The origin of the word 'politics'
Geopolitics are trumping the economy and earnings among investor worries.
“It derives from the Greek ‘poly,’ which means the ‘many,’ and the word tic(k), which is a blood-sucking insect,” an advisor advised me. Blood sucking, but first, Paycheck Protection Program and many advisor stories of small business clients receiving “for no reason” government stimulus largesse during the pandemic and wishing to invest their windfalls. “I’ve heard a dozen such stories,” shared my local colleague; for that matter, so have I. Here in Tampa, many are partying like the “great Gatsby,” intent on enjoying life no matter what. This is expensive for the dating scene, where the ladies want to know “where are you taking me next?” as they pose for Instagram. My reading from Tampa advisors is a reluctance to move beyond cash, though they are now legging into longer-term Treasuries while their clients are worried. One advisor told us about a client who wanted to cash out all his holdings owing to geopolitical risk. He “talked his client off the ledge,” selling only a portion of his portfolio and considers this a bullish “ring the bell moment.” Geopolitical concerns permeated end client meetings as well. So much for, “It’s the economy, stupid.” Here we print the best GDP quarter since 2021 (more below) with earnings on track for their first positive quarter in four (more below) and all anyone wants to talk about is overseas wars, a dysfunctional D.C., runaway debt … and inflation, whose cost is instability, then a new, higher price level. A bag of potato chips (no one raises their hand when I ask audiences, “Who doesn’t like potato chips?”) costs 50% more than it did pre-pandemic, and a simple salad in this beautiful city costs $22!
Difficult market environments have a way of making bears and bulls look foolish. As evidence, Evercore ISI cites the small-cap Russell 2000, which at the precipice of breaking its 2022 lows, was a strong outperformer Thursday vs. the Nasdaq, which remains at an all-time wide ratio vs. the small-cap index. One day does not turn a 20-year trend, but persistent yield pressure could act to compress growth stock multiples while a re-steepening yield curve could aid beleaguered small caps. Renaissance Macro finds it noteworthy that NYSE breadth turned negative this week. When the S&P 500 also is negative, history suggests positive returns lie ahead. With a majority of mutual fund fiscal years ending this month, tax-loss selling may be playing an unappreciated role in October’s sell-off. It’s not just equities, where half of the S&P is down. Fundstrat notes that 13 of the 15 largest bond funds and 13 of the 15 the largest bond ETFs also are down YTD, one of the worst years for bonds in the last 30. The S&P’s stagnation since summer is not unusual. Equities tend to flatline from early July to late October, with the back half of that period typically experiencing declines. On average, today is the day it all turns around, Deutsche Bank says, with the Santa rally commencing thereafter. Earnings could provide a lift, too. Nearly 80% of S&P companies that have reported beat estimates, with EPS growth at 12% y/y, surprising positively by 8% and with eight of 11 sectors printing healthy earnings growth. We are bullish for November (historically the strongest month of the year) and into year-end (see “It’s always darkest before the dawn”).
Advisors want to talk politics—one advisor argues there is a growing polarization between the haves and have-somes who are joining the have-nots in a worsening tribalization. He could be onto something, as millennials have it a lot worse than boomers for the foreseeable future. No doubt we boomers have been beneficiaries of a massive wealth transfer. Since 1980, U.S. government debt jumped from 31% of GDP to 120%, and 10-year Treasury yields fell from 12% to 4.6%. This one-two punch pushed household net worth up 780% over that span, from $17 trillion (3.5x nominal GDP) to $150 trillion (5.5x GDP, a record high). The bulk of that went to boomers, who also have locked in low mortgage rates (if they owe anything at all) while millennials have seen their mortgage debt/costs soar since 2021. Hard to see a solution to the soaring costs of financing our government’s record and climbing debt. Wolfe Research expects there realistically will not be political will for a major deficit reduction plan until late in the next presidential administration, nor any kind of acute crisis from rising debt until 2027-28 at the earliest. Perhaps this is why such sober debt news was met at my boomer-ridden client event with laughter. Revenge of the boomers!
Positives
- Consumer reigns supreme Consumers, government expenditures and, surprisingly, residential investment helped real Q3 GDP growth blow past forecasts. The 4.9% annualized gain was the biggest since Q4 2021. Inventory accumulation was a factor, too. On a nominal basis, GDP has risen 22% the past three years (earnings feed on nominal GDP). Consensus expects a notable slowing this quarter but the breadth of Q3’s gains indicate another surprise is possible.
- Manufacturing perking up September durable goods orders soared, driven by nondefense aircraft and parts. Ex-transportation, orders still surprised, adding to evidence of manufacturing’s emergence (October’s flash PMI rose to a breakeven 50, a 6-month high). So-called core orders—nondefense capital goods ex-aircraft—climbed 0.6% on the heels of a solid upwardly revised gain in August, with gains in machinery, computers and electronic products & equipment.
- Consumer reigns supreme Contrary to analysts and Evercore expectations for a muted increase, consumers surveyed by Deloitte expect to splurge over the holidays. Respondents on average plan to boost spending 14% y/y, including 9% more than last year on gifts, 10% more on experiences & entertainment, and 25% more on “non-gift purchases” such as clothing and home furnishings. This morning’s report on September spending surprised in its strength, Redbook same-store sales for the week ended Oct. 21 rose 5% over last year and real spending on goods in Q3 posted a 4.8% gain.
Negatives
- Is the Fed done? September y/y inflation metrics came in somewhat hotter than expected this morning. But under the surface wasn’t as bad. Chair Powell’s preferred pet inflation index, core services ex-shelter (so-called “super-core”) reflected continued albeit sticky moderation. For all of Q3, core PCE inflation was 2.54%, close to the Fed’s 2% target. “Amazing for a quarter with 4.9% real GDP growth led by personal consumption expenditures,” TrendMacro says.
- Has the housing market bottomed? September new home sales hit a monthly YTD high, lifting the 3-month average sales pace to late 2019 levels. Discounting played a role as the median sales price pace was 12.3% lower than a year ago. Still, prices remain elevated, and with the typical 30-year mortgage rate at 8%, the Atlanta Fed said the ability of median-income households to absorb annual homeownership costs sits at a record low. And with the larger existing home market moribund on a dearth of supply, Mortgage Bankers Association purchase applications hit a 21st century low this week.
- Has global economic growth bottomed? Germany’s Ifo index posted its first increase since April, with current conditions and expectations surprising. While still underwater, the gauge suggests the business outlook is bottoming, a positive for the global manufacturing cycle. Chinese data also showed activity slowly improving, an outcome President Xi this week vowed to improve further.
What else
AI to the rescue? Improving productivity, as reflected in the latest GDP numbers, tends to follow bouts of wage inflation, helping drive earnings growth and margin preservation as opposed to such arbitrary factors as globalization and cheap financing of the last 20 years. Bank of America says the last productivity cycle (mid-’80s to mid ’00s) drove 15% S&P annual total returns despite real rates at 3-4%.
“For no reason” government stimulus largesse Covid relief programs continue to boost state & local coffers. The National Association of State Budget Offices’ Fiscal Survey of States reports states’ general fund balances now sit at 4x pre-pandemic levels despite accelerating expenditures (up 8% this year among state & local governments). A big reason: leftover Covid grants that are forecast to last several more years.
Did you know? Bank of America shares the idea for driverless cars dates back to the 1939 World’s Fair in New York, where the concept was introduced by GM. Keeping with the sustainability theme, if your entire life was powered by nuclear energy, the fuel/waste created would only be the size of a soda can.