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

Click to Download

This week marks the beginning of third quarter earnings season, and it will include four S&P financial companies reporting earnings this Friday. According to LSEG IBES, analysts are forecasting S&P Composite earnings per share to grow 5% YOY this quarter, led by the double-digit gains projected for the technology, communications services, and healthcare sectors. Conversely, energy sector earnings are expected to decline 3.4% and be a drag on S&P Composite earnings and only low single-digit earnings growth is anticipated for the other six sectors. Still, it may not be the results of this quarter that will capture investors’ attention. The guidance for future earnings growth is what may move markets. Keep in mind that while S&P’s third quarter earnings are forecast to grow only 5% YOY, fourth quarter earnings are estimated to increase a healthy 12.5% YOY. With the popular equity indices recently hitting record highs, double-digit earnings growth might be a necessity to keep the current advance in place. Positive earnings guidance will be particularly important since both Dow Jones S&P and LSEG IBES have been cutting earnings estimates for 2024, 2025, and 2026 for the last four consecutive weeks. See page 11. In our view, rising prices and falling earnings are inconsistent, particularly when the market’s trailing 12-month PE is 24.7 times earnings, and the 12-month forward PE is rich at 21.3 times. See page 10.

With this in mind, PepsiCo Inc. (PEP – $170.42) announced third quarter adjusted earnings of $2.31 that were above analysts’ expectations of $2.29. However, revenue growth disappointed in the quarter and the company cut its forecast for annual sales growth stating that price-conscious consumers were opting for cheaper private-label brands and hurting revenue. As a result, PepsiCo now expects annual organic revenue growth to be below its previous forecast of 4%. When banks come into focus later this week, analysts will be concentrating on changes in net interest income. Net interest income, or the difference between what banks earn on loans and what they pay out on deposits, provided a windfall for the sector as the Federal Reserve was raising rates; but September marked a big change after the Fed’s first rate cut since March 2020. Corporate guidance on net interest income, consumer loan delinquencies, office loan reserves, trading, and investment banking activity will be important for the financial sector this quarter and in the quarters ahead.

The source of the market’s recent exuberance was September’s employment report that was much stronger than expected. The 254,000 increase in payrolls and the unemployment rate falling for the second month in a row to 4.1%, pointed to a robust economy. Even the U6 unemployment rate fell from 7.9% to 7.7% in the month.

But the details of the report were not quite as hearty, in our view. The establishment survey indicated jobs grew 1.56% YOY, slightly below the long-term average of 1.69% YOY. Meanwhile, the household survey revealed a weaker employment picture, which in our view, justifies the expected revision to the establishment survey early next year. The household survey has been showing that year-over-year job growth has been less than 1% in each month of 2024. August’s household survey showed employment declined on a year-over-year basis; however, in September, the survey reported job growth improved slightly to 0.2% YOY. This poor job growth is significant because negative job growth is a classic signal of a recession. See page 3.

There has been a focus on foreign-born versus native-born employment this year because of a growing disparity between the two categories since the end of 2019. In the last 12 months foreign-born employment grew by 1.2 million to 31.4 million people; while in the same period, native-born employment fell by 825,000 to 130.6 million. Keep in mind that this data comes from the household survey which is much broader than the establishment survey which only includes workers on a payroll as reported to the state. The total number of unemployed foreign-born residents was 1.4 million in September and the foreign-born unemployment rate was 4.2%. There were 5.2 million native-born workers unemployed in September and the native-born unemployment rate was lower at 3.8%. See page 4.

The ISM nonmanufacturing index rose from 51.5 to 54.9 in September and all components moved higher. The only indices still below the 50 level were employment and order backlog. The best improvement was new orders which rose from 53.0 to 59.4, the highest reading since February 2023. The ISM manufacturing index was unchanged at 47.2, with five components rising and five declining. The biggest improvement was seen in business activity/production, which increased from 44.8 to 49.8, the best reading since May 2024. See page 5.

Employment in the manufacturing index fell from 46.0 to 43.9 and in the nonmanufacturing survey it fell from 50.2 to 48.1. These declines are in sharp contrast to September’s payroll report which was stronger than expected and makes us concerned that September’s payrolls may be revised lower. The ISM backlog of orders was the only other index in the nonmanufacturing survey that remained below 50, even though it increased from 43.7 to 48.3. In the manufacturing survey the backlog of orders was also weak, inching up from 43.6 to 44.1. Overall, the ISM reports suggested a stable economy with good growth in the service sector, stability in the manufacturing sector, but questionable growth in terms of employment. See page 6.

Consumer credit outstanding grew by $8.9 billion in August, underperforming consensus expectations and decelerating sharply from July’s upwardly revised gain of $26.7 billion. Both revolving and nonrevolving credit grew 0.6% in August versus July, and on a seasonally adjusted basis, revolving credit grew 5.4% (down from 10.7% a year earlier) and nonrevolving credit grew 1.2% (down from 1.9% a year earlier). After inflation, revolving credit grew 2.8% YOY and nonrevolving decreased 1.2% YOY. Nonrevolving credit contracted slightly in June, but falling interest rates had a positive impact on mortgage growth in July and August. The importance of consumer credit is similar to that of job growth. Deceleration precedes contraction and contraction is a sign of a recession. See page 7.

