Along with many other stock markets around the world, the Nasdaq Composite index and the S&P 500 index recorded all-time highs this week. These highs came just a day before Nvidia Corp. (NVDA – $953.86), Wall Street’s third largest firm by market capitalization, reports first quarter earnings after Wednesday’s closing bell. Expectations are for another blowout quarter for the chip maker. The global focus on Nvidia’s earnings suggests it could be a significant market catalyst and more importantly, a test of whether the outsized rally in AI-related stocks can be sustained. Nvidia’s earnings report also comes as the stock is about to test the psychological $1,000 level, which could become a challenge, at least in the short run, considering the stock is already up over 8-fold from its October 2022 low. In our view, the obsession surrounding Nvidia’s earnings release is worrisome and revealing. It reflects a certain underlying weakness in the market if one stock is vital to the current advance and to investor confidence.

But it is also interesting to see how many different ways artificial intelligence can drive the stock market. Utilities became the latest AI-related darling. The interim CEO for American Electric Power Company Inc. (AEP – $92.62), Benjamin Fowke, noted in a hearing held by the Senate Energy and Natural Resources Committee this week, that a single data center requires three to fifteen times the amount of power as a large manufacturing facility. According to Fowke, “One small example of this demand surge – OpenAI’s ChatGPT requires 2.9 watt-hours per request, and that’s nearly 10 times more power than a typical Google (Alphabet Inc. C – GOOG – $179.54) search.” And voila! Utilities are now an AI play. As a result, in one month the utility sector jumped from being the next-to-worst performing S&P 500 sector to the third best performing sector. See page 15.

Wednesday will also include the release of the minutes of the May FOMC meeting. The document will be scrutinized for any sign of a possible rate cut in September, since the consensus and the CME FedWatch Tool are currently suggesting a 90% probability of at least one rate cut before the end of the year. We do not expect a rate cut this year. The one exception would be if the economy stumbled into a recession and that does not appear likely either.

The recent rally has had several catalysts, but the key one seems to have been the April CPI report. Headline CPI ratcheted down from 3.5% in March to 3.4% YOY in April while core CPI eased from 3.8% to 3.6%. The general trend of these two indices appears to be stable to lower; however, if one looks at the heavy-weighted components of the CPI index it shows that while prices in food & beverage and housing are decelerating (i.e., rising at a slower pace), transportation and medical prices are now accelerating. See page 3.

Many economists have been theorizing that inflation would already be at 2% if owners’ equivalent rent were excluded, and that rents were not reflecting the slowdown in home prices. There are a number of problems with this theory. First, there has always been a lag between the prices of homes and the level of rents, and this is logical. Rents usually reset every year or two which means that rising or falling housing prices work through the economy slowly with a big lag. Second, the argument that the CPI would be lower excluding OER is losing viability because the housing prices are rising again. Third, the driver of inflation made a significant shift many months ago from housing and energy to services (most notably insurance and medical). See page 4.

Inflation less shelter represents nearly 64% of the CPI and since this index hit a low of 0.6% YOY in June 2023, it has been steadily rising and rose 2.2% in April. All core CPI indices were above 2% in April, up from last year’s lows. More importantly, in April, services less rent rose 4.9% YOY, medical care services, which had been declining in 2023, rose 2.7% YOY and services less medical care services rose 5.6% YOY. See page 5. We fear the stock market may be too complacent about inflation.

Last week we noted that consumer confidence fell in May, this week we see that retail sales for April were disappointing. Seasonally adjusted total retail and food services sales were essentially unchanged from March, although up 3.0% from a year earlier. Note that the March 2024 report was revised down from up 0.7% to 0.6%. From a retailer’s perspective, after adjusting for inflation of 3.4%, real retail sales declined 0.4% YOY. The main high points of the April report were the same familiar areas: miscellaneous stores (up 6.8%), nonstore retailers (up 7.5%), and food services and drinking places (up 5.5%).See page 6.

The area of the economy that could be a concern this year is housing. Housing affordability fell in March from 103.2 to 101.1. The decline came from a combination of a slightly higher mortgage rate of 6.9% and a higher median existing single-family home price of $397,200. The $9,200 increase in home prices was much larger than the $680 increase in the median family income, which increased from $100,876 to $101,556. Similarly, the NAHB confidence index fell from 51 to 45 in May and is now below the 50-point threshold which marks a poor building outlook. Current single-family sales fell from 57 to 51 and the 6-month outlook for sales fell from 60 to 51. See page 7.  

