reported by news sources a month ago and is in addition to the massive stimulus facilities announced a week ago which included lowering interest rates.

The European Central Bank has already cut rates twice this year, is expected to cut again this week, and analysts expect the benchmark rate to fall from its previous 4% level to 2% by early next year. The ECB’s stimulus is beginning to have an impact on the eurozone as seen by the improvements in both industrial production and credit demand in recent releases. The Bank of England cut interest rates in August, paused in September, but is expected to cut interest rates another 25 basis points in early November. Since August, New Zealand cut its official rate by 75 basis points and its annual inflation rate fell to 2.2% in the third quarter, down from 3.3% in the second quarter. The Reserve Bank of Australia has not yet pulled the lever on rate cuts but there is no doubt the economy is slowing, and the timing of a rate cut will depend on the data released over the next few weeks. On the other end of the spectrum, the Bank of Japan, which initiated a negative rate policy in 1999, raised interest rates by 25 basis points in March. However, the BOJ indicated it had no intention of raising interest rates again this year, which is likely due to the upward pressure this would put on the Japanese yen. All in all, the world’s major banks are implementing monetary stimulus, and this has been historically good for global equities.

Earnings Reports Could Still Be Pivotal

As third quarter earnings season begins, analysts will be focused on corporate guidance. Equity prices have been rising, but as of now, earnings estimates have been falling for 2024, 2025, and 2026. See page 8. Valuation does not support equities at this juncture, but this may not matter if this market is a melt-up or a bubble, at least in the short run. The SPX trailing 4-quarter operating multiple is 25.3 times, and well above all long- and short-term averages. The 12-month forwardPE multiple is 21.7 times and when added to inflation of 2.4%, sums to 24.1, which is above the standard deviation range of 14.8 to 23.8. See page 7. By all measures, the equity market remains richly valued and remains at levels seen only during the 1997-2000 bubble, the financial crisis of 2008, or the post-COVID-19 earnings slump. But we should point out that while the current trailing PE of 25.7 is extreme, previous bubbles have reached PE multiples of 29 to 31 times.

Banks typically kick off earnings reporting season and this week most have exceeded expectations citing gains in trading and strong investment banking revenues. Bankers are optimistic that monetary easing around the world will continue to support a pipeline of deals. Dealogic data indicated that worldwide mergers and acquisitions totaled $909 billion as of September 30, 2024. up 22% YOY. However, smaller and regional banks may have more difficult comparisons since they have fewer ways to offset the expected declines in net interest income.

What may be pivotal to several markets was the report from ASML Holding N.V (ASML – $730.43), Europe’s biggest tech firm and the leading supplier of equipment for manufacturing chips. The company lowered 2025 guidance for sales and bookings, citing sustained weakness in parts of the semiconductor market. The company said that despite a boom in AI-related chips, other parts of the semiconductor market have been weaker than expected, companies that make logic chips are delaying orders and customers that make memory chips plan to limit new capacity additions. The stock suffered its worst one-day fall in 26 years and took most of the semiconductor sector with it. Chip stocks were also hurt by a report indicating the Biden administration is considering capping AI-chip exports by US companies.

UnitedHealth Group (UNH – $556.29) beat consensus earnings estimates for the quarter but lowered guidance for 2025 to around $30 a share which fell below analysts’ estimates of $31.18 per share, according to LSEG data. CEO Andrew Witty said the lower 2025 forecast is due in part to payment cuts from the government for Medicare plans and low state payment rates for Medicaid plans for low-income people. Stock prices for UNH and other health insurers fell on the news.

Oil stock also fell this week after OPEC cut its estimate for global energy demand and as the fear that Israel would target Iranian oil facilities faded. Nevertheless, while the broad equity indices traded lower on the sum of this negative news, the pullback was barely visible in the technical charts. See page 10.

Technicals

The breadth of the market has strengthened in recent weeks with the NYSE advance/decline line setting a string of all-time highs in line with the indices. See page 12. The 25-day up/down volume oscillator is at 2.89 and neutral after spending two consecutive days in overbought territory earlier in the week. This oscillator was in overbought territory for seven of eight days ending September 19, the last six of these sessions were consecutive. With many of the indices at or near all-time highs, it is important for this indicator to confirm the advance with an overbought reading of at least 5 consecutive days. See page 11. But by most measures the equity market is demonstrating positive momentum as it approaches what are typically the best three performing months of the year, i.e., November, December, and January.

