The new administration, now in its fifth week, continues to be the main topic of conversation in almost every economic and political circle around the world. However President Trump’s campaign promise of a peace deal in Europe is gaining momentum this week and an agreement could be on the horizon. Some progress has even been made in the Middle East. Germany has a new conservative leader – Friedrich Merz – and he is already considering a special fund for increased military spending. In the United Kingdom, UK Prime Minister Keir Starmer took steps to ramp up its defense spending ahead of his meeting with President Donald Trump later this week. This is an impressive list of achievements for this young administration. But domestically, the press primarily focused on emails from Elon Musk asking all federal employees to send him a list of recent accomplishments. Such a request would not be unusual in the private sector, but for many government employees, it was the cause for a total meltdown. More importantly, it was not the most significant event of the week but it did gather the most media attention.

Meanwhile, a string of recent US economic data points such as retail sales, the NAHB housing market index, new residential construction, and consumer sentiment suggest economic activity may be slowing. The Treasury market appears to believe this is true and yields in the 10-year Treasury bond fell from a high of 4.54% last week to 4.29% this week. Investors also appear to be worried that the layoffs either taking place, or about to take place, in the federal government will negatively impact the February jobs report. This, coupled with the predicted inflationary effect of tariffs, would hurt the overall economy.

Tariffs are yet to be put into place and we doubt that many will be, with the exception of China. But to check the theory of the impact of layoffs in the federal government, we looked at recent Bureau of Labor statistics. We found that the not-seasonally-adjusted level of total nonfarm employment was 157.1 million at the end of January and of that figure federal employees (excluding US Postal Services) represented 2.4 million workers, or 1.5% of the workforce. Since the federal government is the goal of DOGE, and layoffs are to be expected, even a 50% reduction in employment (an extreme case), would equate to 0.75% of the total nonfarm US workforce. Looking further, we found that while the overall unemployment rate was 4.4% in January, for government workers the rate was 1.6%. In short, government workers have not faced the normal ups and downs of economic cycles or unemployment lines, which may explain the pandemonium now seen in Washington DC.

But there is no doubt that the speed of this administration’s actions are creating confusion among some and heightened anxiety among others. The recent Conference Board consumer confidence release showed that consumer sentiment fell in February from an upwardly revised level for January. While the decline in present conditions was modest the decline in expectations was substantial. This is a pattern seen throughout a number of sentiment indicators. At 98.3, the headline index was the lowest since June 2024. The University of Michigan sentiment release was a bit different, with the headline index of 64.7 falling a substantial 7 points to its lowest level since November 2023. This was due primarily to a 9.4 point decline in present conditions to 65.7. In February all three segments of the University of Michigan survey were below 70 for the first time since July 2024. What also disturbs Wall Street traders was that Inflation expectations for the next 12 months soared from 3.3% to 4.3%. See page 3.

Sentiment varied significantly when analyzed by educational level and by current situation versus expectations. In January current conditions sentiment soared, particularly among the college educated, although this index also weakened a bit in February. Sentiment among those with some college education continued to rise in February as it has since the 2024 low. But expectations sentiment plummeted for all groups in February, with the largest decrease seen for participants with a high school diploma or less, where the index fell 23.5 points from 91.3 to 67.8! See page 4.

And the University of Michigan survey showed big discrepancies in sentiment depending upon age and political affiliations. Those 18 to 34 in age had an increase of 10.6 points in current condition sentiment, while the 35 to 54 age group had a 3.3-point decline in January. Those 55+ had a 0.4 point increase in current conditions. Not surprisingly, sentiment by political party affiliation could not be more different and are roughly mirror images of each other. Republican expectations soared in January as Democrat expectations plummeted. Both fell slightly in February. Sentiment for independent voters was somewhere in the middle of the two but declined in February. See page 5.

A survey of personal finances followed a similar pattern with current finances rising for the fifth consecutive month to 87; while expectations of future finances fell two points to 109. Again, surveys are showing that consumers are positive about their current situation but are fearful of what may be ahead. Sentiment of whether $1000 invested in a mutual fund would be worth more in the next twelve months, fell from 59.5 to 55.9 in January. See page 6.

This waning confidence in the equity market is also seen in the American Association of Individual Investors survey on page 12. Last week’s American Association of Individual Investors survey showed bullishness rose 0.8% to 29.2% and bearishness fell 6.8% to 40.5%. Bullishness remained below average for the third consecutive week and bearishness stayed above average for the fourth consecutive week. The decline in bearishness means the survey inched away from the bull/bear split of 20/50 which is rare and very favorable. Nevertheless, the 8-week bull/bear is minus 4.4% and closing in on a positive reading of minus 7.0%.

All in all, we see the rise in investors’ bearishness and the decline in long-term interest rates to be more positive than negative for the equity market. We would be more concerned if these were reversed. The February jobs report will be released next week, and it could be a market-moving event. However, we do not expect it will show a major change. The technical condition of the stock market has deteriorated a bit this week but is in line with a 10% correction which is long overdue. Recent weakness in the equity market carried the S&P 500 below its 50-day and 100-day moving averages for the first time since January 13, 2025. The Dow Jones Industrial Average is the outperformer and is trading above its 100-day moving average. The Nasdaq Composite index is currently below both moving averages and the Russell 2000 index, the weakest of the four indices, is trading below its 200-day moving average. This is the indicator to watch since it is about to test an uptrend off its 2023 low. The 25-day up/down volume oscillator is at 0.33 this week, neutral, but down for the week. This oscillator rose close to an overbought reading of 3.0 or greater, twice this year, without reaching overbought to confirm the recent advance. The 10-day average of daily new highs is 172 this week and new lows are averaging 104. This combination of daily new highs and new lows above 100 is a change that turns this indicator from positive to neutral. The NYSE cumulative advance/decline line made a new high on February 18, 2025, confirming the SPX high on February 19, 2025. In sum, breadth indicators are weaker this week but continue to have a long-term bullish bias. See page 9-11.

