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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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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