Inflation, better but not Gone

Headline CPI for September ratcheted down from 2.5% YOY to 2.4%; however, the decline in headline CPI was due in large part to the 15% YOY declines in gasoline and energy prices. Core CPI edged higher from 3.2% to 3.3%. Service sector inflation edged lower from 4.8% to 4.7% YOY and owners’ equivalent rent edged down from 5.4% to 5.2% YOY. However, the problems in September were found in medical care, which increased from 3.2% YOY to 3.4%, health insurance which jumped from 3.3% to 7.5% YOY and motor vehicle maintenance & repair which jumped from 4.1% YOY to 4.9% YOY. Auto insurance increased 16.3% YOY in September versus 16.5% in August. See page 3 and 4.

Oddly, consumer sentiment declined in October despite the drop in gasoline prices. The University of Michigan consumer sentiment index, while little changed from levels seen in May, remains well below levels seen earlier in the year. See page 6. The economic backdrop is mixed but may become clearer once we see September’s retail sales report later this week. Valuation has been and remains a problem, but with the technical condition of the stock market improving and liquidity from central banks providing support, the outlook for equities is favorable.

Gail Dudack

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This week marks the beginning of third quarter earnings season, and it will include four S&P financial companies reporting earnings this Friday. According to LSEG IBES, analysts are forecasting S&P Composite earnings per share to grow 5% YOY this quarter, led by the double-digit gains projected for the technology, communications services, and healthcare sectors. Conversely, energy sector earnings are expected to decline 3.4% and be a drag on S&P Composite earnings and only low single-digit earnings growth is anticipated for the other six sectors. Still, it may not be the results of this quarter that will capture investors’ attention. The guidance for future earnings growth is what may move markets. Keep in mind that while S&P’s third quarter earnings are forecast to grow only 5% YOY, fourth quarter earnings are estimated to increase a healthy 12.5% YOY. With the popular equity indices recently hitting record highs, double-digit earnings growth might be a necessity to keep the current advance in place. Positive earnings guidance will be particularly important since both Dow Jones S&P and LSEG IBES have been cutting earnings estimates for 2024, 2025, and 2026 for the last four consecutive weeks. See page 11. In our view, rising prices and falling earnings are inconsistent, particularly when the market’s trailing 12-month PE is 24.7 times earnings, and the 12-month forward PE is rich at 21.3 times. See page 10.

With this in mind, PepsiCo Inc. (PEP – $170.42) announced third quarter adjusted earnings of $2.31 that were above analysts’ expectations of $2.29. However, revenue growth disappointed in the quarter and the company cut its forecast for annual sales growth stating that price-conscious consumers were opting for cheaper private-label brands and hurting revenue. As a result, PepsiCo now expects annual organic revenue growth to be below its previous forecast of 4%. When banks come into focus later this week, analysts will be concentrating on changes in net interest income. Net interest income, or the difference between what banks earn on loans and what they pay out on deposits, provided a windfall for the sector as the Federal Reserve was raising rates; but September marked a big change after the Fed’s first rate cut since March 2020. Corporate guidance on net interest income, consumer loan delinquencies, office loan reserves, trading, and investment banking activity will be important for the financial sector this quarter and in the quarters ahead.

The source of the market’s recent exuberance was September’s employment report that was much stronger than expected. The 254,000 increase in payrolls and the unemployment rate falling for the second month in a row to 4.1%, pointed to a robust economy. Even the U6 unemployment rate fell from 7.9% to 7.7% in the month.

But the details of the report were not quite as hearty, in our view. The establishment survey indicated jobs grew 1.56% YOY, slightly below the long-term average of 1.69% YOY. Meanwhile, the household survey revealed a weaker employment picture, which in our view, justifies the expected revision to the establishment survey early next year. The household survey has been showing that year-over-year job growth has been less than 1% in each month of 2024. August’s household survey showed employment declined on a year-over-year basis; however, in September, the survey reported job growth improved slightly to 0.2% YOY. This poor job growth is significant because negative job growth is a classic signal of a recession. See page 3.

There has been a focus on foreign-born versus native-born employment this year because of a growing disparity between the two categories since the end of 2019. In the last 12 months foreign-born employment grew by 1.2 million to 31.4 million people; while in the same period, native-born employment fell by 825,000 to 130.6 million. Keep in mind that this data comes from the household survey which is much broader than the establishment survey which only includes workers on a payroll as reported to the state. The total number of unemployed foreign-born residents was 1.4 million in September and the foreign-born unemployment rate was 4.2%. There were 5.2 million native-born workers unemployed in September and the native-born unemployment rate was lower at 3.8%. See page 4.