Nevertheless, the good news is found in the technical condition of the stock market, which is much improved this week. The S&P 500 and Nasdaq Composite index made record highs on May 21, 2024 and the Dow Jones Industrial Average made a record high on May 17, 2024. The Russell 2000 index remains 14% below its high of 2442.74 made on November 8, 2021, however, the technical pattern is positive, and it is trading above all its moving averages. See page 10.

The 25-day up/down volume oscillator is at 4.02 and in overbought territory for the third consecutive trading session. This is positive; however, a minimum of five consecutive trading days in overbought territory is required to confirm a new high which means, to date, this indicator is yet to confirm this week’s all-time highs. The last confirmation from this oscillator appeared at the turn of the year when it was overbought for 22 of 25 consecutive trading days ending January 5, 2024. See page 11.

The 10-day average of daily new highs is 400 and new lows are 44. This combination of new highs above 100 and new lows below 100 is positive. The NYSE advance/decline line made a new record high on May 21, 2024, is positive, and confirms the new high in the popular indices this week. The one caveat is that daily volume has been weak and running consistently below the 10-day average for most of the recent advance. See page 12. The current rally has been a liquidity-driven event and not a valuation-driven advance. Despite the fact that earnings have exceeded consensus expectations, those expectations were significantly lowered just ahead of earnings season. The S&P 500 trailing four quarter operating PE multiple is now 24.3 times and is well above all long-term averages. See page 8. The 12-month forward PE multiple is 20.8 times and well above its long-term average of 15 times and its 1985 to present average of 17.8 times.  

Gail Dudack

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With 85% of the S&P 500 components having reported earnings for the first quarter of 2024, LSEG IBES estimates that the earnings will grow 7.8% YOY on revenues that are up 3.9% YOY. This 7.8% growth rate brings the quarter’s estimate back to where it was at the start of this year and before estimates fell significantly in April. It is this downward guidance ahead of each earnings season that generates a healthy number of positive earnings surprises each quarter. There are many ways to generate a small earnings surprise which is why we do not put much weight on earnings surprises.

Apple Inc. (AAPL – $182.40), which is challenged in several of its business segments, reported its fiscal second quarter earnings last week and its results beat the Street’s modest expectations. However, revenue fell 4% to $90.8 billion and iPhone sales fell 10%. Apple reported net income of $23.64 billion, or $1.53 per share, down 2% from $24.16 billion, or $1.52 per share, in the year-earlier period.

Nevertheless, the stock surged after it announced a 4% increase in its cash dividend and authorized an additional program to buy back $110 billion of stock, the largest buyback in the company’s history. The stock climbed 7% in extended trading after this announcement.

But this response to Apple’s buyback announcement made us look at the history of Apple’s outstanding shares.* What we found was that Apple’s shares outstanding peaked at the end of the first quarter of 2013 at 26.489 billion shares. At the end of March 2024, Apple’s fiscal second quarter just announced, shares outstanding were 15.465 billion, or 42% lower. We were surprised by the extent of this decline. In other words, over the last eleven years, Apple’s earnings per share are 42% higher due to a lower denominator, not earnings growth. In the first quarter, Apple’s shares outstanding declined by 2.4%, making earnings that much higher. One could say that each share of Apple is more valuable because there are fewer shares, which is true. But it does say something about the quality of earnings, in our view. Apple is rather unique due to its cash flow and its ability to buy back shares. An investor might want to focus more on top line revenues and income, rather than on earnings per share to monitor real growth in Apple’s business.

The major leader in terms of first quarter earnings growth is currently the communications services sector where IBES forecasts earnings will rise 44% on revenue gains of nearly 7%. The communications services sector includes Meta Platforms, Inc. Class A (META – $468.24), Alphabet Inc. A (GOOGL – $171.25), Alphabet Inc. C (GOOG – $172.98), and Netflix Inc. (NFLX – $606.00).

This year to date, the S&P 500 and the Nasdaq Composite index have gained 8.8%, whereas the Dow Jones Industrial Average is up 3.2% and the Russell 2000 index is up only 1.9%. All together this suggests that despite a broadening in the rally, the bulk of the gains continue to be in the large cap technology-driven stocks.

