The stock market has been advancing strongly based on the belief that 1.) inflation is trending lower 2.) the Fed’s next move will be a rate cut not a rate hike and 3.) that there will be two rate cuts this year. Yet, when the JOLTS report showed that job openings fell to more than a three-year low in April, investors got uneasy about the economy, stocks sold off, and bond yields fell. We find this reaction naïve. Moreover, it suggests that investors have been expecting a perfect soft landing of slower economic growth, inflation trending to 2%, and earnings growth in the low double digits. In our view, even if the Federal Reserve were to navigate the economy to the perfect “soft landing” it is apt to be a bumpy ride at best.
Moreover, historical precedent indicates that once inflation reaches more than double the long-term average of 3.4%, the aftermath has always included a recession. We admit it is slightly different this time. As we noted last week, the massive fiscal stimulus that has been employed by the Biden administration through various bills passed by Congress and through federal agency spending over the last three and a half years has successfully postponed a recession. But we are not convinced it has eliminated one forever. And since this stimulus and deficit spending pushed the US debt-to-GDP ratio to 123% as of September 2023, it might mean that the next recession will be worse than it would have been otherwise. Politics and economics simply do not mix.
At the end of this week, the Bureau of Labor Statistics will release the employment report for May. It will be an important indicator in terms of the economy, particularly since recent data releases are giving a mixed picture. However, the Atlanta Fed’s GDPNow tracker — which uses data inputs from throughout the quarter to extrapolate how GDP is pacing — has moved its estimate down to 1.8% after forecasting growth above 4% at the beginning of May. The second estimate for first quarter GDP was revised from 1.6% to 1.3% last week by the Bureau of Economic Analysis.
If Only Earnings Mattered
However, none of these aforementioned items worried equity analysts who raised estimates significantly last week. The S&P Dow Jones consensus estimate for calendar 2024 is now $241.02, up $0.14, and the 2025 estimate is $276.50, up $1.05. The LSEG IBES estimate for 2024 is currently $244.68, up $0.42 and for 2025 is $279.67, up $0.92, reflecting a 21.7% YOY increase. But the optimism of analysts is best seen in the IBES guesstimate for 2026 earnings which has been steadily jumping higher. Last week this forecast rose $1.23, making the 2026 S&P 500 earnings estimate $314.81, a 12.6% increase.
Yet even as estimates rise, the market is not cheap. Based upon the IBES earnings estimate for calendar 2024, equities remain overvalued with a PE of 21.6 times. Incorporating inflation at 3.4%, the sum of the PE and CPI is 25.0 and above the 23.8 level that defines an overvalued equity market. Even at current S&P 500 prices and with next year’s earnings, the market is trading at a PE of 19.1 times. And assuming inflation does fall to 2% next year, this sum of 21.1 is not far from the 23.8 level that has defined an extremely overvalued market. Overall, this points to an equity market that continues to be driven by liquidity and momentum and not by fundamentals. See page 10.
Technical Indicators Struggling to Remain Positive
The Nasdaq Composite index made a record high on May 28, 2024, the S&P 500 made a record high on May 21, and the Dow Jones Industrial Average made a record high on May 17, 2024. On the other hand, the Russell 2000 index remains 14% below its high of 2442.74 made on November 8, 2021. This week, both the Russell and the DJIA are trading below their 50-day moving averages, and at 2033.94, the Russell 2000 index remains just slightly above the 1650 to 2000 range that contained prices for most of the last 2 ½ years. See page 11.
The 25-day up/down volume oscillator is at 0.97 and neutral after being in overbought territory for four consecutive trading days between May 17 and May 22. This followed six weeks in neutral territory. Since a minimum of five consecutive trading days in overbought is required to confirm a new high, this indicator has not confirmed any of the new highs made in the S&P 500 index and Dow Jones Industrial Average since early January. See page 12.
Daily new highs are falling, and new lows are increasing and this week the 10-day average of daily new highs is 187 and new lows are 72. This combination of new highs above 100 and new lows below 100 is still positive. The NYSE advance/decline line made a new record high on May 20, 2024, is positive, and confirms the new highs in the popular at that time. However, with the exception of May 28th and May 31st, daily volume has been weak for most of the last three weeks, and largely trailing behind the 10-day average for most of the recent advance.
Economics
The PCE deflator for April showed prices rising 2.65% YOY versus 2.7% YOY in March — a fractional decline — but still faster than the 2.46% YOY pace seen in January. The core PCE deflator was 2.75% YOY in April versus 2.8% YOY in March and this index has been sequentially lower since the 5.47% YOY rate recorded in September 2022. Core CPI has been only fractionally lower in the last three months and core PPI has been virtually unchanged for the last four months. Nonetheless, consensus scored this as an inflation victory. See page 3.
Personal income increased 4.5% YOY in April, which was a slight improvement over March’s 4.4%, while disposable personal income rose 3.7% YOY. However, after inflation and taxes, real personal disposable income rose merely 1.0% YOY, down from the 1.3% YOY reported in March. Personal consumption expenditures increased 5.3% YOY, down from 5.6% in April, and this was well above the 4.5% increase in personal income and the 3.7% rise in disposable income. April was the third consecutive month in which consumption exceeded disposable income. The pattern cannot last forever. See page 4.
Real disposable income rose 1.0% YOY, bringing the 3-month average down to 1.3%. There is a close relationship between income and job growth which will make May payrolls important. In April the household survey employment growth was 0.8% YOY, well below trend. Whenever job growth turns negative on a year-over-year basis, the economy is usually entering a recession. Still, establishment payrolls grew 1.8% YOY in April, which is the average pace. See page 5.
Personal income trends in April included a deceleration in personal interest payments; however, these were still growing at 13.25% YOY. Tax payments are trending higher and were up 9.96% YOY in April. Government transfers have been volatile in recent years but rose 4.25% YOY in April. Also notable is the continuous increase in government wages which rose 8.6% YOY in April, as compared to private industry wages which rose 4.2% YOY. This disparity may explain why Washington DC believes inflation is not and has not been, a problem for consumers. See page 7.
The ISM manufacturing index fell to 48.7 in May and has been below the 50 benchmark for 18 of the last 19 months. The one bright spot in the May report was the increase in the employment index from 48.6 to 51.1. The pending home sales index fell to 72.3 in April, down 7.7% for the month and down 7.4% YOY. This was the lowest reading since the pandemic low of 70 seen in April 2020. This does not bode well for the housing industry in the second half of this year.
Gail Dudack
PLEASE NOTE: Unless otherwise stated, the firm and any affiliated person or entity 1) either does not own any, or owns less than 1%, of the outstanding shares of any public company mentioned, 2) does not receive, and has not within the past 12 months received, investment banking compensation or other compensation from any public company mentioned, and 3) does not expect within the next three months to receive investment banking compensation or other compensation from any public company mentioned. The firm does not currently make markets in any public securities.
