The stock market made a steady string of all-time highs in the first half of December. But equities lost their luster after the December FOMC meeting held on December 17-18. The news from Chair Jerome Powell was that the Federal Reserve Board was now anticipating two, not four rate cuts in 2025. This halving of rate cuts was not a surprise to us given the level of inflation and the strength in the economy, so we were surprised at how poorly stocks reacted to the news. However, the market’s response revealed how much investors were counting on easy monetary policy to support their equity holdings; and as we noted in December, it also disclosed the level of speculation in the stock market.

In our view, only speculators would rank Fed policy, and the number of fed funds rate cuts as the number one driver of stocks in 2025. In reality, the real fed funds rate has fallen from 280 basis points in August of 2024 to 160 basis points and this suggests that the current fed funds rate is already dovish. Rate cuts should be less important this year than the strength of the economy, the ability of the economy to grow jobs, and corporate America’s ability to produce profits. We would also place federal deficits at the top of the list of drivers for 2025. Nevertheless, equities weakened again this week after the JOLTS report showed job openings were greater than expected and the ISM nonmanufacturing index showed prices paid were significantly higher. This reaction to the price index exposes a growing sensitivity to potential inflation.

Market commentators are suddenly sensitive to inflation and the rise in the 10-year Treasury yield to 4.6%, which is a big jump from the 4.1% seen in late November, but still within the 3.7% to 4.9% range it has maintained since June of 2023. And strategists are suddenly worried about the comparison of the S&P 500’s earnings yield (earnings divided by the S&P’s price) and the Treasury yield. In fact, little has changed in recent history, and the trailing earnings yield (based upon S&P Dow Jones data) is 4% and the 12-month forward earnings yield is 4.6%. These have been the average for both earnings yields throughout 2024. However, when the dividend yield of 1.3% is factored in, the total forward earnings yield for equities is actually 5.9%. In short, little has changed in the last few quarters, equities remain competitive with bonds, yet market commentators are suddenly worried.

Equity valuation has been an issue for a long time, but the total expected return from equities continues to favor equities over bonds in our view. We think too many market forecasters are simply worried that fiscal and monetary easing will no longer be supporting equities. We, on the other hand, have been worried that fiscal and monetary easing were the drivers of equities rather than job and earnings growth. In our opinion, jobs and earnings are the two factors that will matter most in 2025.

This is why December’s job report this week will be important. There has been a disconnect between the establishment and the household surveys throughout 2024, and we will be looking primarily at the household survey for clues as to whether the job market is weakening or improving. The incoming administration has been working overtime on getting foreign companies to invest in the US and to grow the job market. This is a plus. And while newscasters are forecasting higher inflation in 2025 as a result of potential tariffs, it could be that the threat of tariffs is what will keep manufacturers in the US and entice foreign companies to invest here as well. If so, this will be good for job growth, household income, GDP, and corporate profits. Time will tell.

Good News?

Good news is a matter of perspective. Investors appear worried this week that job and economic growth will inspire inflation and increase interest rates. If so, this is exactly why the Federal Reserve should not be cutting interest rates! However, historically interest rates will rise as economic activity improves. This is fine as long as earnings also grow. From this perspective, stronger economic activity is a plus. And there were a number of good economic signs in recent days.

The ISM manufacturing index rose 0.9 points to 49.3 in December, with 8 of 10 components increasing in the month. This was favorable; the only outlier was employment, which fell from 48.1 to 45.3. The ISM nonmanufacturing index rose 2 points to 54.1, with six of 9 components increasing in the month. However, the biggest increase was in prices paid, which jumped from 58.2 to 64.4. This is the part that spooked the market this week. Order backlog fell from 47.1 to 44.3 and employment eased from 51.5 to 51.4. We are more concerned that both employment indices fell in December! See page 3.

After a long stretch of weakness in the housing market in 2022, 2023, and most of 2024, tiny green shoots appeared at the end of the year. The November NAHB confidence index had a big uptick in single-family sales expected over the next six months and the pending home sales index rose to 79, its best reading in nearly two years. This pending home sales uptick represented a 6.9% increase from a year earlier and sales were strong in most areas of the country with the exception of the Northeast. See page 4.