Gail Dudack

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If you own a business that is part of the traditional mainstream of any industry, you will probably be very skeptical of any innovative upstart that enters your world. Not all upstarts are disruptors, but some are, and a few are legendary. For example, in 1994, Amazon.com, Inc. (AMZN – $226.65) led by Jeff Bezos, began a new online marketplace for books and soon became a massive disruptor to traditional bookstores. Not only did Amazon deal a major blow to Barnes and Noble (founded in 1873), but over time it changed the entire retail industry. Change is not easy for anyone. I remember being upset when the Borders bookstore closed in my neighborhood in 2011. Borders was a special place where I could take my young son on a Saturday morning, and he could peruse Manga (Japanese comic books) while I sipped a cappuccino at the instore coffee bar. I was an early skeptic of Amazon. Nevertheless, I am now an Amazon Prime member. Technology has and continues to change many industries, and artificial intelligence will take this to another level. In the end, bookstores have faded away, just like Blockbuster, the video store chain ended when streaming became available. It is impossible to say right now, but technology may also be changing politics.

President Trump has always been a disruptor. But in his second term, Elon Musk, and his expertise in technology, artificial intelligence, and business, may become a true disruptor of the political scene as we know it. By combining modern technology and business acumen to find redundancies, fraud, and dark pools of money in the political system, we wonder if Washington DC will ever be the same. Transparency of government money flows has been absent for generations and Washington DC is bereft of modern software systems and people who know how to use them. So, Elon Musk, by posting his findings on the DOGE website, is educating the voting public of the inner workings of federal agencies. This may be why we are seeing so much head spinning and uproar in the federal government this week. However, if this disruption actually results in reducing the federal deficit and making the government more efficient, we cannot imagine how anyone could be opposed. Nonetheless, it will mean many career federal workers will lose jobs and we doubt that they will go quietly.

The stock market has clearly taken the worries about tariffs in stride. The S&P 500 index scored a record high this week, and most of the other popular indices, including the Russell 2000 index, are not far behind. See page 11. Our 25-day up/down volume oscillator is at 2.77 and closing in on an overbought reading. In this indicator an overbought reading that lasts a minimum of five consecutive trading days or more, confirms a new high. What this would signal is that volume is supporting higher prices. See page 12. Last week’s American Association of Individual Investors (AAII) survey indicated that bullishness fell 4.9% to 28.4% and bearishness rose 4.4% to 47.3%. Bullishness has declined 15% in the last three weeks and bearishness has increased 18%. These numbers are close to a bull/bear split of 20/50 which is rare and favorable. The 8-week bull/bear is minus 2.6% and neutral but closing in on a positive reading of minus 7.0%. See page 14. In short, the technical backdrop of this stock market continues to be favorable.

Conversely, valuation is not supportive of equities, but this is not new. Momentum, hope, and sentiment have been overruling valuation for two years. The SPX trailing 4-quarter operating multiple is 25.8 times, and well above all long- and short-term averages. See page 9. However, we have noticed that analysts have been raising their 2024 earnings estimates as fourth quarter earnings season ends but simultaneously lowering estimates for 2025 and 2026. Fears of economic slowdown and higher inflation as a result of tariffs appear to be the underlying cause of earnings forecasts falling, but we believe this is overdone. If we are correct, there will be positive earnings surprises on the horizon and that should support equities. See page 10.

Recent inflation data was unfriendly, but the consensus has already shifted to no Fed rate cuts for the near future, so this did not impact financial markets. Headline CPI rose from 2.9% YOY to 3.0% YOY and core CPI increased from 3.2% YOY to 3.3% YOY. Owners’ equivalent rent remains high, but it did inch down from 4.8% YOY to 4.6% YOY. The areas of concern in January’s report were transportation, which rose 1% over the month, and 3.2% YOY, and eggs, which are now in short supply due to the avian flu. The index for meat, poultry, fish, and eggs soared to 6.1% YOY in January, up from 4.2% YOY in December, but egg inflation should be temporary. For January, food at home rose 1.9% YOY (up 0.1%), but food away from home fell to 3.4% YOY (down 0.2%). See page 3.

Service sector inflation is slowly ratcheting lower, but it remains high at 4.2% YOY. Services less rent of shelter was 3.9% YOY, down from 4%. However, most core indices have been trending up, not down in recent months. One of the Fed’s favorite inflation benchmarks is all items less food, shelter, and energy, and it rose to 2.3% YOY, up from 2.1% YOY in December. See page 4.

The PPI indices had relatively small changes in January. The finished goods index was 2.9% YOY, up from 2.8% YOY, and core finished goods rose 2.2% YOY down from 2.6% YOY. PPI final demand was 3.5%, unchanged from December, but still at the highest pace since February 2023. The main issue regarding these benchmarks is that rising inflation indices also mean the real fed funds rate is falling, leaving the Fed no room to lower rates. Unless inflation data improves in coming months, the consensus view could shift from Fed rate cuts to Fed rate hikes in 2025. See page 5.