But we also want to point out that the technical condition of the equity market has markedly improved this week. Our 25-day volume oscillator remains neutral for the fifth consecutive week; but the 10-day averages of daily new highs and new lows have gained momentum. New highs are averaging 128 and new lows are averaging 46, a combination that is now positive. In addition, the NYSE advance/decline line made an all-time high on May 7, 2024, and has now confirmed the advance. See pages 11-12.

All four of the popular equity indices have recently tested their 100-day moving averages and to date, with the exception of the Russell 2000 index, these rebounds appear successful and are in line with a normal correction. The Russell 2000 broke its 100-day moving average and tested its 200-day moving average, and despite a recent dip into its long-term neutral trading range of 1650 to 2000, the index appears to have tested this key support level successfully. In sum, the charts are positive and appear to support further gains.

It has been a busy two weeks with an FOMC meeting, a Treasury offering, inflation data, income data, and employment statistics. The next key release will be the CPI on May 15^th, so it will be interesting to see how the market trades without an external stimulus to drive the daily trading.

Economic Releases

Although the job market remained solid in April, payrolls rose by 175,000, which was below expectations. Healthcare represented nearly half of the gains, while leisure/hospitality and government together added only 13,000 jobs in the month. The household survey showed modest job growth (25,000) relative to job losses (63,000) which translated into an unemployment rate of 3.9%, up 0.1%. Job growth in the establishment survey was 1.8% YOY versus the long-term average of 1.7%; however, the household survey had job growth of 0.3% YOY which was well below the long-term average of 1.5% YOY. This statistic will be important to monitor since negative job growth is a classic sign of a recession. See page 3.

Average hourly earnings for production and non-supervisory workers were up 4.0% YOY in April, down from the 4.2% YOY seen a month earlier. There has been a steady deceleration in earnings growth since the March 2022 post-pandemic peak of 7% YOY. Average weekly earnings for production and non-supervisory workers were $1005.27, down from February, but up 3.7% YOY. However, again this was a deceleration from February’s 3.9% YOY pace. See page 4.

April’s ISM nonmanufacturing index contracted for only the second time in nearly 4 years. However, both the ISM manufacturing and the ISM nonmanufacturing indices showed that prices paid rose in April (inflationary) to 60.9 in manufacturing and 59.2 in nonmanufacturing. Service industry employment fell to 45.9 and manufacturing inched higher but remained below 50 at 48.6 (contraction). See page 5.

Private residential construction spending fell 0.7% in March to $884.3 billion, reversing February’s gains, but still up 4.4% YOY. New home unit sales were up 8.3% YOY in March to 693,000 units, the best level since September 2023. However, existing home sales were 4.19 million in March, down 3.7% YOY. The price of a new single-family home rose 1.0% YOY after months of declining prices. The median price of a single-family existing home rose 4.7% YOY in March, supported by a low level of inventory. See page 6.

The existing home market is six times larger than the new home market, but sales have been slowing in both markets after the post-Covid boom. Moreover, homeownership also declined in the first quarter to 65.6% and the only area of the US with a gain in homeownership in the first quarter was the Northeast where it rose from 61.5% to 62.6%. Housing prices are rebounding, and new home sales are rising. These are good signs in an important segment of the economy. Still, many potential homeowners have already been priced out of the market. *https://www.macrotrends.net/stocks/charts/AAPL/apple/shares-outstanding#:~:text=Apple%20shares%20outstanding%20for%20the,a%203.78%25%20decline%20from%202020

Gail Dudack

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Recent economic releases suggest inflation is reaccelerating while the economy and the consumer may be decelerating. In normal times, these opposing trends would be fine since a slowdown in the economy would be enough to curb inflation in the coming months or quarters. But these are not normal times. It is an election year. And in the pre-election and election years the party in power in the White House often gives the economy a boost. The reasoning is obvious; voters tend to boot incumbents out of the White House during a recession.

As we show on page 7, inflation has never been as high as it was in 2022 without eventually triggering a recession. Moreover, a Fed tightening cycle, particularly when it is fighting inflation, has rarely ended without the real fed funds rate hitting a minimum of 400 basis points and eventually triggering a recession. However, the recent peak in the real fed funds rate only hit 290 basis points before the Federal Reserve paused rate hikes. Whether the Fed felt rates were high enough to calm inflation, or if they were fearful of triggering a recession, is unknown. But in our view, interest rates were not particularly high given the level of inflation, and therefore, were likely to stay higher for longer.