The housing cycle had been artificially boosted in 2020-2021 due to stay-at-home mandates issued during the pandemic; and this pandemic boom was followed by a housing slump in 2022-2024. But the housing cycle may finally be normalizing. New home sales grew 8.7% YOY in November, the best improvement in over a year. Existing home sales similarly rose 6.1% YOY, its best increase since June 2021. In both cases, the sales trends have been improving in recent months. The housing market will also be supported in 2025 by historically low existing single-family home inventory which fell to 3.7 months in November. See page 5.

Total retail sales picked up at year end, growing 3.4% YOY in November. Sales excluding motor vehicles & parts and gas stations were even stronger, increasing 3.6% YOY. What is most encouraging is that November’s unit sales of vehicles hit 17.0 million on an annualized basis, the best level seen since May 2021. Despite the fact that interest rates remain high, total vehicle sales were finally approaching their pre-pandemic levels at the end of the year. See page 6.

Dear Santa Claus

The market failed to have a Santa Claus Rally this year and market breadth has weakened. As a result, many prognosticators are turning bearish for 2025. However, at present, the charts of the indices do not reflect anything other than a normal pause in an uptrend. Only the DJIA and the Russell 2000 index have tested their 100-day moving averages, while the SPX and Nasdaq are trading well above these benchmarks. In short, the jury is still out on the recent market weakness which still appears to be a normal pullback. See page 10. The 25-day up/down volume oscillator is at negative 1.74, neutral, and down significantly from last week, and below an uptrend that has been in place since the October 2022 low. Since the October 2022 low, every oversold reading in this indicator has been met with solid bargain-hunting buying. In short, an important test may be on the horizon, and we will be watching to see if this indicator reaches an oversold reading and how long it lasts. An oversold reading that lasts more than five consecutive trading sessions is a warning and would be a sign that the bullish momentum that has been in place since the October 2022 low has been broken and a decline of more than 10% is on the horizon. In short, there are reasons to be cautious in the near term.

Gail Dudack

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The Federal Reserve is likely to lower interest rates by 25 basis points this week, but we doubt the Federal Open Market Committee will be unanimous in its decision and for good reason. In our view, at this juncture there is no need to lower interest rates and in fact, another rate cut could risk encouraging a rebound in inflation. But unfortunately, the Federal Reserve Board Chaired by Jerome Powell has never disappointed the consensus in the past, and we doubt this pattern will change this week. This predictability of the Fed is unfortunate because an obvious and dovish Federal Reserve emboldens speculation which is the opposite of what a central banker should do. In our view, Wednesday’s compromise will be that the Fed lowers interest rates by 25 basis points but makes a hawkish statement indicating that additional cuts may, or may not, be needed, in 2025. At least this will keep the consensus guessing in the near term, which is good.

Positives

There is a slew of indicators that suggest the economy is in good shape and may actually be accelerating as 2024 ends. The University of Michigan and Conference Board consumer sentiment surveys have both shown a significant boost in confidence in recent months. The NFIB small business survey jumped to its highest level since June 2021 in November. Consumer credit expanded by $19.2 billion in October and despite an increase in inflation, real personal disposable income grew a healthy 2.6% YOY in the third quarter. The National Association of Home Builders survey improved substantially in November and expected sales of single-family homes over the next six months jumped to 64, its highest level since April 2022. The pending home sales index rose 5.2 points in October to 75.8. Top-line retail sales were far better than expected in November, marking the third straight month of strong growth. This was the first time sales have grown strongly for three consecutive months in over a year.

