As we prepare for a day of Thanksgiving, we want to express our appreciation and gratitude to all DRG clients and thank you for your continuing support in 2024. We wish you and your loved ones a special Thanksgiving gathering and a happy and healthy holiday season.

Much Ado About Nothing

The equity market continues to score a string of new all-time highs in contrast to, and in the face of, a slew of headlines such as Reuters’ “Trump tariffs would harm all involved, US trade partners say” and “GM and other US automakers would take big hit from Trump tariffs” or AP News’ “Trump’s economic plans would worsen inflation, experts say.” But the dichotomy between the press and the market is not a surprise to us. We would put many of these media articles in the same category as political polls, fun to read, but biased and often wrong. It is true that financial markets can get overly emotional at major tops and bottoms, but in general, markets tend to be more logical and accurate in terms of assessing the trend of the economy and earnings. Perhaps it is because real money is involved and there are real consequences.

Moreover, technical analysts will assert that “in price there is knowledge” and we have found that technical analysis brings excellent discipline to our work. Price trends and shifts will undeniably prove you right or wrong well before one has the ability to see a change in an earnings trend. And it is clear that the markets are celebrating Trump’s victory and are in sync with his policies, including tariffs. Given the headlines in the financial press, one might ask why.

In terms of “Trump’s tariffs,” investors do have President-elect Trump’s first administration to use as a history lesson. Even though tariffs were put in place in 2018, GDP strengthened, and inflation fell during President Trump’s four years. And in the midst of a number of articles bashing tariffs, the Wall Street Journal published a piece entitled “How Trump’s Tariffs on China Changed US Trade, in Charts” (see link below*) which demonstrated that between 2017 and 2023, tariffs created a seismic shift in production and imports away from China and to countries like Mexico, Vietnam, Taiwan, and Malaysia. Shifting US dependence on Chinese imports was the purpose of Trump’s tariffs and it was successful. Not surprisingly, the Biden administration continued Trump’s tariff policies. It now appears that President-elect Trump plans to use tariffs to dissuade China from exporting deadly fentanyl into the US through Mexico and Canada. If successful, he would be the first president in US history to curb the illegal drug trade into the US. Most importantly, we believe Trump will impose tariffs if needed, but also think he can succeed in changing policy without having to enforce tariffs. Keep in mind that Donald Trump is not a politician by profession, but he is a professional negotiator: And he wrote “Trump: The Art of the Deal.”

Raising Earnings Estimates and Equity Allocation

The goals of President-elect Donald Trump’s nominee for Secretary of the Treasury, Scott Bessent, are also important and supportive for both the equity and debt markets. Summarized as 3-3-3, Bessent describes Trump’s US economic plan as getting the annual federal deficit down to 3% of nominal GDP, increasing GDP growth to 3%, and increasing US oil production by an additional 3 million barrels per day. This plan, plus his support of using tariffs as a negotiating tool to implement policies that benefit US workers and improve the US economy is another example of good business sense, in our view. (For example, General Motors Company [GM – $ 54.79] may find it more economical to shift auto production to the US from Mexico.) All of this, coupled with a reduction in regulatory red tape, particularly for small businesses, gives us confidence that corporate earnings can increase in 2025 more than previously expected. Therefore, we are raising our 2025 S&P earnings estimate from our below consensus $255 to $270, representing a 15% YOY increase. We are also initiating a 2026 above-consensus earnings estimate of $310.50.

In both cases, these earnings estimates could prove to be conservative if energy production is able to ramp up quickly (difficult to accomplish), merger and acquisition activity increases as expected, and the US sees a revitalization of domestic manufacturing. All three of these would increase employment, personal income, and personal consumption. We are also increasing our equity allocation to 60% and reducing cash holdings by 5%. Because the market appears to be discounting much of the good news expected in 2025 and 2026, a correction seems likely in the first quarter of 2025, and therefore, we are keeping some cash on the sidelines. However, we would make another 5% shift should equities suffer any significant market weakness.