But again, these are not normal times. The main difference in this cycle, in our opinion, is the four consecutive years of massive fiscal stimulus. We have found it difficult to track the various forms of stimulus employed by the current administration, but it is worth looking at the White House website at https://www.whitehouse.gov/american-rescue-plan/ to see the various forms of relief offered to American families. Most of these are family and small business assistance programs and do not include the aid given to illegal immigrants, the $5 trillion in pandemic stimulus, President Biden’s Inflation Reduction Act (Goldman Sachs estimates the IRA fiscal cost to be $1.2 trillion), the Bipartisan Infrastructure Bill and Build Back Better Agenda, or the estimated $56.6 billion of student loan forgiveness delivered through the Department of Education’s new SAVE program. This steady stream of fiscal stimulus is boosting economic activity in ways that are impossible to measure accurately, but it is an external stimulus, and it means these are not normal times.

Massive fiscal stimulus is typically seen only during major recessions, and it is unsustainable in the long run. Plus, as we noted in our US Strategy Weekly Inflation Redux (April 17, 2024), stimulus programs mean bigger deficits and mounting debt will ultimately translate into higher interest rates and slower economic growth. In fiscal 2024, interest outlays on the federal deficit are estimated to be 3.1% of GDP and net interest costs account for 13% of current federal outlays.

Without strong leadership in Congress, deficits and net interest costs will undoubtedly move higher. To the extent that there is a steady increase in demand for US Treasury securities the US will be able to fund these deficits. But the supply/demand balance for any security can shift very quickly. For this reason, we believe one of the biggest risks in 2024 could be found in the debt markets. In fact, the debt markets may eventually become the disciplinarian needed to put the US, and Congress, on the road to fiscal responsibility. In sum, debt markets are key to this cycle!

Economic Weakness

After some modest improvement in February, the March University of Michigan consumer sentiment survey showed weakness across the board. The Conference Board confidence index fell significantly in March and February data was revised downward. Consumer expectations in the Michigan survey were the lowest since December and in the Conference Board survey, expectations were the lowest since July 2022. See page 3.

The University of Michigan sentiment surveys are extensive and on page 4 we show sentiment by level of education and political affiliation. Those with a college degree tend to be the most optimistic most of the time, but sentiment for all levels hit a record low in 2022. Nonetheless, March data showed a noticeable improvement in sentiment for college grads. Conversely, sentiment fell for those with a high school degree or less. Politics plays a role in sentiment and optimism tends to rise when your political party is in power, which explains why Republicans have been so glum in recent years. But while sentiment in general remains well below the 100 neutral level, there has been a bit of improvement in sentiment, particularly for independent voters.

After growth of 4.9% and 3.4% in the last two quarters of 2023, preliminary data for first quarter GDP showed growth slowing to 1.6% (SAAR). Some of the drivers of first quarter growth were fixed residential investment, computer & peripheral investment (artificial intelligence?), services, and farming. The prospect of interest rates remaining higher for longer suggests that the housing market could see less growth in coming quarters. If so, a soft housing market could slow GDP further. See page 5.

Inflation Rebounds

The March personal consumption expenditure deflator was up 2.7% YOY, higher than the 2.5% YOY seen in February, and higher than expectations. While the uptick appears small, the components of the deflator show that only goods inflation was flat. Services, energy goods & services, and the PCE excluding energy, food, and housing all trended higher in March. The core PCE deflator was unchanged at 2.8% YOY in March. See page 6.

The employment cost index showed that total compensation for private industry workers rose 4.2% YOY in the first quarter of 2024 versus the 4.8% YOY seen a year earlier. Wages were the driving force, rising 4.4% YOY in the first quarter, while total benefits increased a smaller 3.7% YOY. See page 8. The Fed may focus on wage gains since inflation could prove more difficult to control with the CPI increasing 3.5% in the same quarter as wages are increasing 4.4%. Keep in mind that wage costs feed into every area of the economy and result in higher prices for consumers. One reason inflation has been difficult to control in the past is that once price gains become embedded in the economy, a vicious circle of higher prices, higher wages, is difficult to break. Only a recession can reverse the cycle.    