January retail sales were solid. Advance estimates for total retail and food services sales for January 2025 were $723.9 billion (seasonally adjusted), down 0.9% on a monthly basis, but up 4.2% YOY. Total sales excluding motor vehicles and parts were up 3.7% YOY and excluding autos and gasoline stations were up 3.9% YOY. Motor vehicle & parts dealers rose a solid 6.4% YOY and gasoline stations increased 2.0% YOY. General merchandise store sales increased 3.7% YOY (an acceleration) and nonstore retailers rose 4.7% YOY (a deceleration). See page 6.

Industrial production rose 0.5% in January following an upwardly revised 1% gain in December. The overall industrial index rose 2% YOY. Manufacturing output rose 1% YOY and mining production rose 3.4% YOY. Utilities output, which can be volatile and weather-dependent, rose nearly 7% YOY. Overall, total capacity utilization rose from 77.5% to 77.8% YOY – the highest since August 2024 – and is back in line which levels seen prior to the pandemic. See page 7. Retail sales and industrial production reflect a healthy level of consumption and an expanding economy; however, the housing market is showing some signs of weakness. After three consecutive months of improvement, the pending home sales index fell from 78.5 to 74.2 in December. The National Association of Home Builders confidence index for February also fell for the first time in seven months, dropping from 47 to 42, with the greatest weakness seen in the expected sales over the next 6 months, which declined from 59 to 46. High mortgage rates are one of the reasons President Trump is lobbying for lower interest rates; but this is out of his control. Meanwhile, the housing sector may be slowing.

Gail Dudack

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The 3-week-old Trump presidency continues to generate multiple headlines every day and this week was no exception. The big news was that the United States imposed a 25% tariff on imports of aluminum and steel and also cancelled exemptions for major suppliers such as Canada and Brazil. Trump also imposed a blanket 10% tariff on imports from top trading partner China and threatened a 25% barrier on all imports from Canada and Mexico, as well as looking at new reciprocal tariffs on imports of cars, computer chips and pharmaceuticals. These actions triggered condemnations by Mexico, Canada, and the European Union and ignited fears of a trade war; yet the stock market was unmoved. In our view, this stoic reaction by the market was rational because from a purely economic perspective these tariffs will be very troublesome for Mexico, Canada, China, and other major exporters to the US, but they are unlikely to be much of an issue domestically. And as we noted previously, a strong dollar will help to mute the impact of tariffs. More importantly, these tariffs are more likely to change the behavior of consumers and corporations and nullify much of the impact of tariffs. At least this is the long-term goal and US equities appear to have figured this out.

Gold has risen 16% since Trump was elected and the media has attributed this to the unpredictability of President Trump and the potential of trade wars; however, many precious metal analysts have noticed that demand for gold from abroad, particularly China, has increased and this is a reaction to their concern of weakness in their own currencies and a fear that tariffs will pressure their already declining economies. However, our favorite event of the week was the 30-minute press conference in the Oval Office with President Trump, Elon Musk, and X Musk, where Elon detailed much of what DOGE is doing and finding. Plus, Elon gave a mini course in business discipline and accounting. Nevertheless, the star was little X who clearly stole the show. (https://www.foxnews.com/video/6368671861112)

Overall, the story of the week was the resilience of the stock market even though a wave of tariffs were being imposed. Perhaps more surprisingly, our technical indicators improved this week. The 25-day up/down volume oscillator is at 1.42 this week, neutral and down a bit from two weeks ago when it was closing in on an overbought reading of 3.0 or greater. Nevertheless, it has a bullish bias. See page 14. The 10-day average of daily new highs is 162 this week and new lows are averaging 75. This combination of daily new highs above 100 and new lows below 100 is definitely positive. But the surprise of the week was the NYSE cumulative advance/decline line which made a new high on February 6, 2025. The previous high was made in November, generating a period of nonconfirmation; however, this new high confirms the current advance. See page 15. Last week’s AAII survey showed bullishness fell 7.7% to 33.3% and bearishness rose 8.9% to 42.9%. Bullishness is now below average, and bearishness is above average, which is a favorable combination for the equity market. See page 16. All in all, these indicators, along with the charts of the popular indices, are all bullish.

What is not bullish is the growing federal deficit. This is shown on page 3, with newly released data from the CBO, the fiscal 2024 (September 30, 2024) deficit was 6.2% of GDP. However, new Treasury data show federal debt subsequently grew $711 billion in the last three months of 2024, and the 12-month deficits-to-GDP rose to 6.9% (October), 7.1% (November), and 6.8% (December). This combination of rising deficits and rising interest rates has lifted interest payments as a percentage of outlays from 5.3% in 2020 to 13.1% in 2024. These deficit trends are unsustainable. See page 3.

Nonetheless, economic data has been favorable. The ISM nonmanufacturing index fell 1.2 points in January but continues to show an expanding service sector. See page 4. The NFIB small business survey dipped 2.3 points in January but remained above the long-term average of 98 for the third consecutive month. See page 5. The January employment report showed a 143,000 increase in the month of January, while revisions to previous months added an additional 100,000 more jobs. The household survey showed the unemployment rate fell slightly from 4.1% to 4.0% in the month. See page 6.

