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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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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This week marks the beginning of third quarter earnings season, and it will include four S&P financial companies reporting earnings this Friday. According to LSEG IBES, analysts are forecasting S&P Composite earnings per share to grow 5% YOY this quarter, led by the double-digit gains projected for the technology, communications services, and healthcare sectors. Conversely, energy sector earnings are expected to decline 3.4% and be a drag on S&P Composite earnings and only low single-digit earnings growth is anticipated for the other six sectors. Still, it may not be the results of this quarter that will capture investors’ attention. The guidance for future earnings growth is what may move markets. Keep in mind that while S&P’s third quarter earnings are forecast to grow only 5% YOY, fourth quarter earnings are estimated to increase a healthy 12.5% YOY. With the popular equity indices recently hitting record highs, double-digit earnings growth might be a necessity to keep the current advance in place. Positive earnings guidance will be particularly important since both Dow Jones S&P and LSEG IBES have been cutting earnings estimates for 2024, 2025, and 2026 for the last four consecutive weeks. See page 11. In our view, rising prices and falling earnings are inconsistent, particularly when the market’s trailing 12-month PE is 24.7 times earnings, and the 12-month forward PE is rich at 21.3 times. See page 10.

With this in mind, PepsiCo Inc. (PEP – $170.42) announced third quarter adjusted earnings of $2.31 that were above analysts’ expectations of $2.29. However, revenue growth disappointed in the quarter and the company cut its forecast for annual sales growth stating that price-conscious consumers were opting for cheaper private-label brands and hurting revenue. As a result, PepsiCo now expects annual organic revenue growth to be below its previous forecast of 4%. When banks come into focus later this week, analysts will be concentrating on changes in net interest income. Net interest income, or the difference between what banks earn on loans and what they pay out on deposits, provided a windfall for the sector as the Federal Reserve was raising rates; but September marked a big change after the Fed’s first rate cut since March 2020. Corporate guidance on net interest income, consumer loan delinquencies, office loan reserves, trading, and investment banking activity will be important for the financial sector this quarter and in the quarters ahead.

The source of the market’s recent exuberance was September’s employment report that was much stronger than expected. The 254,000 increase in payrolls and the unemployment rate falling for the second month in a row to 4.1%, pointed to a robust economy. Even the U6 unemployment rate fell from 7.9% to 7.7% in the month.

But the details of the report were not quite as hearty, in our view. The establishment survey indicated jobs grew 1.56% YOY, slightly below the long-term average of 1.69% YOY. Meanwhile, the household survey revealed a weaker employment picture, which in our view, justifies the expected revision to the establishment survey early next year. The household survey has been showing that year-over-year job growth has been less than 1% in each month of 2024. August’s household survey showed employment declined on a year-over-year basis; however, in September, the survey reported job growth improved slightly to 0.2% YOY. This poor job growth is significant because negative job growth is a classic signal of a recession. See page 3.

There has been a focus on foreign-born versus native-born employment this year because of a growing disparity between the two categories since the end of 2019. In the last 12 months foreign-born employment grew by 1.2 million to 31.4 million people; while in the same period, native-born employment fell by 825,000 to 130.6 million. Keep in mind that this data comes from the household survey which is much broader than the establishment survey which only includes workers on a payroll as reported to the state. The total number of unemployed foreign-born residents was 1.4 million in September and the foreign-born unemployment rate was 4.2%. There were 5.2 million native-born workers unemployed in September and the native-born unemployment rate was lower at 3.8%. See page 4.

The ISM nonmanufacturing index rose from 51.5 to 54.9 in September and all components moved higher. The only indices still below the 50 level were employment and order backlog. The best improvement was new orders which rose from 53.0 to 59.4, the highest reading since February 2023. The ISM manufacturing index was unchanged at 47.2, with five components rising and five declining. The biggest improvement was seen in business activity/production, which increased from 44.8 to 49.8, the best reading since May 2024. See page 5.

Employment in the manufacturing index fell from 46.0 to 43.9 and in the nonmanufacturing survey it fell from 50.2 to 48.1. These declines are in sharp contrast to September’s payroll report which was stronger than expected and makes us concerned that September’s payrolls may be revised lower. The ISM backlog of orders was the only other index in the nonmanufacturing survey that remained below 50, even though it increased from 43.7 to 48.3. In the manufacturing survey the backlog of orders was also weak, inching up from 43.6 to 44.1. Overall, the ISM reports suggested a stable economy with good growth in the service sector, stability in the manufacturing sector, but questionable growth in terms of employment. See page 6.

Consumer credit outstanding grew by $8.9 billion in August, underperforming consensus expectations and decelerating sharply from July’s upwardly revised gain of $26.7 billion. Both revolving and nonrevolving credit grew 0.6% in August versus July, and on a seasonally adjusted basis, revolving credit grew 5.4% (down from 10.7% a year earlier) and nonrevolving credit grew 1.2% (down from 1.9% a year earlier). After inflation, revolving credit grew 2.8% YOY and nonrevolving decreased 1.2% YOY. Nonrevolving credit contracted slightly in June, but falling interest rates had a positive impact on mortgage growth in July and August. The importance of consumer credit is similar to that of job growth. Deceleration precedes contraction and contraction is a sign of a recession. See page 7.

The NFIB small business optimism index was 91.5 in September, in line with the 88.5 to 91.9 range it has maintained since June 2022. This made July’s increase to 93.7 a positive “outlier.” September was the 33rd consecutive month of the optimism index falling below the 50-year average of 98. Plans for capex, employment, expansion, and inventories were somewhat lower, but little changed in the month. See page 8. Actual sales changes for small business owners fell from negative 16 to negative 17 in September and actual earnings rose from negative 37 to negative 34. Nevertheless, both remain historically weak. Sales expectations rose from negative 18 to negative 9 in September. With this backdrop it is not surprising that the NFIB uncertainty index rose from 92 to 103 in September, its highest level since data began in 2017. NFIB stated “Uncertainty makes owners hesitant to invest in capital spending and inventory, especially as inflation and financing costs continue to put pressure on their bottom lines.” See page 9.

There were no significant changes in our technical indicators this week. See page 12 to 16. In our view, stock prices should always be supported by solid earnings growth, and this makes third quarter earnings season critically important. However, earnings do not matter in a bubble market and with liquidity flowing due to monetary easing taking place in Europe, China, and the US, the path of least resistance for equities may still be up.

Gail Dudack

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