Technical Momentum

Most equity indices have recorded a series of all-time highs recently, including the Dow Jones Transportation Average (a positive Dow Theory signal) and the Dow Jones Utility Average (which is unusual, but the DJ Utility Average has become linked to the growth in artificial intelligence). Price trends and momentum are favorable. The Russell 2000 index tested its record high of 2442.74 on an intra-day basis, but to date, has failed to close above it. In coming weeks this will be the most interesting index to monitor. See page 8.

The 25-day up/down volume oscillator is at 1.06, neutral, and up from last week. The good news is that this indicator is not yet overbought, which would be indicative of a vulnerable marketplace in need of correction. However, since this indicator measures the level of volume supporting an advance, we would be concerned if the oscillator does not reach overbought territory in coming days or weeks and confirm the new highs. Nevertheless, daily volume was greater than the 10-day average for the last several trading days and that is encouraging. See page 9.

The 10-day average of daily new highs eased to 329 this week and new lows are 81. This combination of new highs above 100 and new lows below 100 is a bit weaker but remains positive. The NYSE advance/decline line made a new record high on November 25, 2024, which is favorable. In sum, breadth indicators are uniformly positive. See page 10.

Housing and Sentiment

Total housing starts declined 4% YOY in October, to an annualized rate of 1.311 million units. Single-family housing starts declined 7% while multifamily construction increased 10%. Permits fell 7.7% YOY and single-family permits fell 1.8% YOY. The NAHB Housing Market Index indicated that about 60% of builders used sales incentives to make a sale in November. According to Moody’s Analytics, if all else were equal, the rate on a 30-year fixed mortgage on a typical home would need to fall by 460 basis points to restore the level of housing affordability seen in 2019. See page 3.

New home sales fell in October to 610,000 units, down 9.3% YOY, but still above the pre-pandemic level of 600,000. Nearly all the decline occurred in the South, down 27.7% YOY, due to hurricanes Helene and Milton. Existing home sales rose to 3.96 million (SAAR) in October, up 3.4% from September and up 2.9% YOY. Sales remain below the 10-year average due to elevated mortgage rates; however, the single-family segment rose 4.1% YOY. The existing median home price rose to $407,200, up 4% YOY. Overall, the housing market is sluggish but primarily due to high interest rates. See page 4. *https://www.wsj.com/economy/trade/how-trumps-tariffs-on-china-changed-u-s-trade-in-charts-bb5b5d53?page=2

Gail Dudack

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Global markets were choppy, but higher in recent trading even though President Vladimir Zelensky of Ukraine marked the 1,000^th day of the Russian invasion by attacking an arsenal inside Russia with US-made ATACMS missiles – all with lame-duck President Joe Biden’s approval. Russian President Vladimir Putin retaliated by signing a new threatening nuclear doctrine that lowers the threshold under which Russia might use nuclear weapons. Markets were anxious, yet, for a small rise in energy prices, surprisingly not impacted by this dangerous escalation of war in Europe.

In addition, Russian interference is suspected in the damage to two undersea fiber-optic communication cables in the Baltic Sea—one between Lithuania and Sweden, and the other between Finland and Germany. Germany’s Defense Minister Boris Pistorius said this should be regarded as sabotage.

Nonetheless, global investors appeared to be less interested in geopolitics and more interested in President-elect Donald Trump’s cabinet picks, which continue to dominate the news feeds on a regular basis. There is no doubt that there will be changes under the new administration, particularly since many of the candidates Trump has selected seem primed to make a sweeping overhaul of Washington, DC.  

This political shift inspires us to make some initial changes to our sector emphasis. The proposal of Robert F. Kennedy, Jr. as the new Secretary of Health and Human Services is likely to shift the government’s emphasis from medicines and pills to “healthfulness.” And we expect the new administration will be less likely to mandate vaccines (a major boon for big pharma over the last five years) while also looking for ways to downsize Medicare/Medicaid expenditures. This leads us to downgrade the healthcare sector from overweight to neutral this week. And assuming Trump will succeed in his promise to Middle America to create and retain jobs in the US, we are upgrading the consumer discretionary sector from neutral to overweight. See page 15.