Technical Update All four of the popular equity indices have recently tested their 100-day moving averages and to date, with the exception of the Russell 2000 index, these rebounds appear successful and are in line with a normal correction. The Russell 2000 appears to be returning to its long-term neutral trading range of 1650 to 2000. See page 11. The 25-day up/down volume oscillator is at negative 0.50 and neutral after recording a 90% down day on April 12. See page 12. The 10-day average of daily new highs is 74 and new lows are 64. This combination of new highs and new lows, both below 100, is neutral. The NYSE advance/decline line made a new record high on March 28, 2024, confirming the advance but is now 6750 net advances away from its high. We remain cautious.

Gail Dudack

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This could be an important week for the stock market since 30% of the S&P 500 components are expected to report first quarter earnings results. Earnings have become critically important now that expectations of Federal Reserve rate cuts are fading; but to date, earnings season has been mixed. The weekly S&P Dow Jones consensus estimate for calendar 2024 is $239.83, down $1.10, as of April 19, 2024. The estimate for 2025 is $273.65, down $0.33. The LSEG IBES estimate for 2024 is $242.06, down $0.98, and only the 2025 IBES estimate rose to $276.37, up $0.24. Using the IBES EPS estimate for calendar 2024, equities remain overvalued with a PE of 20.9 times and with the S&P estimate, the 2024 PE is 21.1 times. Both are extremely high, particularly with inflation currently at 3.5% YOY. See page 9.

However, the debt market is also having an important week given that the Treasury is scheduled to sell $183 billion of 2, 5, and 7-year notes. As we noted last week, fiscal 2024 year is a pivotal time for the US deficit since the CBO estimates that net interest outlays will soon exceed the primary deficit. This year the annual deficit is forecasted to be 2.5% of GDP, while interest payments will be 3.1% of GDP, a percentage last seen in 1995, 1992, and 1990. In fact, since 1940 net interest outlays exceeded 3.1% of GDP only once, in 1991 (3.2%), during the 1990-1991 recession. In our view, debt markets are a significant risk factor for the equity market since the supply/demand balance for debt and inflation each pose a threat.

And this week could also prove important for other reasons since we see a new trend developing in Washington DC – that of federal agencies “legislating” rules that are typically reserved for Congress. According to the Constitution, the power of the purse belongs only to Congress and all spending bills go through the Budget Committee in the House of Representatives, the legislative body that is closest to citizen voters. The Founders of our Constitution believed that the separation of powers would protect against “monarchy” and provide an important check on the executive branch. Keep in mind that our Founders fought against the British monarchy in the American Revolutionary War (1775 to 1783), and it was this experience that helped them to frame the Constitution in order to keep power with the people and not with politicians (or monarchy).

Nevertheless, after the Supreme Court ruled that President Biden did not have the authority to erase $400 billion in student debt without prior authorization from Congress, the Department of Education changed the rules on student loan repayment plans. Under Biden’s new effort, called the Saving on a Valuable Education plan (SAVE), “borrowers who originally took out $12,000 or less in loans and have been in repayment for 10 years are eligible to get their remaining debt canceled.” It also forgives debt for borrowers in public service for 10 years who have made 120 months of qualifying payments. In other cases, borrowers who have had loans for 20 years or more will see the remaining loan forgiven in total. Keep in mind that loan forgiveness impacts both the budget and deficits. It means less revenue to the Treasury and the likelihood of higher tax rates for others. There is no free money.

This week another agency, the US Federal Trade Commission, approved a rule to ban noncompete agreements commonly signed by workers in some industries. These agreements mean workers cannot just join their employers’ rivals or launch competing businesses without restrictions. According to the FTC, these agreements limit worker mobility and suppress wages and a ban should increase workers’ pay by $488 billion over the next decade and create 8,500 new businesses. (We would like to see that research!) Those who support the rule say it is necessary to rein in noncompete agreements, even in lower-paying service industries such as fast food and retail.

However, like many rules and bills coming out of Washington DC, we see both a risk and the possibility of unintended consequences. First, we doubt many minimum wage workers are asked to sign noncompete agreements. Lower-paying service industry workers tend to be supported by unions that fight for better conditions and better pay. But to the extent that nonunionized middle-level workers will have fewer barriers to switch jobs, this could force employers to increase salaries, which would be inflationary. Second, in many industries, worker knowledge, data, programs, systems, information, client lists, client relationships, etc. are proprietary and/or valuable assets of a company. The banning of noncompete agreements means this information can simply walk away and move to a competitor anytime a worker leaves the company. It could be very damaging to a business if there were no rules or agreements in place. And though there may be a need to set rules around noncompete agreements, the outright banning could be potentially harmful to many companies and to the economy.