Negatives

There are some areas of concern. Industrial production fell 0.1% in November following a downwardly revised 0.4% decline in October (previously -0.3%), leaving output 0.9% lower than a year earlier. This was the weakest annual rate since January. More importantly, despite the fact that the November jobs report showed an increase of 227,000 new jobs in the month, the household survey told a different story. It indicated there was a decrease of 355,000 jobs in the month and an increase of 161,000 people unemployed, and this is what led to the increase in the unemployment rate from 4.1% to 4.2%. However, the household survey also shows that the number of people employed declined by 0.45% YOY in November. This was the second contraction in four consecutive months, and it is significant because a steadily declining labor force is a classic sign of a recession. This could explain the Fed’s desire to lower interest rates.

Inflation Dilemma

Still, the Fed’s big dilemma in 2025 could be a resurgence in inflation. Headline inflation accelerated for the second month in a row in November, rising 2.75% (which the BLS rounded to 2.7%) year-over-year versus 2.6% in October. Core CPI rose 3.3% YOY, unchanged from a month earlier. Note that headline CPI speeded up even though the energy component fell 1.7% for the month and 3.2% YOY. Also notice that all major segments of the CPI rose more than the headline number except for transportation, and lesser components such as education and communication, recreation, and apparel. See page 3.

On a positive note, both headline and core CPI have been below the 77-year long-term average of 3.7% YOY for many months; but unfortunately, prices have now become sticky, and several areas of the economy — such as airline fares — are experiencing price acceleration. In particular, one of the Fed’s favorite benchmarks — all items less shelter — rose 1.6% YOY up from 1.3% in October and is up from 1.1% in September. Most economists are encouraged that shelter inflation was 4.7% YOY in November, down from 4.9% in October and owners’ equivalent rent was 4.9% YOY in November, down from 5.2% in October. Nevertheless, while shelter inflation may be decelerating (some of this due to falling energy costs), it remains elevated. See page 4.

Energy costs were the initial driver of inflation; however, service sector inflation is the current problem, and the broad service sector saw prices rising 4.5% YOY in November, down a bit from 4.7% in October. Conversely, medical care costs which averaged 0.2% YOY gains in 2023, rose by 3.1% YOY in November and have been rising 3% YOY or more for the last seven months. The only consolation to the sharp rise in medical care costs is that price spikes seem to appear every four years and should be peaking in 2024. See page 5.

Wages grew 3.9% YOY in November versus the CPI’s 2.7% YOY pace and have been growing faster than inflation since May 2023. This is a potential problem since it means that inflation may be making a classic shift from being supply-driven to demand-driven. We believe the Fed sees this risk but is either ignoring it or is more concerned about a weakening labor market. With inflation at 2.7%, assuming the Fed announces a 25-basis point cut this week, the real fed funds rate would fall from the peak of 280 basis points seen in August to 160 basis points this week. This 160 basis points would still be above the long-term real fed funds rate average of 130 basis points but is a dovish move and we think the timing would be poor. See page 6.

Price Action

The Dow Jones Industrial Average closed down 267 points on Tuesday, for its ninth-straight day. According to FactSet, this index has not had nine consecutive down days since February 1978, so this decline is gaining attention. However, we would point out that the other indices have not had the same trend, and this Blue Chip index has several unique factors that explain its weakness. First, Nvidia Corp. (NVDA – $130.39) replaced Intel Corp. (INTC – $20.44) in the DOW 30 on November 8, 2024, and the stock peaked at a price of $148.88 on November 7, 2024. The subsequent sell-off in NVDA is a phenomenon that often happens to new stocks added to an index due to pre-buying. In addition, United Healthcare Group Inc. (UNH – $485.52) has been in a tailspin since the murder of UnitedHealth CEO Brian Thompson on December 4, 2024. This horrible event has become a flashpoint for the healthcare industry and a group of lawmakers are pushing to force health insurers to sell pharmacies. Our technical indicators remain positive, but there have been signs of deterioration in the past week. The 10-day average of new highs is now over 100, turning the new high/new low index from positive to neutral. It is also mid-December, and strong cross currents always occur at year end. We believe the stock market will move higher but fear it may peak around Inauguration Day since a lot of good news has already been factored into prices. In addition, the S&P 500 index is currently trading at 25.9 times trailing earnings. Historically, only stock market bubbles have reached 30 times earnings. See page 8.