And as we wrote last week (Post-election Euphoria, November 13, 2024, page 1), “The appointment of billionaire Elon Musk and entrepreneur Vivek Ramaswamy to a newly created Department of Government Efficiency may be Trump’s most interesting and challenging “disruptive” effort yet. It may be Elon’s greatest challenge as well; but if successful, it could be revolutionary and move the needle on the federal government spending and the federal deficit.” In our view, this new department of the federal government may also be the source of new investment ideas in the longer run.

2025 Challenges will include the Deficit

However, President-elect Trump will have a host of challenges when he takes over the Oval Office, and along with trouble in the Middle East, Russia/Ukraine, making the federal government more efficient and agencies more responsive and responsible, he will also inherit a massive federal deficit.

In October 2024, the first month of the fiscal 2025 year, the deficit was $257.45 billion, up from $66.56 billion in October 2023 and it was the 71^st consecutive October that federal receipts fell short of outlays. This deficit represented 6.9% of nominal GDP and was well above the average of 6.1% recorded in fiscal 2024 or the 6.5% seen in fiscal 2023. However, in 2022, the average debt-to-GDP was even higher at 7%. One reason for this was that the IRS allowed individuals and corporations affected by natural disasters to delay filing their taxes from April to November 2023 and this resulted in higher-than-usual receipts in October and November 2024. Adjusting for various timing effects of other federal outlays suggests that the increase in total outlays from October 2023 to October 2024 would have been around $40 billion instead of the reported $114 billion. Still, total receipts were 19% lower and total outlays increased 24% from October 2023. Some of the outlays were to fill the Veterans’ Administration’s $12 billion budget hole. Even so, in the past year individual income taxes fell 24%, corporate tax receipts plummeted 73%, and the deficit is bleeding red ink.

All in all, the fiscal 2024 deficit of $1.83 trillion was 8.1% larger than in 2023 and as a percentage of nominal GDP increased 0.3% to 6.4%, the largest deficit during an economic expansion since World War II. The federal government borrowed $2.3 trillion in fiscal 2024, bringing total outstanding debt to $35.46 trillion, a 7% increase from the previous fiscal year. Since nominal GDP was $29.35 trillion in the third quarter, this means outstanding debt to GDP rose to 121% in September. Interest payments were more than 13% of total federal outlays in 2024. In sum, these deficits will be a huge burden to the bond market in 2025. See page 7.

Inflation is Not Going Quickly

Headline CPI increased 2.6% YOY in October, up from September’s 2.4%. Energy was unchanged month-to-month on a seasonally adjusted basis, but down 1.1% month-to-month when not seasonally adjusted, and down 4.9% YOY. Gasoline prices were down 12.2% YOY. In other words, lower energy costs substantially helped headline CPI in October. Core CPI rose 3.3% YOY, which was unchanged from September, but many segments of the CPI index increased more than headline on a month-to-month basis. In particular, other goods and services rose 0.4%, medical care increased 0.3%, recreation was up 0.3%, and housing rose 0.2%. See page 3.

The downtrends in headline and core CPI are clearly on pause since headline CPI is ticking up for the second month in a row and core CPI at its highest level since May 2024. In addition, a variety of core CPI indices have been trending higher in recent months. See page 4. This means it is possible that the Fed may pause in December, or until there is more economic data to suggest another rate cut is necessary.

Since many economists appear to be singularly focused on housing, particularly owners’ equivalent rent, they can take solace in the fact that this segment of the CPI continues to ratchet lower, although it remains relatively high at 5.2% YOY in October. The same is true of the broad service sector, which is moving lower, but at 4.7% YOY remains well above the Fed’s target of 2%. More importantly, some service sector areas are reporting that prices are trending higher. In October, health insurance rose 6.8%, motor vehicle maintenance and repair rose 5.8%, medical care rose 3.3%, and other goods and services increased 3.3% YOY. See page 5.

There was good news this week from the National Association of Home Builders which announced that their confidence index inched higher for the second month in a row in November. And Walmart Inc. (WMT – $86.60) raised its annual forecast for the third consecutive time indicating that consumers are buying more groceries and merchandise.