The ISM nonmanufacturing index rose from 51.5 to 54.9 in September and all components moved higher. The only indices still below the 50 level were employment and order backlog. The best improvement was new orders which rose from 53.0 to 59.4, the highest reading since February 2023. The ISM manufacturing index was unchanged at 47.2, with five components rising and five declining. The biggest improvement was seen in business activity/production, which increased from 44.8 to 49.8, the best reading since May 2024. See page 5.

Employment in the manufacturing index fell from 46.0 to 43.9 and in the nonmanufacturing survey it fell from 50.2 to 48.1. These declines are in sharp contrast to September’s payroll report which was stronger than expected and makes us concerned that September’s payrolls may be revised lower. The ISM backlog of orders was the only other index in the nonmanufacturing survey that remained below 50, even though it increased from 43.7 to 48.3. In the manufacturing survey the backlog of orders was also weak, inching up from 43.6 to 44.1. Overall, the ISM reports suggested a stable economy with good growth in the service sector, stability in the manufacturing sector, but questionable growth in terms of employment. See page 6.

Consumer credit outstanding grew by $8.9 billion in August, underperforming consensus expectations and decelerating sharply from July’s upwardly revised gain of $26.7 billion. Both revolving and nonrevolving credit grew 0.6% in August versus July, and on a seasonally adjusted basis, revolving credit grew 5.4% (down from 10.7% a year earlier) and nonrevolving credit grew 1.2% (down from 1.9% a year earlier). After inflation, revolving credit grew 2.8% YOY and nonrevolving decreased 1.2% YOY. Nonrevolving credit contracted slightly in June, but falling interest rates had a positive impact on mortgage growth in July and August. The importance of consumer credit is similar to that of job growth. Deceleration precedes contraction and contraction is a sign of a recession. See page 7.

The NFIB small business optimism index was 91.5 in September, in line with the 88.5 to 91.9 range it has maintained since June 2022. This made July’s increase to 93.7 a positive “outlier.” September was the 33rd consecutive month of the optimism index falling below the 50-year average of 98. Plans for capex, employment, expansion, and inventories were somewhat lower, but little changed in the month. See page 8. Actual sales changes for small business owners fell from negative 16 to negative 17 in September and actual earnings rose from negative 37 to negative 34. Nevertheless, both remain historically weak. Sales expectations rose from negative 18 to negative 9 in September. With this backdrop it is not surprising that the NFIB uncertainty index rose from 92 to 103 in September, its highest level since data began in 2017. NFIB stated “Uncertainty makes owners hesitant to invest in capital spending and inventory, especially as inflation and financing costs continue to put pressure on their bottom lines.” See page 9.

There were no significant changes in our technical indicators this week. See page 12 to 16. In our view, stock prices should always be supported by solid earnings growth, and this makes third quarter earnings season critically important. However, earnings do not matter in a bubble market and with liquidity flowing due to monetary easing taking place in Europe, China, and the US, the path of least resistance for equities may still be up.

Gail Dudack

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Stock markets are always uneasy about unpredictable or unforeseen events, and this week two appeared, the dockworkers strike in the East and Gulf coasts of the US and Israel’s ground raids of Hezbollah strongholds in Lebanon followed by Iran’s missile attack on Israel. These two issues could prove to be temporary disruptions, but if not, they could just as easily change the economic and political balance of the financial markets.

The International Longshoremen’s Association union (ILA), representing 45,000 port workers, initiated a strike on October 1, 2024, which was its first large-scale stoppage in 50 years. It is estimated that the strike, which impacts half of the country’s ocean shipping, could cost the economy an estimated $5 billion a day. The US Maritime Alliance (USMX) said it offered union workers wage increases of nearly 50%, up from a prior proposal. However, according to CNBC, the union is pushing for a 61.5% pay increase to compensate for recent rampant inflation. What is worrisome is that this strike could create substantial shortages ahead of the holiday season and reignite inflation. The negative impact due to perishable produce could also be significant to farmers, wholesalers, and consumers. Given the potential this has on future inflation, it is not surprising that Federal Reserve Chair Jerome Powell indicated in comments to the National Association for Business Economics that he is not in a rush to lower rates further.

Oil prices, which had been trending lower, jumped 3% following reports that Iran, which backs the Hezbollah group, launched a retaliatory missile launch against Israel. To date, Israel was not aware of any casualties. Iran is the third largest producer of oil in the OPEC+ group and accounts for about 3% of world production. However, this is modest when compared to the US which ranks first with 22% of the world’s production and Saudi Arabia which ranks 7^th, with 11% of worldwide production (according to US Energy Information Administration data). In other words, the real impact of Middle East turmoil on oil production may not be as large as the market perceives, unless this conflict escalates.