Unfortunately, the January employment release is a difficult report to analyze due to the annual benchmark revisions in the establishment survey, the Census population revisions to the household survey, and the updating of seasonal adjustments in both surveys. This year the establishment survey benchmark revision for March 2024, without seasonal adjustments, lowered employment by 598,000 workers, or 0.4%. This was unusually large since the typical revision is plus or minus 0.1%.

The population adjustment to the household survey increased the civilian noninstitutional population (age 16 and over) by 2.9 million and increases were substantial for Asians and Hispanics. The total civilian labor force increased 2.1 million, including an increase of 2.0 million in employment and 105,000 in unemployment. The number of people not in the labor force increased by 765,000. As is its usual practice, the BLS does not revise official household survey estimates for earlier months and therefore this bump in population is very obvious in many of the charts on the following pages. The uptick in January employment in the household survey depicts a 1.7% YOY growth rate, which is well above the long-term average of 1.5%. However, this spike in employment could be less an increase in real workers and more an increase in the Census Bureau’s estimate of population growth. Still, we are relieved that the household survey, which had been showing no employment growth for much of 2024, could simply have been an undercounting of both population and employment.

Nevertheless, the January report is dubious for a variety of reasons. We know that seasonal adjustments were revised in both surveys, however there were unusually large differences between the seasonal adjusted data and the not-seasonally-adjusted data this month. For example, January’s establishment survey showed the addition of 143,000 new jobs in seasonally adjusted data, and a loss of 2.85 million jobs in the not-seasonally adjusted data. That is a strangely large discrepancy.

In the household survey, January’s seasonally adjusted unemployment rate fell from 4.1% to 4.0%, but the unadjusted unemployment rate for those 16 and over rose from 3.7% to 4.2%. Unadjusted unemployment rates for men, women, and workers by level of education also rose in January. Only the not seasonally adjusted unemployment rate for those with less than a high school diploma actually fell from 5.6% to 5.2%. Those with a bachelor’s degree or higher saw their unemployment rate ease from 2.4% to 2.3%. But other educational categories saw a rise in their unemployment rates, contrary to the decline in the overall rate. Similarly, native versus foreign employment statistics, which are not seasonally adjusted, showed the native unemployment rate rising from 3.7% to 4.3% and the foreign unemployment rate rising from 4.3% to 4.6%. The seasonally adjusted employment-population ratio and labor force participation rates both rose 0.1% due to Census revisions, but the unadjusted employment population ratio fell from 59.3% to 57.6%. In sum, January’s job report is filled with contradictions. We wonder if Elon Musk and his minions can do something to improve government agency data.

Gail Dudack

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The first two weeks of Donald Trump’s presidency have been both hectic and head-spinning. And while some might call these past few days chaotic, the new administration has definitely been impactful, transparent, accessible, and game changing. And despite a tremendous amount of pearl-clutching by the media, the much-telegraphed tariffs on goods from Mexico, Canada, and China did not hurt the financial markets like most economists expected. To date, what has materialized are postponements due to potential political agreements with Mexico and Canada. The objectives here appear to be the monitoring of both borders to help prevent illegal immigration and the smuggling of illegal and lethal fentanyl.

Tariffs and deals with China may be more difficult to resolve in the near term, but China is also pivotal in terms of illegal fentanyl and that may be one of the longer-term goals. Meanwhile, economists and analysts are revising forecasts on future corporate earnings, inflation, and the economy based upon the administration’s actions, but if one is honest, no one knows how the tariffs will play out, even the negotiators. These tariffs are part of a process and Trump’s administration is currently working on a vast number of negotiations making outcomes extremely difficult to predict. Most importantly, one should not let personal political views color one’s forecast. In our view, it is important to analyze economic data skeptically and to make predictions objectively and separately from media headlines.

What is known is that Donald Trump used tariffs successfully in his first term and it did not impact inflation. What it did do was change American and global corporate behavior and as a result China lost manufacturing to other areas of Asia, such as Vietnam, Malaysia, and Cambodia. President Trump has been clear that this is another one of his goals and he is using the threat of tariffs as a catalyst to bring manufacturing back to the US. It is important to remember that inflation was 1.9% YOY when Trump left office and President Biden maintained Trump’s tariffs when he came to office.

This time it is different however because inflation is already a problem and service sector inflation has been sticky for several months. Farmers are facing rising feed stock costs, and this will trickle down into higher food prices. On the other hand, energy prices are expected to move lower. This could offset some of these threats and a higher dollar will also mute the potential impact of tariffs on imported goods. (But it will also be a handicap for exporters.)

What is also known is that President Trump takes pride in his pledge of “promises made, promises kept,” and this will be the cornerstone of his four years. To this end, the key financial-related promises are to increase energy production, increase jobs, reduce or eliminate government waste, lower taxes, and put the US in better fiscal shape. While not being specific, in our view, putting the US in better fiscal shape is apt to include a mixture of boosting economic activity and shrinking annual deficits. This combination would thereby lower the total public debt-to-GDP ratio which rose to 120% as of December 19, 2024 (https://fred.stlouisfed.org/series/gfdegdq188S). These are ambitious goals, but goals that are difficult to challenge.

The last week has also been hectic in terms of corporate earnings and economic releases. According to an S&P earnings scorecard, of the 211 companies in the S&P 500 that have reported earnings for the fourth quarter, 76.8% reported above analyst expectations. In general, earnings have helped boost equity prices.

