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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