US Strategy Weekly: Double Black Swans

Stock markets are always uneasy about unpredictable or unforeseen events, and this week two appeared, the dockworkers strike in the East and Gulf coasts of the US and Israel’s ground raids of Hezbollah strongholds in Lebanon followed by Iran’s missile attack on Israel. These two issues could prove to be temporary disruptions, but if not, they could just as easily change the economic and political balance of the financial markets.

The International Longshoremen’s Association union (ILA), representing 45,000 port workers, initiated a strike on October 1, 2024, which was its first large-scale stoppage in 50 years. It is estimated that the strike, which impacts half of the country’s ocean shipping, could cost the economy an estimated $5 billion a day. The US Maritime Alliance (USMX) said it offered union workers wage increases of nearly 50%, up from a prior proposal. However, according to CNBC, the union is pushing for a 61.5% pay increase to compensate for recent rampant inflation. What is worrisome is that this strike could create substantial shortages ahead of the holiday season and reignite inflation. The negative impact due to perishable produce could also be significant to farmers, wholesalers, and consumers. Given the potential this has on future inflation, it is not surprising that Federal Reserve Chair Jerome Powell indicated in comments to the National Association for Business Economics that he is not in a rush to lower rates further.

Oil prices, which had been trending lower, jumped 3% following reports that Iran, which backs the Hezbollah group, launched a retaliatory missile launch against Israel. To date, Israel was not aware of any casualties. Iran is the third largest producer of oil in the OPEC+ group and accounts for about 3% of world production. However, this is modest when compared to the US which ranks first with 22% of the world’s production and Saudi Arabia which ranks 7^th, with 11% of worldwide production (according to US Energy Information Administration data). In other words, the real impact of Middle East turmoil on oil production may not be as large as the market perceives, unless this conflict escalates.

And these are not the only potential market-moving events of the week. The first and only Vice Presidential debate is schedule for October 1st and the employment release for September will be released on October 4^th. The August JOLTS report showed that job openings unexpectedly increased by 329,000 in the month after two straight monthly decreases. This could boost job growth in September, but hiring fell by 99,000, and this is consistent with a slowing labor market. Overall, the JOLTS report suggests September’s job number should not disrupt the market.

Tracking the Economy

Some economists are now suggesting that the futures market is expecting too many rate cuts by the end of the year. We would agree, but in September Euro zone inflation dipped below 2% for the first time since mid-2021, and this implies that interest rates could continue to fall in Europe. In general, recent economic data has been mixed, but not weak enough to suggest that another rate cut is imminent.

In August, personal income rose 7.6% YOY, disposable income rose 7.2% YOY, and real disposable income rose 4.7%. Real personal disposable income, or income after taxes and inflation, has been positive since early 2023 and this year has been averaging 4% year-over-year. This has been supporting household consumption. Wages grew 5.5% YOY in August, led by the 6.5% YOY gain for government workers. On the other hand, workers in distributive industries only saw a 3.7% YOY gain in wages in August. Adding to personal income was government social benefits which increased 10.7% YOY in August, a big bump up from the 4.9% YOY increase seen at  the end of 2023. See page 3.

The Fed’s favorite inflation index the PCE deflator increased 2.24% in August, down from the 2.45% pace in July. Energy goods and service fell 5.0% YOY in August versus a gain of 0.4% YOY in July and this was a major factor in headline PCE falling. If data is not rounded it shows that many other categories of the PCE ticked higher. Excluding food and energy, or core PCE, rose slightly to 2.68% YOY in August from 2.65% in July. The services index was up 3.74% YOY, an increase from 3.70% a month earlier. PCE services excluding energy and housing rose 3.3% YOY in August, up from 3.2% in July. And finally, the housing PCE index increased to 5.27% YOY in August, versus 5.24% in July. See page 4. It seems that most of the good news in August’s PCE deflator came from lower energy costs.

In August, existing home sales were 3.9 million units, down 4.2% YOY, and continuing the negative YOY comparisons seen since August 2021. New home sales were 716,000, down from the 751,000 units seen a month earlier, but up 9.8% YOY. These are not new trends, but home prices are currently decelerating, or in some cases declining, and this could be favorable for new buyers but could also negatively impact homeowners. The price of an existing single-family median home was still increasing and up 2.9% YOY, but this was down from the 3.9% YOY gain in July, and the average of 5.1% YOY seen in the first five months of the year. The price of a new single-family home fell 4.6% YOY versus the 1.6% YOY decline reported in July. See page 5.

Politics and Economics

The final revisions to September’s University of Michigan consumer sentiment survey showed a pickup in sentiment with a rise in the main index from 67.9 to 70.1. This came from an increase in present conditions from 61.3 to 63.3 and a rise in future expectations from 72.1 to 74.4. As the November election approaches it is interesting to see the gaping dichotomy in the University of Michigan sentiment indices when shown by political party affiliation. In August, Democrats appear very upbeat with a headline index of 90.9, current conditions at 86.1, and expectations soaring to 94.0. Conversely, Republican headline sentiment is abysmal falling from 52.6 to 47.4 in August (the lowest on record), current expectations fell from 42.3 to 33.5 and expectations declined from 59.2 to 56.3. See page 6.

Valuation As we stated last week, valuation does not support equities, but if this is the start of a melt-up or bubble, equity valuation will not matter. The SPX trailing 4-quarter operating multiple is now 24.8 times, and well above all long- and short-term averages. The 12-month forward PE multiple is 21.3 times and when added to inflation of 2.5%, sums to 23.8, or the top of the normal range of 14.8 to 23.8. By all measures, the equity market remains richly valued and is at levels seen only during the 1997-2000 bubble, the financial crisis of 2008, or the post-COVID-19 earnings slump. See page 7. Equally important, earnings estimates are declining. The S&P Dow Jones consensus estimate for calendar 2024 is $236.67, down $0.59 this week. The 2025 estimate is at $274.73, down $1.89. The LSEG IBES estimate for 2024 may have had a typo last week but is currently at $241.25 down $1.26 from three weeks ago. The estimate for 2025 is $277.28, down $1.43 and the 2026 forecast is $312.92, down $1.45. Monitoring these estimates will be critical as we approach third-quarter earnings season since equity prices have been rising, but right now, earnings estimates are falling for 2024, 2025, and 2026. It is a bad combination.

Gail Dudack

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