Economic releases were mixed this week. In December, personal income grew 5.3% YOY, disposable income grew 5% YOY, and real personal disposable income (RPDI) grew 2.4%. RPDI fell from 2.6% in November and was below the long-term average of 3.2% for the tenth month in a row. See page 4. Government workers had the largest increase in wages in December with a gain of 6.5% YOY, and this pattern of government wages growing faster than private sector wages, has been ongoing since November 2022. Manufacturing workers had minimal increases in wages in the last six months of 2024. Meanwhile, government transfer payments and supplements to wages were robust in 2024. See page 5.

Personal consumption expenditures rose 5.7% YOY in December and service sector expenditures grew 6.7% YOY. In short, the growth in spending was greater than wage growth for most households, so it was not surprising that the savings rate fell from 4.3% to 4.1% at year end. Given this decline in household savings and the persistent rise in prices, household consumption could encounter headwinds in 2025. See page 6.

Average weekly earnings grew 3.5% in December, which was above the 2.9% YOY rate of inflation. However, this gap is narrowing since wage growth has been decelerating and inflation accelerating in recent reports. The PCE deflator rose from 2.4% in November to 2.6% in December and core PCE deflator was unchanged at 2.8% YOY. These figures were a disappointment to the consensus, and it has led to a consensus view that the Fed is unlikely to cut rates again in the near future. We agree. As previously noted, our concern is that farmers are currently seeing a rise in core feed stocks, and this will be a future driver of food prices at home and at restaurants. See page 7.

Hopefully, lower energy prices will offset higher food prices in 2025, however the bigger issue is that core inflation indices have been trending flat to higher. The core PCE deflator was unchanged at 2.8% in December. Core PPI was 2.6%, up from 2.5%, and up for the second month in a row. Core CPI was 3.2% in December, down from 3.3%, but has been stuck at 3.3% for three months in a row. This is why we do not expect rate cuts in the near future. Moreover, the real fed funds rate (fed funds minus the PCE deflator) is currently 180 basis points, down from 300 basis point in August. In our opinion, the Fed’s neutral rate is when the real fed funds rate is 200 to 300 basis points. See page 8.

The most favorable economic release of the week was the ISM manufacturing index for January. It was 50.9 and above 50 for the first time in 26 months! Seven of the ten components were higher in the month. Customers’ inventories were unchanged, and the inventories index and order backlog index were lower. The employment index rose to 50.3 and was above 50 for the first time in eight months. The best component was new orders, which increased from 52.1 to 55.1. See page 9. Since the DeepSeek controversy, technology stocks have underperformed, and this can be seen in the performance of the indices. The DJIA is up 4.7% year-to-date, the S&P 500 and the Russell 2000 are up 2.7%, and the Nasdaq Composite is up only 1.8%. Nevertheless, all the indices are in relatively stable and favorable uptrends. See page 12. Our 25-day volume oscillator remains neutral but has a bullish bias. In summary, we would be a buyer on dips.

Gail Dudack

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This week, Liang Wenfeng, the 39-year-old founder of Chinese AI startup DeepSeek, went from being a total unknown to a well-known market disruptor. Out of the blue DeepSeek launched an open-source free AI assistant that it says uses less data and was developed at a fraction of the cost of current services. This triggered a global selloff in technology stocks, and a rout in key stocks like Nvidia Corp. (NVDA – $128.99). Analysts are still determining what this will mean for the AI world. However, the downdraft in equity prices was short-lived, and most stocks rebounded the following day. Still, the controversy will remain. Even though DeepSeek’ s “free” AI is an attractive alternative to many around the world, it collects and stores all user data in China. If it is not TikTok, it is DeepSeek.

Despite the momentary shock of DeepSeek, both the S&P 500 and the Dow Jones Industrial Average remain just fractionally away from setting new all-time highs. The Nasdaq Composite, which was impacted the most by the news, is only 2.2% away from its recent high. The Russell 2000 index, which a few sessions ago was threatening to break below its 200-day moving average, has also rallied and is now above its 100-day moving average and approaching its 50-day moving average. All in all, the charts of the popular indices remain solidly bullish. See page 9.

A Positive Shift in Technicals

More importantly, the 25-day up/down volume oscillator is at 2.16 this week, in neutral territory, but up significantly from a week ago. In fact, it is closing in on an overbought reading of 3.0 or greater. This uptick in the volume oscillator materialized despite the DeepSeek collapse in equities. This is surprising, but 25 days ago the market experienced a 91% down volume day after the Federal Reserve shifted its forecast from four to two rate cuts this year. Twenty-five days later, or on January 27, 2025, downside volume was only 54% of total volume. In short, the DeepSeek decline did nothing to hurt our technical indicators. In fact, the indicator is closer to producing five consecutive days in overbought territory – which would confirm the current advance — than it was a week ago. See page 10.

In addition, the 10-day average of daily new highs is 178 this week and new lows are averaging 50. The combination of daily new highs above 100 and new lows below 100 is a major positive shift and swings this indicator from negative to positive. The NYSE advance/decline line last made a record high on November 29, 2024, but the disparity between this peak and current levels has been narrowed to a net 1880 issues. See page 11. In sum, breadth indicators have turned much more favorable this week.

Investor sentiment also had a big shift this week. The American Association of Individual Investors (AAII) survey showed bullish sentiment jumped 18.0% to 43.4% while bearishness fell 11.2% to 29.4%. Bullishness is no longer below average (and closing in on the positive 25% level), and bearishness is no longer above average. Both levels are currently neutral but note that sentiment came close to a positive signal a few weeks ago. See page 11.