Gail Dudack

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In its August 2024 country report, the International Monetary Fund indicated that in 2023, China’s central and local governments and other government-related funds and entities, owed as much as 116.9% of GDP in debt. Moreover, the IMF estimated that China’s debt burden would grow to nearly 150% of GDP by the end of the decade. This IMF forecast was ominous; however, it was made well before this week’s announcement by Chinese leaders. This week China declared that the government is ready to deploy whatever stimulus is needed to counter the impact of US trade tariffs on next year’s economic growth. The timing of this declaration is notable since next year’s growth, budget deficit and other targets will be discussed in coming days at an annual meeting of Communist Party leaders, known as the Central Economic Work Conference (CEWC). China is currently forecasting GDP growth of 5% for 2025 and this week’s message shows China is willing to go even deeper into debt and will prioritize growth over financial risks, at least in the near term. It also shows the angst government officials feel regarding their economy and the pressure that China has regarding the prospect of US tariffs.

We are highlighting these statements from China because too many economists are focused on the “inflationary impact” of President-elect Trump’s potential tariff policy while neglecting to acknowledge either what happened in Trump’s first term or how tariffs may simply change the behavior of domestic and foreign corporations and countries. If one assesses tariffs in an “all things being equal” world a tariff will certainly be a tax, but that is not the way the world works. It will lead you to an inaccurate outcome. In the case of China, this appears to be an excellent time for the US to bring them to the negotiating table.

In a different area of the world, it is interesting to reflect on how the threat of tariffs on Mexico has already changed behavior at the Mexican border. On November 26, 2024 according to Newsweek, Mexican President Claudia Sheinbaum asserted that migrant caravans are no longer reaching the US-Mexico border. And at the end of November 2024, US Customs and Border Protection (CBP) reported a significant decrease in migrant encounters at the US-Mexico border compared to the previous year (and months).

It is stunning to see how many things have changed in the past month. Although Donald J. Trump will not be in the Oval Office for several more weeks, we are already seeing a marked difference in sentiment readings and consumer behavior. Recent financial headlines are revealing: “Goldman Sachs CEO David Solomon says dealmaking could surpass 10-year averages in 2025,” “Warburg Pincus sees an uptick in private equity deals in 2025,” “BlackRock sees investors shifting from cash to stocks and bonds.” And to a large extent, this sentiment supports what has been happening to stock prices in recent  weeks. One could call it “the Donald effect.”

Valuation is not supportive of equities, but momentum, hope, and sentiment are now overruling valuation. The SPX trailing 4-quarter operating multiple is 25.8 times, and well above all long- and short-term averages. The 12-month forward PE multiple is 22.1 times and when added to inflation of 2.6%, sums to 24.7, which is above the top of the normal range of 14.8 to 23.8. By all measures, the equity market remains richly valued. But we believe valuation may be next year’s problem. See page 8.

In a definitive response to the presidential election, November’s National Federation of Independent Business (NFIB) small business optimism index jumped 8 points to 101.7 from 93.7, its highest level since June 2021. The NFIB outlook for general business conditions index went from negative 5 to 36 and rose to its highest level since June 2020. All categories improved in November and plans for capital expenditures, additional employment, business expansion, and an increase in inventories improved in the month. See page 5. The importance of small business owners to the US economy should not be underestimated. According to the Office of Advocacy (housed within the US Small Business Administration), the US contains 34.8 million small businesses, which account for 45.9% of total employment.

Both the Conference Board and University of Michigan consumer sentiment indices had positive upticks in confidence in November. The preliminary survey for December’s University of Michigan sentiment revealed another 2.2-point increase from 71.8 to 74.0. However, all of that increase came from the present conditions segment of the survey which jumped a stunning 13.8 points to 77.7. The expectations index, which had been the source of strength in this survey, fell 5.3 points to 71.6, its lowest level since July. Nonetheless, consumer sentiment is much improved. See page 4.