Nonetheless, the more important issue may be that rules that impact federal and/or state finances, personal finances, or the ability of a corporation or entrepreneur to conduct business should be left to Congress, where it belongs. It should not be in the hands of anonymous unelected agency personnel in the executive branch. It simply challenges our Constitution.

New Housing Data

There were some signs of stress in recent housing statistics. Existing home sales for March fell to 4.19 million (SAAR) down 3.7% YOY, but the median price for existing home sales was $393,500, up 4.8% YOY. Newly constructed home sales were 693,000 units annualized, up 8% YOY, yet the median home price of $430,700, was down 2% YOY. From a broader perspective, the charts on page 3 show residential sales are well below both cyclical and historical peaks and home prices appear to have peaked in early 2023. Higher interest rates are apt to weigh heavily on the housing market in the coming months.

Existing home sales represent the bulk of housing transactions, but when combined with new home sales, it is clear that total sales, despite a recent increase, remain well below the average level seen over the last 30 years. Not surprisingly, total housing permits and starts for March were down on a year-over-year basis, although single-family housing activity was a bright spot for home builders. See page 4. In general, new home sales have done better in the last year than existing home sales, but builders have had to cut prices to generate demand. Existing home sales have been down on a year-over-year basis, but prices have remained relatively stable due to low inventory. In short, there are subtle signs of stress in both segments of the housing market. See page 5.

Technical Update

Last week we pointed out the technical breakout patterns in gold and silver. This week cocoa and coffee futures have had huge gains. These two commodities could increase food prices in the near future. See page 7. All four of the popular equity indices have recently tested their 100-day moving averages and to date, the rebounds from these levels have been successful. This is in line with a normal correction. However, note that the Russell 2000 appears to be slipping back into its long-term trading range of 1650 to 2000. See page 10. The 10-day average of daily new highs is now 57 and new lows are 94. This combination of new highs and new lows below 100 is neutral but note that new lows now outnumber new highs. This is not unusual in a correction, but both trends should reverse soon. In our view, the equity market remains vulnerable to inflation, rising interest rates, and disappointing earnings and we remain cautious.

Gail Dudack

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At a policy forum focused on US-Canada economic relations, Federal Reserve Chairman Jerome Powell questioned whether the Fed would be able to lower interest rates this year prior to significant signs of an economic slowdown. This was not a huge shock to the equity market since the Fed futures markets had already signaled that there was little chance of a Fed rate hike before September. The culprit for this shift from multiple fed rate cuts to few if any rate cuts in 2024 was last week’s release of March inflation data.

Headline CPI for March rose 3.5% YOY, up from 3.2% YOY in February, and core CPI remained unchanged at 3.8% YOY. In general, March’s data reversed a fairly steady deceleration that has been seen in most inflation components since the June 2022 peak. The main exception to this was owners’ equivalent rent which did decelerate from 6% YOY to 5.9% YOY. See page 3.

The rebound in headline inflation was a disappointment to those expecting multiple Fed rate cuts this year; however, it was the underlying data that was truly worrisome. All the inflation indices excluding shelter, food, energy, used cars and trucks, and medical care, moved higher in March and service sector inflation accelerated. Prices in the broad service sector (which is 64.1% of the CPI weighting) increased from 5.0% to 5.3%. Hospital & related services prices rose from 6.1% to 7.7%. Tenants’ and household insurance rose from 4.1% to 4.6% and motor vehicle insurance rose from 20.6% to 22.2%. Medical care services, where prices were declining for most of the second half of 2023, reversed this trend and were up 2.1% YOY in March. See page 4. We continue to hear some market commentators state that headline inflation would be less than 2% if the housing component was eliminated. In our view, these comments will soon be silenced because inflation has become embedded in the system and is no longer tied to the price of oil or housing.