Technical Update This week brought little change to our technical indicators and though the major indices have given back half of their pre-and post-election rally, they continue to show positive momentum. There are a few signs of deterioration in the 10-day averages of new highs and new lows and our 25-day volume oscillator is yet to record an overbought reading indicating a lack of upside volume. This, plus the lack of a new high in the NYSE advance/decline line since October 18, 2024 suggests the Trump rally may be extended near term. Nevertheless, seasonality and a history of yearend gains following most presidential elections favors the bulls.

Gail Dudack

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In the four trading sessions following the election, the equity market recorded stunning gains of 3.8% in the S&P 500 index, 4.9% in the Dow Jones Industrial Average, 4.7% in the Nasdaq Composite index, and a remarkable 7.7% in the Russell 2000 index. The pace of this action was amazing and euphoric, but unsustainable. However, the momentum underlying the rally suggests stock prices will continue to advance. Moreover, equities tend to advance in the two months following a presidential election, and November through January has historically been a good period for equities. We expect stocks will move higher in the near term.

The stock market is a good, but imperfect, discounting mechanism, and our only concern is that equities are pricing in much of the good news expected from a four-year Trump presidency. But only time will tell. Still, we are not surprised stocks are celebrating since President-elect Trump’s business and energy friendly platform is clearly positive for corporate profits. Equally important, Scott Bessent, CEO and chief investment officer of Key Square Group, and a current candidate for Secretary of the Treasury in the Trump administration, wrote a Wall Street Journal opinion article on November 10, 2024 emphasizing the need to restart the American growth engine, address the federal debt and preserve the dollar’s role in the global economy. The fact that the new administration will have a focus on reducing the debt-to-GDP ratio is a significant step in the right direction and lowers our angst on a topic that we believe will be crucial in 2025. Link to the article: https://www.wsj.com/opinion/markets-hail-trumps-economics-he-will-repair-biden-damage-pro-growth-investment-boost-f3954dbe

President-elect Trump has always been a disruptor (something that causes radical change in an existing industry or market by means of innovation) within the federal government, which may be at the core of why he attracts so much animosity. Most people do not like change and government officials like it less than most individuals. So, his appointment of billionaire Elon Musk and entrepreneur Vivek Ramaswamy to a newly created Department of Government Efficiency may be Trump’s most interesting and challenging “disruptive” effort yet. It may be Elon’s greatest challenge as well; but if successful, it could be revolutionary and move the needle on the federal government and the federal deficit.

In terms of the post-election rally, what we believe is most favorable is that it has been led by small capitalization and financial stocks. The action in the Russell 2000 index is a sign that investors feel good about the future of the US economy and the earnings potential of small businesses. Furthermore, participation in small capitalization stocks is what has been missing in the market’s advance for over two years and has been at the root of less-than-favorable breadth statistics. Plus, every sustainable bull market cycle has been led by financial stocks, particularly the banking sector. At the core of any good economy is a solid banking system and without good price action in bank stocks, an equity advance is questionable. In sum, the market’s reaction in recent days has been bullish.

In terms of breadth data, our 25-day up/down volume oscillator is 0.68 and neutral. The good news is that this indicator is not overbought and not signaling a major correction. However, since this indicator measures the level of volume (or conviction) behind any advance or decline, the bad news is that this indicator is not yet overbought. With most of the indices at or near all-time highs, in the days or weeks ahead, it is important for this indicator to confirm the advance with an overbought reading of at least 5 consecutive trading sessions. See page 11.

Last week was also FOMC meeting week and the 25-basis point cut in the fed funds rate was no surprise to investors. This week there will be new data regarding inflation for the month of October and it will be the first of two CPI releases before the next Federal Reserve Board meeting on December 17-18. Fed watchers have become mixed in their view of whether there will be another rate cut next month, but in our opinion, the long end of the Treasury curve is more important at this juncture since it impacts consumers more directly. Consumer credit outstanding expanded by $6 billion in September, short of expectations for a $14.5 billion gain, and less than August’s downwardly revised gain of $7.6 billion. The increase in credit was driven primarily by growth in the nonrevolving segment, which added $5 billion while revolving credit added $1 billion. Revolving credit grew a mere 0.9% at an annualized rate, and 4.9% YOY versus the 10.3% YOY pace seen a year earlier. See page 6.