Consumer credit expanded by $19.2 billion in October, a big increase from the $3.2 billion seen in September. Most of the increase came from revolving credit which rose by $15.7 billion. This expansion in credit is a positive omen for the broader economy since contractions in consumer credit tend to be associated with recessions. We have been closely monitoring consumer credit after total credit grew by a mere 1.5% YOY in June and nonrevolving credit contracted 0.2% YOY in the same month. October’s expansion in credit is a favorable event and is another sign of a lift in consumer spirit. See page 6.

The November jobs report showed an increase of 227,000 new jobs in the month, of which 194,000 were in the private sector and most were in the services sector. There was also a positive revision of 24,000 jobs for October and a positive 32,000 for the month of September which equates to a total increase of 283,000 jobs in the report. However, the report was not all good news since the unemployment rate increased from 4.1% to 4.2%. This ratio comes from the household survey, which is much broader than the establishment survey, and it told a different story. It indicated there was a decrease of 355,000 jobs in the month and an increase of 161,000 people unemployed. Therefore, the civilian labor force (the total of employed and unemployed) declined by 194,000, to just under 168.3 million. The participation rate also fell 0.1 to 62.5 and the employment-population ratio fell 0.2 to 59.8, its lowest level since early 2022. See page 7.

Our favorite indicator of economic strength or weakness is the year-over-year change in the number of people employed. According to the establishment survey, job growth was 1.45% YOY in November, below the long-term average of 1.69%, but still healthy. However, the household survey shows the number of people employed declined 0.45% YOY in November, contracting for the second time in four consecutive months. The long-term average growth rate for this series is 1.5% YOY. See page 7. Our concern is that once the BLS finalizes its annual revisions to payroll data for January 2025 (reported in early February), it will fall in line with the household survey and show that the job market has been slowly contracting for most of 2024. But again, that may be a problem for next year. At present all our technical indicators continue to be supportive of the market. The 25-day up/down volume oscillator is 1.39, neutral, and relatively unchanged from last week. The good news is that this indicator is not yet overbought, which would be indicative of a stretched or vulnerable marketplace. 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 to confirm the new highs. See page 11. All in all, seasonality and liquidity suggest stock prices could move higher through the end of the year.

Gail Dudack

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Against a backdrop that included a sudden burst of political chaos in South Korea, Israel threatening to expand the war if the Hezbollah truce collapses, and China issuing a ban on exports of critical minerals to the US, the S&P 500 and Nasdaq Composite indices were unfazed and made new all-time highs this week. Offsetting some of this geopolitical news was the US Labor Department’s announcement that job openings increased by 372,000 in October to 7.74 million jobs. Layoffs declined by 169,000, the most in 18 months, indicating a stable employment environment. However, hires fell by 269,000 to 5.313 million, dragged lower by declines in construction, manufacturing, finance and insurance, professional and business services, and the leisure and hospitality industry. The hires rate dropped to 3.3% from 3.5% in September, but the Labor Department also indicated that there are 1.11 job openings for every unemployed person in October. This was up from 1.08 reported in October, but below the 1.2 ratio seen prior to the pandemic and below the 2.03 peak seen in early 2002. Overall, this report suggested the labor market is well anchored.

Solid Economic News

The revision to third quarter GDP revealed few changes and showed the economy increased at a 2.8% (SAAR) pace, down slightly from the 3% rate seen in the second quarter of the year. However, both of these quarters suggested the economy was growing just below the long-term average of 3.2% and was thereby expanding at a healthy pace.

Yet despite this hearty growth in the economy, at the end of the third quarter, total US market capitalization rose to 2.13 times nominal GDP. This ratio is not far from the record 2.2 recorded in June of 2020 (in the midst of the pandemic) and well above the previous record of 1.83 made at the March 2000 bubble peak. See page 3. More importantly, the stock market has been booming since the presidential election, and if we were to use today’s market capitalization and compare it to September’s GDP, it would set a new record at 2.25. In short, various forms of market valuation indicate the current stock market is very richly valued. Nonetheless, the exuberance surrounding the re-election of Donald J. Trump is overruling a host of geopolitical and fundamental issues and that is likely to continue through the end of the year.