Nonetheless, oil prices are rising again, and this suggests that headline inflation could continue to rise in the months ahead. It is important to note that in 12 of the 13 months ended in January of this year, the price of crude oil was down on a year-over-year basis, and this was a significant factor in helping to slow headline inflation. For example, WTI was down 3.8% YOY in January 2024 and headline CPI was 3.1% YOY. In February, WTI was up 1.6% YOY and headline CPI rose 3.2% YOY. In March WTI was up 9.9% YOY and headline CPI was up 3.5% YOY. To date, in April, WTI is up 11.2% YOY and we expect headline CPI will also rise in April. What is more important is that energy is one of the few commodities that has the ability to drive prices higher throughout the broad economy. Higher energy costs increase transportation, manufacturing, and service costs, which then get passed down to the consumer (who is already burdened by higher gasoline, electric, and heating bills).  

Therefore, it was not surprising to hear Chair Powell temper expectations of rate cuts. In fact, interest rates have clearly been on the rise after the March inflation release.

Warnings from the CBO

Another factor impacting interest rates is the mounting level of federal debt. We agree with those who believe a day of reckoning is ahead for the debt markets. A steady stream of fiscal stimulus packages over the last four years has been both inflationary and a catalyst for higher interest rates. According to Congressional Budget Office (CBO) data, federal debt held by the public is expected to reach a record 107% of GDP in 2029 and reach 166% of GDP by 2054. And according to the CBO (the independent advisor on budgetary and economic issues providing cost estimates for current and proposed legislation), mounting debt will slow economic growth and raise interest rates.

2023 was an important turning point for the federal budget since it marked the year when the annual primary deficit (federal inflows minus outflows) equaled 3.8% of GDP versus interest outlays which represented 2.4% of GDP. According to CBO data, this balance will shift this year and the primary deficit is estimated to equal 2.5% of GDP and interest outlays rise to 3.1% of GDP. CBO forecasts show interest outlays growing to a shockingly high 6.3% of GDP by 2054. See page 5. At present, net interest costs are 13% of current federal outlays and this is estimated to rise to 23% by 2054.

Whether or not the Federal Reserve raises or lowers interest rates will impact deficits since 3-month Treasury bills now represent 14.5% of total federal debt and total Treasury bill issuance represents 25% of total Treasury debt outstanding. This is the highest level since 2009. And though Washington DC is at the center of this spending, inflation, debt, and interest rate spiral and it seems oblivious to it and all its consequences. It must be an election year…. 

In general, this combination of high interest rates, growing deficits, and interest payments on federal debt exceeding the primary deficit is reminiscent of the 1980-1990 decade when the combination of high debt levels and high inflation led to a series of rolling recessions.

Technical and Earnings Update

Charts of gold, silver, gasoline, and WTI crude oil are all technically strong. See page 7. Gold and silver may be breaking out of major base patterns due to concern of war escalating in Europe and the Middle East, which in turn impacts the price of oil and most commodities. But regardless of the reason, these four commodity charts are bullish, and that has inflationary implications.

Conversely, all four of the popular equity indices are trading below their 50-day moving averages this week and the DJIA and Russell 2000 are also trading below their 100-day moving averages. Given the huge advance seen from the October low, this appear to be a normal correction; however, the Russell 2000, which never got close to making a new record high, has fallen back into its long-term trading range of 1650 to 2000. See page 10.

The NYSE 25-day up/down volume oscillator is at negative 1.15 this week and neutral after recording a 90% down day on April 12. The prior 90% day was also a down day made on February 13, 2024. This oscillator reached overbought territory for two consecutive days on March 13 and 14 and March 20 and 21 and for three consecutive trading days on March 27, March 28, and April 1. These overbought readings followed the string in early January when the oscillator recorded readings of 3.0 or higher for 22 of 25 consecutive trading days ending January 5. Since a minimum of five consecutive trading days in overbought is required to confirm a new high, this means that, since early January, this indicator has not confirmed the new highs in the averages made in January, February, and March. See page 11. The S&P Dow Jones consensus estimate for calendar 2024 is $240.93, up $0.26, and the LSEG IBES estimate for 2024 is $243.04, up $0.01. Based upon the IBES EPS estimate for calendar 2024, equities remain overvalued with a PE of 20.8 times and inflation of 3.5%. This sum of 24.3 is above the 23.8 level that defines an overvalued equity market. The LSEG IBES earnings growth estimate for the current first quarter earnings season declined from 5% YOY to 2.7% YOY this week. Growth for calendar 2024 fell from 9.9% YOY to 9.2% YOY. We remain cautious.

Gail Dudack

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