The reason we are closely monitoring credit is that negative growth in revolving credit is often a signal of a recession. The trend in consumer credit has not turned negative but it has been decelerating. And despite a recent string of fed fund rate cuts, consumer finance rates remain stubbornly high. The delinquency rate on credit card loans has been trending higher and was 3.25% in the second quarter, up from 3.15% in the second quarter. Data for the third quarter should be release later this month.

Productivity increased to 2.2% in the third quarter, up from 2.1% in the second quarter, and this increase appeared even though GDP growth slowed from 3.0% to 2.8% in the same period. Since the rate of productivity usually follows the pace of economic activity, this bump in productivity is good news for employers. Labor productivity rose due to lower unit labor costs. However, a better measure of labor cost is the employment cost index, and this was also favorable since it decelerated in the third quarter from 4.1% YOY to 3.9% YOY. See page 3.

While trends in employment costs were uniformly lower in the quarter, the actual levels were different between private industry and government workers. Government workers in this analysis represent state and local employees, and here total compensation grew 4.7% YOY, wages and salaries rose 4.6% YOY, and benefits rose 4.8% YOY. This compares to private sector employees where total compensation rose 3.6% YOY, wages and salaries grew 3.8% YOY, and benefits increased 3.3% YOY. See page 4.

Third quarter employment costs were also distinctly different between union and nonunion employees. For union workers, total compensation rose 5.8% YOY, wages and salaries grew 6.4% YOY, and benefits increased 4.9% YOY. Note that these numbers would not have included the results of the Boeing strike. However, the large union increases in 2024 are likely a catch-up from the below average increases seen in 2021 and 2022. Nonunion total compensation rose 3.4% YOY, wages and salaries increased 3.8% YOY, and benefits rose 3.1% YOY. See page 5. The NFIB small business optimism index rose 2.2 points in October to 93.7, returning to the level seen in July. The surprise was the record high in the NFIB uncertainty index of 110, however, this poll was taken before the election. There were only a few big moves in October. One of these was the business outlook which rose from negative 12 to negative 5. The area of concern is that actual earnings changes were a bit better at negative 33 from negative 34, but actual sales changes fell from negative 17 to negative 20. See page 7.

Gail Dudack

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It is finally election day and hopefully results will come quickly, and it will not take days, or weeks, to get final tallies of votes. (It does not make sense to us that in this era of technology we cannot have results in less than a 24-hour timeframe.)

As we noted last week, results for Congress may be more significant than who wins the White House, but that does not mean there are no differences between the two presidential candidates. The rally in recent sessions has been called a “Trump Rally” by traders and we think we know why. To Wall Street, former President Trump represents less regulation, lower taxes, more energy production, and this means lowers energy and transportation expenses and higher margins. Vice President Harris has indicated she wants to raise the corporate tax rate, promises voters she will investigate corporations for price gouging, and is part of an administration that has increased regulation and initiated anti-trust cases against most US large technology companies. Wall Street tends to focus less on campaign rhetoric, promises, and threats of tariffs, and more on numbers and actions.

Still, the stock market should be able to handle any election result. In our view, a Republican sweep could trigger a short-term rally since this is more supportive of earnings growth. The more likely result would be a divided Congress which is something Wall Street has typically favored and historically it means little gets passed or done in Congress. If this materializes, politics will take a back seat to earnings results. A Democratic sweep is unlikely in our opinion but would not be ideal for stocks since it would mean more regulation and taxes on Corporate America. However, it would be good for companies involved in green technology.

This is also Fed week, and the Fed’s announcement could come before election results are finalized, which would be interesting. Nevertheless, the market has priced in a 25-basis point cut and we do not think the Fed will disappoint. What we see in the employment data suggests another cut or two may be in store in coming months.