Fed Week

The FOMC meets this week, but it should be uneventful. The CME forecasts a 97.3% probability that no change in policy will take place at this meeting, and we agree. See page 3. It has been our view that there would be two or less rate cuts in 2025. However, the enthusiasm of the small business community since the election could translate into more job growth and therefore no rate cuts in 2025. However, assessing job growth could become extremely difficult in coming months. The January employment report (to be released February 7, 2025) will contain a number of significant benchmark revisions. In August the Bureau of Labor Statistics estimated that one revision would lower the establishment survey by 818,000 jobs. In some cases, data will be revised back to April 2023, some data back to January 2020, and some data not at all. These changes occur every year but revisions typically average only 0.1%. The upcoming revision is anticipated to be a 0.5% decline, or five times the norm.

In addition, fourth quarter earnings releases are expected from 98 S&P 500 companies this week; and to date, the season has been impressive. Currently 81% of companies reporting have beaten expectations. If the post-Covid stimulus years are excluded, 81% would set a record. Equally important is the fact that only 4.34% of S&P companies repurchased 4% or more of their shares in the quarter. This is a relatively low percentage, and it means that the quality of earnings in the quarter is high. See page 3.  

Housing and Sentiment

The housing market displayed green shoots at the end of the year. New home sales climbed to 698,000 annualized units in December, up 6.7% YOY and back above the pre-pandemic average of 600,000. The inventory of new homes for sale was up 1% over the month and the months’ supply of inventory at the current pace of sales was 8.5. The median price for a new home was $427,000, up 2% from a year ago.

Existing-home sales rose to a seasonally adjusted annual rate of 4.24 million, up more than 9.3% YOY, the largest yearly increase since 2021. The median price of a new home was $404,400, up 6% from a year earlier. The months’ supply of existing homes for sale fell from 3.8 to 3.3 and single-family supply fell from 3.7 months to 3.1. This decline in supply should keep home prices stable to higher in coming months. In sum, there was a nice improvement in the housing market at the end of 2024 and it will be important for this to continue. Pending home sales for December will be released later this week, and this index also showed improvement in the final months of the year, rising from 70.6 in August to 79.0 in November. See pages 4 and 5.

The Conference Board consumer confidence index for January was lower but it remains in the middle of the range it has held for the last 3 years. The headline index fell from an upwardly revised 109.5 to 104.1. Both the present conditions and expectations components fell. Similarly, the University of Michigan consumer sentiment index was lower in January after a substantial gain in December. The headline index fell from 74.0 to 71.1; present conditions eased from 75.1 to 74.0 and expectations were down from 73.3 to 69.3. There has been a string of sizeable revisions in both indices in recent months and this makes the overall trend of sentiment surveys difficult to assess. Nevertheless, January’s sentiment readings were much better in January than they were a year ago. See page 6.

In Sum Equity valuation remains high. The SPX trailing 4-quarter operating multiple is 25.7 times, and well above all long- and short-term averages. The 12-month forward PE multiple is 24.2 times and when added to inflation of 2.9%, it comes to 27.1, which is well above the top of the normal range of 14.8 to 23.8. See page 7. By all measures, the equity market remains richly valued and is at levels last seen during the 1997-2000 bubble, the financial crisis of 2008, or the post-COVID-19 earnings slump. However, this has been true for two consecutive years, and it has been ignored. In our view, the odds of better earnings growth in 2025 and 2026 have improved and this may be the most important factor.  

Gail Dudack

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President Donald J. Trump declared in his inauguration address that this would be the beginning of great change and a “golden age” for America. Twenty four hours later it became clear that a big change had indeed come to American politics. It began with Trump describing and signing a number of executive orders in front of cheering crowds at his “inauguration parade” at the Capital One Arena in Washington, D.C. This was quickly followed by a press conference in the Oval Office where he signed more executive orders and answered media questions for nearly an hour. This open and accessible president is in sharp contrast to his predecessor, and it was obvious that President Trump has amazing energy for a man his age — because his inaugural day was already very long yet even after these events his day was still far from over. What was also clear is that like him or not, he is a man more determined, more comfortable, and more prepared in his second term in office.

The Goal is Job Growth

On his first full day in office, along with CEO’s from Oracle Corp. (ORCL – $172.57), OpenAI, and SoftBank Group Corp. (9984.T – $10,075.00), President Trump announced a private sector investment of $500 billion to fund artificial intelligence beginning with a $100 billion investment with an ongoing and previously announced massive Texas-based infrastructure project called Stargate. Personally, we found it inspiring to listen to Oracle’s CEO Larry Ellison discuss the possibilities of this project, particularly in the area of diagnosing and curing cancer, which it has as one of its goals. Trump’s role in this project is to facilitate the project from a regulatory perspective. From an economic perspective, it should generate thousands of jobs both in construction and AI and contribute substantially to economic growth and productivity. More importantly, it keeps AI investment in the US rather than making it easier for corporations to move outside our borders.

The financial press is focusing almost entirely on Trump’s tariffs and pardons, but a closer look indicates that the underlying goal of his economic policy is to create good-paying jobs for Americans. Trump’s threat of imposing tariffs on Canada and Mexico is intended to keep US corporations from building outside the US (where there is less regulation and lower taxes) and to keep good paying jobs at home. In addition, other countries impose tariffs on our exports to them in order to protect their companies, and President Trump is looking to even the playing field and reduce our trade deficit by encouraging countries to offset our imports of their goods by purchasing our American goods and services. In short, President Trump enjoys negotiating and dealmaking.

