Just in time for the holidays
Reasons to believe the equity rally has legs.
Travel this week took me to Minneapolis, where I spoke on a panel before 400 financial planners. The audience generally expressed concern for the economy & markets and was surprised all three speakers are bullish for 2024. In his charming accent, the Brit expressed his awe of a U.S. consumer who “continues to spend more money they don’t have to impress someone they don’t like.” Truer words…. Reminding us that “hating the government is not an investment strategy,” the New Jersey born economist observed that, “pessimists sound smart; optimists make money.” Amen brother! Yardeni Group thinks the big surprise in ’24 won’t be a recession but stronger-than-expected growth. It notes productivity pops such as Q3’s 2.2% y/y typically occur at the tail end of recessions and in early recovery periods. That fits with its take (and our equity CIO’s) that the economy since early ’22 has been experiencing rolling recessions, not an economy-wide one. Goldman Sachs sees lots of growth tailwinds ahead: strong real household income growth. A smaller drag from monetary and fiscal tightening. A recovery in manufacturing. An increased willingness among central banks to deliver insurance cuts if growth slows. And increasingly benign inflation—a core rate that, having fallen from 6% in 2022 to 3% sequentially across global economies, could reach 2-2.5% by year-end ’24.
What about disinflation? The most notable takeaway from Q3 apartment REIT earnings was how quickly rental rate momentum hit a wall. JP Morgan says new supply (apartment vacancies back to pre-pandemic levels and new units under construction topping the previous all-time high for 12 consecutive months) is eviscerating landlord pricing power. The Manheim Used Vehicle Index showed October used-car prices falling the most in three months and accelerating downward. Housing (of which rents are a dominant component) and used-car prices represent more than half of core CPI. Also, dollar strength has import price weakness filtering down to consumer goods, and softening wage costs are pressuring core services inflation. To be sure, wage growth remains elevated but has moderated significantly from a year ago (with rising productivity further easing employer costs). Average hourly earnings in October rose at their slowest pace since June ’21. This year’s growth in labor force participation by women (aided by WFH's popularity—an estimated 30% of all days worked are now done at home, vs. 5% before the pandemic) and immigrants also are helping ease labor costs, a trend Wolfe Research sees continuing at a slower pace. Whether the labor market is normalizing or heading for something worse is the question. Economic theory suggests the unemployment rate is simply rising to its implied rate given GDP growth. But rare in history does the jobless rate simply go up a little and stop. As long as elevated profit margins remain OK (growth in costs for the S&P 500 continue to decelerate), broad-based layoffs are unlikely (weekly layoffs remain near all-time lows). But if that dynamic changes all bets are off.
Thursday ended an 8-day S&P up stretch. It was driven by technicals (by Oct. 20, nearly all S&P industries were trading below their 50-day moving average, a sign the market was oversold). Sentiment (AAII was unusually depressed). Rising peak Fed expectations. A decline in oil prices (NYMEX crude has fallen $17 off its September peak to $77 a barrel). And of course, falling bond yields. Wolfe believes last week’s sharp decline across the curve was driven by an epic short covering rally in the Treasury market, not a longer-term trend. In fact, it thinks the 10-year Treasury could soon trade back to a 5% yield, a view Gavekal Research shares. It says investors “will have to learn to live with” yields that revert indefinitely to their pre-2008/2020 crises range before unprecedented intervention disrupted markets. Perhaps. Short of a recession, higher for longer, longer seems justifiable. That may help explain the negative attitudes toward a Q3 earnings season where 82% of companies beat estimates. But after the best week of ’23 during the best month of the year historically, the S&P remains in a strong position to break out to a new year-to-date high (above 4,635), Evercore ISI says. Record shorts in the bond market and a “Doom Loop” of negativity offer a nice contrarian bullish package to close out the year. Just in time for the holidays.
Positives
- A tailwind for manufacturing? An inventory rebuild may be underway, with September wholesale inventories rising more than expected—sales were up 1.1% m/m ex-petroleum—even as the inventory-to-sales ratio dipped below its 2019 average. Piper Sandler isn’t so sure restocking is needed, given real goods inventories (ex-autos) are still far above trend.
- A tailwind for housing? With the average 30-year mortgage rate plunging 30 basis points the past two weeks to its lowest since the end of September, mortgage purchase applications jumped 3% (156% annualized) over the week ending Nov. 3, the largest 1-week gain since June. Buyers could use a break—the average monthly mortgage payment has essentially doubled since the start of 2022 on a doubling in mortgage rates and home prices that remain near record highs.
- A tailwind for consumers At $3.40 a gallon, the average AAA gas price is down 40 cents from 2022. That translates into $54 billion of annual savings, Renaissance Macro calculates, freeing up 0.3 percentage points of consumption elsewhere as the holiday shopping season kicks off.
Negatives
- Lag effects A Q3 New York Fed survey puts the percentage of seriously delinquent (90 days or more) auto loan balances at a 13-year high, and with the average credit card rate 21% vs. a pre-pandemic 15%, the number of newly delinquent card borrowers has moved above pre-pandemic levels. Credit card debt now exceeds $1 trillion, having risen the most in a 12-month span since ’99. Business lending standards are still tightening, the Fed’s bank Senior Loan Officer survey found, further squeezing small businesses.
- A headwind for GDP Weaker overseas growth and a robust U.S. consumer caused the trade deficit to widen more than expected in September. August was revised up as well. The worsening gap reflected an increase in imports, primarily consumer & capital goods and autos, that dwarfed an increase in exports. Services exports were revised lower. A widening deficit is a negative for GDP growth.
- A little less largesse October’s budget deficit improved slightly but remained above $2 trillion. One-time payments of deferred taxes were nearly offset by a 69% jump in interest cost, which on a net basis has surpassed 15% of tax revenues. The month saw a big roll-off of consumer aid, $240 billion annualized (food stamps, Medicaid, tax refunds and student loans).
What else
Election Day is 360 days away Dems flipped the Virginia legislature, held onto the Kentucky governor’s seat, won the Ohio abortion ballot question and added to their Pennsylvania Supreme Court majority, giving a deeply unpopular Biden something to run on—reproductive rights and MAGA extremism, Strategas Research says. The GOP has now lost 6 of 7 elections since Trump’s 2016 victory.
Election Day is 360 days away With the White House typically deploying all its policy tools to prime growth and boost prospects, the S&P has never declined in the year a sitting president runs for re-election. S&P performance in the three months leading to Election Day should reveal if the strategy is working, Strategas says, as it has an 83% accuracy rating predicting if the incumbent will win.
Election Day is 360 days away The 2020 presidential election was decided by 42,922 combined votes in Arizona, Georgia and Wisconsin. The margin was even closer in 2022’s midterms: 11,792 combined votes among five districts in Arizona, California, Colorado and New York flipped the House. It marked the sixth straight midterm election (’02, ’06, ’10, ’14, ’18, ’22) with at least one chamber of Congress turning, a first in modern times.