Recent Economic Releases

In the third quarter GDP grew 2.8% on a seasonally-adjusted-annualized basis, just shy of the 3.0% seen in the second quarter and not much below the long-term average of 3.2%. Driving third quarter growth was personal consumption. However, services have usually been the main driver of personal consumption, but in the third quarter growth came primarily from durable goods, or more specifically vehicles. Government spending was also a significant positive in the third quarter, along with inventories. The major negative in the quarter was international trade, with imports exceeding exports. See page 3.

October’s employment report showed payroll growth was surprisingly low at 12,000 jobs, plus August and September were revised lower, reducing total employment by 112,000 jobs. While October’s weakness was attributed to hurricanes and the Boeing strike, it does not explain the weakness seen in earlier months. Keep in mind that earlier this year the BLS announced that there will be an annual revision for January 2025’s employment report and this could lower employment statistics by as much as 818,000 jobs, or more than 86,000 jobs per month, representing a 0.5% benchmark revision. This would be the largest benchmark revision on record in terms of the number of jobs and the percentage of the revision. In our view, this lowers the confidence one can have in these statistics, but it explains the massive divergence we have been pointing out all year between the establishment and household surveys. Headline job growth looked stellar in 2024 while the household survey showed zero growth. It appears that the household survey may prove to be more accurate in the long run. Weak job growth could become a very important topic in 2025 because year-over-year declines in the level of employment have been a reliable predictor of a US recession. See page 4.

The unemployment rate for October was unchanged at 4.1%, but the household survey reveals there are differences in unemployment according to age, sex, education, and citizenship. The unemployment rate for those 65 and older was the lowest at 2.7%; whereas the unemployment rate for women 16 to 64 was relatively high at 3.8%. The unemployment rate appears to be inversely correlated to level of education. The unemployment rate for those with a bachelor’s degree or higher was up but still low at 2.5%, for those with some college education it was 3.4%, for high school graduates it was 4.0%, and for those with less than a high school degree the rate was down, but still high the highest at 6.6%. The native-born unemployment rate was 3.9% in October and the non-native unemployment rate was 4.1%. See page 5.

The Bureau of Labor Statistics did a study of foreign-born workers based on 2023 data and it shows foreign-born workers were concentrated on both coasts and represented 23.9% of the labor force in the West and 22.6% in the Northeast. In both cases, this was above the US average of 18.6%. Native-born workers earn more than the foreign-born workers at most educational attainment levels. Among high school graduates, full-time foreign-born workers earned 88% as much as their native-born counterparts. However, among those with a bachelor’s degree and higher, the earnings of foreign-born workers were just slightly higher than the earnings of native-born workers. As of the latest data for September, there were 130.8 million native-born workers and 31.1 million foreign-born workers in the US, but on a year-over-year basis, native-born employment fell by 825,000 and foreign-born employment grew by 1.2 million workers. The foreign-born population includes legally admitted immigrants, refugees, temporary residents such as students and temporary workers, and undocumented immigrants. The survey data, however, do not separately identify the number of people in these categories. See page 6.

Average hourly earnings for production and non-supervisory workers rose 4.1% YOY in October, but average weekly earnings only rose 3.8% YOY due to a slowdown in hours worked. Looking at average hours, it is clear that manufacturing hours peaked at 42.3 in April 2018, and this represented a post-WWII record high. After a pandemic decline and a post-pandemic recovery, manufacturing weekly hours slowly declined to the 40.6 seen in October. This decline in manufacturing hours is in line with the weak data seen in the ISM manufacturing surveys. See page 7. The ISM manufacturing survey indicated that this sector of the economy was contracting at a faster pace in October. The headline number fell from 47.2 to 46.5 and business activity fell from 49.8 to 46.2. The biggest increase was in prices which jumped from 48.3 to 54.8. In October, the ISM service survey was up 1.1 point to 56 and it marked the eighth time this year that the composite index has been in expansion territory. October was driven by gains of more than 4 points in both employment and supplier deliveries; however, business activity and new orders both dropped by at least 2 points. In short, the ISM manufacturing survey remains anemic, and the service survey was mixed. We believe these releases fully support another 25-basis point cut in the fed funds rate this week. See page 9.

Gail Dudack

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