Whether any of this will work and create a golden age is unknown, but it certainly is a change. Around the world stock markets opened cautiously in anticipation of President Trump’s first day in office, but in the US the day ended with a gain of 538 points in the Dow Jones Industrial Average and with the S&P 500 index moving back above the 6000 level. Equally important was the fact that the yield on the 10-year Treasury bond fell to 4.57% after recently moving as high as 4.8% in recent days. Still, the most important factor of the session was that companies were reporting good profits for the fourth quarter. Companies that beat analysts’ expectations on the first day of this shortened week included Charles Schwab Corp. (SCHW – $80.93), 3M Company (MMM – $146.89), Capital One Financial Corp. (COF – $193.21), D.R. Horton Inc. (DHI – $143.70). KeyCorp (KEY – $17.64), United Airlines Holdings Inc. (UAL – $110.52), and Netflix Inc. (NFLX – $869.68). Note that these better-than-expected earnings results materialized in a wide range of sectors, which is excellent news. Investors have reason to be encouraged by this combination of lower long-term interest rates and rising earnings.

Technical Improvement

Despite a selloff and a bearish tilt in sentiment in the early weeks of 2025, the charts of the popular indices do not reflect anything other than a normal pause in an uptrend. The S&P 500, Dow Jones Industrial Average, and Nasdaq Composite all appear to have successfully tested their 100-day moving averages. More importantly, the Russell 2000 index, which has been the weakest index of all, appears to have successfully tested its 200-day moving average. This is important. See page 9. In all cases, the longer-term uptrends remain intact.

The 25-day up/down volume oscillator is 0.52 this week, neutral, but up significantly from a week ago and this neutralizes the risk of an imminent oversold reading. The recent weakness in breadth data broke an uptrend in breadth that has been in place since the October 2022 low. In short, momentum was the weakest in over two years in early January, but this oscillator is now rebounding. This is favorable because an oversold reading that lasts more than five consecutive trading sessions is a warning and would suggest a decline of more than 10% is on the horizon. See page 10.

Last week’s AAII survey showed bullishness fell 9.3% to 25.4% and bearishness rose 3.2% to 40.6%. Bullishness is now below average (and closing in on the positive 25% level), and bearishness is above average for the third time in eight weeks. It would be unusual for the equity market to have a significant decline with public bullishness this low. See page 12.

Economic News is Mixed, but Fine

December’s CPI report was viewed favorably by investors because headline CPI rose from 2.7% YOY to 2.9% but core CPI fell from 3.3% YOY to 3.2%. In reality, the pace of headline CPI rose a mere 0.4% from 2.749% in November to 2.888% in December. Similarly, the decline in core CPI from November to December was only 0.08%. In other words, there was little change in the rate of inflation in December. This is favorable; however, the current trend of inflation is ambiguous. This ambiguity is partially explained by the chart on page 3 that shows housing inflation has flattened but remains high and above 4%. Meanwhile, medical care pricing is decelerating, while transportation and food prices are rising. In sum, inflation is not one-dimensional, which is what makes it difficult to control or predict. However, if President Trump’s goal of producing more US oil lowers energy prices, this will dampen inflation.

The NAHB single-family index rose one point to 47 in January, due in large part to present sales which rose 3 points and traffic of potential buyers which gained 2 points. However, the next six months sales index fell 6 points to 60. Housing starts jumped 16% in the month of December but were still 4.4% below a year earlier. Single-family housing starts were 2.6% lower than December 2024. Permits were 3.1% lower YOY and single-family permits were down 2.5% YOY. In general, data shows residential construction was decelerating at year end, but homebuilders’ optimism is rising. See page 8. December’s total retail and food sales lagged expectations; however, headline sales grew 3.9% YOY, which was just under the 4.1% seen in November. Overall, it was the fourth straight month of solid sales. See page 6. Year over year gains were led by auto dealers, furniture stores, nonstore retailers, and electronic and appliance stores. Goods pricing is falling which undermines total reported sales, and high interest rates are a hurdle for high-priced items, nevertheless, this report translates into a rather impressive performance for retailers in December. In sum, economic news supports equities.  

Gail Dudack

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This strategy weekly is being written prior to the release of December’s CPI report, and many commentators are suggesting that the report could be a market moving event. Most economists are expecting inflation to trend lower in 2024, but with the caveat that tariffs could increase inflation. However, December’s CPI report is coming out before tariffs can be used as an excuse for inflation, and if inflation is higher than expected, the market is apt to respond poorly.

This belated fear of inflation – belated because inflation data has already been flat to higher for several months — is hiding another issue which we have discussed previously. The underlying issue of this inflation fear, in our view, is that stock prices have been driven up by speculators betting on an accommodative and rate-cutting Federal Reserve to support the financial markets and their investments. In our view, a fear of inflation and higher interest rates is irrational at this juncture since a stronger economy that provides good corporate earnings growth should counterbalance the risk of higher interest rates. In other words, the real concern for investors should be earnings growth. Nonetheless, if inflation fears shake out speculation in the equity market, it is a good thing in the long run. Speculators are the icing on the cake, the real cake is investors who buy for fundamentals not momentum. Momentum works in the short-term; fundamentals work in the long term. In sum, focusing on fourth quarter earnings results and corporate projections for this year are the important issues in coming weeks.