And these are not the only potential market-moving events of the week. The first and only Vice Presidential debate is schedule for October 1st and the employment release for September will be released on October 4^th. The August JOLTS report showed that job openings unexpectedly increased by 329,000 in the month after two straight monthly decreases. This could boost job growth in September, but hiring fell by 99,000, and this is consistent with a slowing labor market. Overall, the JOLTS report suggests September’s job number should not disrupt the market.

Tracking the Economy

Some economists are now suggesting that the futures market is expecting too many rate cuts by the end of the year. We would agree, but in September Euro zone inflation dipped below 2% for the first time since mid-2021, and this implies that interest rates could continue to fall in Europe. In general, recent economic data has been mixed, but not weak enough to suggest that another rate cut is imminent.

In August, personal income rose 7.6% YOY, disposable income rose 7.2% YOY, and real disposable income rose 4.7%. Real personal disposable income, or income after taxes and inflation, has been positive since early 2023 and this year has been averaging 4% year-over-year. This has been supporting household consumption. Wages grew 5.5% YOY in August, led by the 6.5% YOY gain for government workers. On the other hand, workers in distributive industries only saw a 3.7% YOY gain in wages in August. Adding to personal income was government social benefits which increased 10.7% YOY in August, a big bump up from the 4.9% YOY increase seen at  the end of 2023. See page 3.

The Fed’s favorite inflation index the PCE deflator increased 2.24% in August, down from the 2.45% pace in July. Energy goods and service fell 5.0% YOY in August versus a gain of 0.4% YOY in July and this was a major factor in headline PCE falling. If data is not rounded it shows that many other categories of the PCE ticked higher. Excluding food and energy, or core PCE, rose slightly to 2.68% YOY in August from 2.65% in July. The services index was up 3.74% YOY, an increase from 3.70% a month earlier. PCE services excluding energy and housing rose 3.3% YOY in August, up from 3.2% in July. And finally, the housing PCE index increased to 5.27% YOY in August, versus 5.24% in July. See page 4. It seems that most of the good news in August’s PCE deflator came from lower energy costs.

In August, existing home sales were 3.9 million units, down 4.2% YOY, and continuing the negative YOY comparisons seen since August 2021. New home sales were 716,000, down from the 751,000 units seen a month earlier, but up 9.8% YOY. These are not new trends, but home prices are currently decelerating, or in some cases declining, and this could be favorable for new buyers but could also negatively impact homeowners. The price of an existing single-family median home was still increasing and up 2.9% YOY, but this was down from the 3.9% YOY gain in July, and the average of 5.1% YOY seen in the first five months of the year. The price of a new single-family home fell 4.6% YOY versus the 1.6% YOY decline reported in July. See page 5.

Politics and Economics

The final revisions to September’s University of Michigan consumer sentiment survey showed a pickup in sentiment with a rise in the main index from 67.9 to 70.1. This came from an increase in present conditions from 61.3 to 63.3 and a rise in future expectations from 72.1 to 74.4. As the November election approaches it is interesting to see the gaping dichotomy in the University of Michigan sentiment indices when shown by political party affiliation. In August, Democrats appear very upbeat with a headline index of 90.9, current conditions at 86.1, and expectations soaring to 94.0. Conversely, Republican headline sentiment is abysmal falling from 52.6 to 47.4 in August (the lowest on record), current expectations fell from 42.3 to 33.5 and expectations declined from 59.2 to 56.3. See page 6.

Valuation As we stated last week, valuation does not support equities, but if this is the start of a melt-up or bubble, equity valuation will not matter. The SPX trailing 4-quarter operating multiple is now 24.8 times, and well above all long- and short-term averages. The 12-month forward PE multiple is 21.3 times and when added to inflation of 2.5%, sums to 23.8, or the top of the normal range of 14.8 to 23.8. By all measures, the equity market remains richly valued and is at levels seen only during the 1997-2000 bubble, the financial crisis of 2008, or the post-COVID-19 earnings slump. See page 7. Equally important, earnings estimates are declining. The S&P Dow Jones consensus estimate for calendar 2024 is $236.67, down $0.59 this week. The 2025 estimate is at $274.73, down $1.89. The LSEG IBES estimate for 2024 may have had a typo last week but is currently at $241.25 down $1.26 from three weeks ago. The estimate for 2025 is $277.28, down $1.43 and the 2026 forecast is $312.92, down $1.45. Monitoring these estimates will be critical as we approach third-quarter earnings season since equity prices have been rising, but right now, earnings estimates are falling for 2024, 2025, and 2026. It is a bad combination.

Gail Dudack

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