Meanwhile, a number of data releases imply the economy is on solid footing in the final quarter of 2024. In October personal income rose a solid 5.3% YOY, up from 5% in September, and above the 49-year average of 5.2%. Real personal disposable income – which is key to personal consumption — increased 2.7% YOY, up from 2.6% a month earlier, and is just slightly below the 40-year average of 2.8%. The savings rate increased to 4.4% from 4.1%. In sum, personal income trends were improving for the average household.

Personal consumption increased a hefty 6.8% YOY in October, up from 6.6% in September, and well above its 40-year average of 5.4% YOY. This was due primarily to the consumption of services, which rose 9.8% YOY at the start of the fourth quarter, versus goods which increased 0.7% YOY. Yet it is also worth pointing out that since the beginning of the year the consumption of durable goods has been negative on a year-over-year basis which means the modest 0.05% YOY decline in October was a significant improvement. See page 3.

We noticed that government transfer payments were an important part of personal income growth in 2024 and grew a whopping 12.7% in October on a year-over-year basis. Total social security payments grew 6.9% YOY, Medicare rose 16.7% YOY, Medicaid increased 6.8% YOY, veterans’ benefits grew nearly 30% YOY, unemployment insurance payments increased 63% YOY, and other government subsidies increased 20% YOY. In many cases, the growth in government subsidies in 2023 and 2024 were retroactive adjustments to the high inflation rates seen in 2021 and 2022. The increases in social security and veterans’ benefits were due to a combination of a growing number of participants and COLA increases. The 20% increase in “other” government transfers was interesting but not surprising in a presidential election year. However, the 63% YOY increase in unemployment insurance surprised us and this suggests that Friday’s employment report for November will be important, and we will be looking to see if there is an adjustment to October’s release and if there is a significant rise in the number of unemployed in November’s report. See page 5.

The manufacturing sector has been the weakest segment of the US economy for a long while, but there may be green shoots on the horizon. The ISM manufacturing index, which has been contracting for 24 of the last 25 months, actually rose in November to 48.4 from 46.5 in October. Hopefully, this index will inch its way back above the neutral 50 level in coming months. President-elect Trump’s focus on increasing US energy production and manufacturing could help this trend in 2025. Overall, the details of the ISM report were mostly positive, and the new orders, production and employment indexes all moved higher. November’s data for the ISM service indices, which have been the strength of the US economy for the last two years and were strong in September and October, will be reported later this week. See page 6.

Technically Robust

While the S&P and Nasdaq Composite indices made new highs this week, most other equity indices have also recorded all-time highs recently, including the DJ Transportation and Utility averages, which makes Dow Theory positive. The Russell 2000 index has been testing its record high of 2442.74 on an intra-day basis, but to date, has failed to close above it. This will be the most interesting index to monitor in coming weeks. Nevertheless, the charts of the popular indices are positive and display good momentum. See page 9.

The 25-day up/down volume oscillator is 1.14, neutral, and relatively unchanged from last week. The good news is that this indicator is not yet overbought, which would be indicative of a stretched or vulnerable marketplace. 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 weeks to confirm the new highs. In sum, this indicator suggests there is room for the current rally to move higher, but we will be looking for volume in advancing stocks to improve. See page 10.

The 10-day average of daily new highs is 397 this week and new lows are averaging 64. This combination of new highs above 100 and new lows below 100 is a bit stronger this week and remains positive. The NYSE advance/decline line made a new record high on November 29, 2024. These breadth indicators are uniformly positive. See page 11. Last week’s AAII sentiment survey revealed there is no bullish extreme on the part of individual investors and this is good news. In fact, bullishness fell 9.6% to 31.7% and bearishness increased 5.4% to 38.6%. Bullishness is now below average, and bearishness is above average for the first time since April 24, 2024. All in all, momentum remains with the bulls, at least in the near term.

Gail Dudack

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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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