However, as the 10-year Treasury bond yield rises to 4.78%, analysts have begun to focus on the S&P 500’s earnings yield and are concerned. We see this shift in the consensus’ focus from momentum to fundamentals to be a long-term positive.

The earnings yield (earnings divided by the S&P 500 price) is a good short cut for assessing the appeal of stocks versus bonds; however, like most fundamental benchmarks, it varies depending upon one’s inputs. The current IBES 2025 earnings estimate of $273.91 creates an earnings yield of 4.7% and the S&P/Dow Jones estimate of $271.22 generates an earnings yield of 4.6%. These are in line with, or slightly below the current bond yield, however, stocks also have a dividend yield. The current dividend yield of 1.3% generates a total equity yield of 6% for equities. This means the earnings yield still favors equities, but by a slim margin. The risk is that things could change later this year. Bond yields, which are threatening the 5% level, could move higher this year, which is why some institutional investors are shifting money from equities to bonds. Still, earnings growth in 2025 could be better than expected and this would favor equities. However, if the economy is stronger than expected and interest rates move higher (a natural event in a strong economy), earnings growth could exceed expectations and continue to favor equities. In short, earnings growth and higher interest rates can exist together, and history shows that this is often the case.

Data Shows Strength

Most recent economic releases are pointing to a stronger economy. The NFIB small business optimism index jumped 3.4 points in December to 105.1, the highest level since October 2018 and the second consecutive month above the long-term average of 98. The uncertainty index plunged 12 points to 86, its lowest level in six months. Both indices are showing great optimism after the re-election of Donald Trump, which is not a surprise given the promise of less regulation, lower energy prices, and a business-friendly environment; however, this is the opposite of the tone of many financial articles. A bigger surprise in the survey was the improvement reported in actual sales and earnings in December. Although the net index remains in negative territory, the actual earnings index increased from a low of -37 in August to -26 in December. Similarly, actual sales trends improved from a low of -20 in October to -13 in December. Small business owners also showed great expectations for the economy (up 16 points to 52), sales expectations (up 8 to 22), and credit conditions (up 3 to -2). See pages 3 and 4.

December’s employment report was much stronger than expected with an increase of 256,000 jobs and the unemployment rate inching down to 4.1%. What impressed us more was the improvement in the household survey which indicated an increase of 478,000 jobs and a decrease of 235,000 unemployed during the month. This combination lowered the unemployment rate to 4.1%.

Our favorite indicators are the year-over-year increases in jobs as reported by the establishment and the household surveys. In December, the establishment survey indicated job growth of 1.4% YOY, slightly below the long-term average of 1.7%, but still a healthy increase. The household survey showed jobs growing 0.3% YOY, which is low, however, it was an important reversal from the 0.4% YOY decline reported in November. The household survey has been on our radar because of the negative growth rate seen in November, so this report was good news. See page 5.

The December jobs report was also in line with the recently released JOLTS report for November. This report showed total nonfarm job openings of 259,000, with the majority of these openings in the professional and business services sector. This was a favorable development; however, it does not explain why the decline in the unemployment rate in December was greatest for those with less than a high school degree. The unemployment rate for this group had been as high as 7% in August but fell from 6% to 5.6% at yearend. The unemployment rate for those with a bachelor’s degree or higher fell from 2.5% to 2.4%. In sum, the job market has been improving on many levels. See page 6. In addition, average weekly earnings grew 3.5% YOY in December, which remains above the level of inflation which is currently 2.75%. This means real earnings are increasing. See page 7.

However, there is a potential problem for interest rates in 2025 and it may not be inflation. White House data indicates that the fiscal 2024 deficit was $1.5 trillion or 6.6% of GDP. This is well above the long-term average of deficits-to-GDP of 3.6%. The White House estimates the current fiscal 2025 deficit will be $1.4 trillion, representing 6.1% of GDP. These deficit levels are unsustainable and represent a major challenge for the incoming administration. Interest payments on government debt totaled $881.7 billion in fiscal year 2024 which was 13.1% of total government outlays and is up from 5.3% in fiscal 2020. See page 9. Our only consolation is that the incoming administration has focused on the deficit as a problem, rather than ignoring it.

Market and Breadth

Many prognosticators are turning bearish for 2025, however, to date, the charts of the indices do not reflect anything other than a normal pause in an uptrend. The S&P 500 is testing its 100-day moving average, the DJIA is trading slightly below its average, and the Nasdaq Composite is trading well above this benchmark. The Russell 2000 is the index to watch since it is getting perilously close to testing its 200-day moving average. This will be an important test of market strength or weakness. See page 13.

The 25-day up/down volume oscillator is at negative 2.01 this week, neutral, but down significantly from a week ago and potentially closing in on an oversold reading of minus 3.0 or less. An oversold reading that lasts more than five consecutive trading sessions is a warning and would be a signal that the bullish momentum that has been in place since the October 2022 low has been broken and a decline of more than 10% is on the horizon. Again, an important test is on the horizon for the equity market. See page 14.

Gail Dudack

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

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

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

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

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

Good News?

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

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

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

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

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

Dear Santa Claus

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

Gail Dudack

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

Positives

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

Negatives

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

Inflation Dilemma

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

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

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

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

Price Action

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

Gail Dudack

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

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

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

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

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

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

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

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

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

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

Gail Dudack

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