The NFIB small business optimism index was 91.5 in September, in line with the 88.5 to 91.9 range it has maintained since June 2022. This made July’s increase to 93.7 a positive “outlier.” September was the 33rd consecutive month of the optimism index falling below the 50-year average of 98. Plans for capex, employment, expansion, and inventories were somewhat lower, but little changed in the month. See page 8. Actual sales changes for small business owners fell from negative 16 to negative 17 in September and actual earnings rose from negative 37 to negative 34. Nevertheless, both remain historically weak. Sales expectations rose from negative 18 to negative 9 in September. With this backdrop it is not surprising that the NFIB uncertainty index rose from 92 to 103 in September, its highest level since data began in 2017. NFIB stated “Uncertainty makes owners hesitant to invest in capital spending and inventory, especially as inflation and financing costs continue to put pressure on their bottom lines.” See page 9.

There were no significant changes in our technical indicators this week. See page 12 to 16. In our view, stock prices should always be supported by solid earnings growth, and this makes third quarter earnings season critically important. However, earnings do not matter in a bubble market and with liquidity flowing due to monetary easing taking place in Europe, China, and the US, the path of least resistance for equities may still be up.

Gail Dudack

Click to Download

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

Click to Download

Immediately after the Federal Reserve lowered the fed funds rate by 50 basis points last week, the debate shifted from when will the Fed cut rates, to what does a 50 basis-points cut mean? The table on page 3 shows all the easing cycles in Federal Reserve history that began with a cut of 50 basis-points or more. Of the 12 prior instances, five of these cuts occurred with a recession already in place (although that may not have been known at the time) and two other cuts preceded a recession by a few months. One 50 basis-point cut, in 1967, was a one-off, and the Fed soon returned to a tightening policy. In short of the 11 easing cycles that began with a 50 basis-point cut, seven, or 64%, were associated with a recession.

However, the current cycle is unique since the economy and inflation have been driven by a combination of trade disruptions and fiscal and monetary stimulus. With these external factors returning to normal, it is possible, perhaps even likely, that the economy will have a soft landing. But in our view, it is also possible that the economy falters badly once fiscal stimulus fades. The key to the economy’s next move will be the unemployment rate. As seen in the chart on page 3, if the unemployment rate continues to rise, the odds of a recession will increase substantially.

Nevertheless, the current backdrop for the equity market is promising. The Fed has begun to lower rates and its balance sheet, despite quantitative tightening, is $7.23 trillion, up 70% from the $4.21 trillion seen at the end of 2019. Plus, liquidity in the banking system remains high. For example, other liquid deposits are $10.58 trillion, down from a peak of $14.0 trillion, but assets such as demand deposits, retail money market funds, and small-denomination time deposits, have been increasing. As a result, banks held $18.8 trillion in liquid deposits for customers as of August 5^th, down only 5.5% from their April 2022 peak. See page 4.

This is good news since liquidity is a key ingredient for a bull market. At present, liquid deposits at commercial banks equate to 34% of total US market capitalization. This percentage is down from the 48% recorded in January 2023, but it is much higher than the 12% to 14% seen at the end of 2019. It is also well above the average seen over the last 30 years, or 22%. Total assets of commercial banks were $23.46 trillion as of September 11, 2024, more than 35% greater than the $17.7 trillion recorded at the end of 2019. See page 5. Overall, the banking system is awash in cash which supports equities, particularly since the Fed is, and is expected to continue to lower short-term interest rates.

What does not support equities is valuation, but if the current rise in stock prices is the start of a melt-up, or a bubble, valuation will not matter, at least in the short run. The S&P 500 trailing 4-quarter operating multiple is now 25.2 times, and well above all long- and short-term averages. The 12-month forward PE multiple is 21.5 times. When this multiple is added to inflation of 2.5%, it sums to 24.0, which is above 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. But it is worth noting that those prior markets peaked when the 12-month trailing PE multiple reached a range of 27 to 31. In other words, if this is a bubble market, it could move higher. See page 6.

But this may depend upon the results of the upcoming third-quarter earnings season. The S&P Dow Jones consensus estimate for calendar 2024 is currently $237.26, down $0.44 this week, and the 2025 estimate is $276.62, down $1.05. The LSEG IBES estimate for 2024 had a typo this week, but the estimate for 2025 is $278.71, down $0.94, and the guesstimate for 2026 EPS is $314.37, down $0.52. The current pattern of equity prices soaring, while earnings estimates are falling for 2024, 2025, and 2026, is unsustainable and worrisome. This means third quarter earnings results, and corporate guidance, will be critically important for equity investors. See page 7.

Recent data on housing permits and starts for August were favorable and erased all of July’s declines. Existing home sales fell slightly in August and were down 4.2% YOY. The median price of an existing home fell to $416,700, but was still up 3.1% YOY. Months of supply of homes rose from 4.1 to 4.2. However, Moody’s Delinquency Tracker showed commercial delinquency rates are on the rise and in particular, the office sector delinquency rate rose to 9.18%, up from 5.5% in January.

September’s Conference Board consumer confidence survey showed the headline index fall from an upwardly revised 105.6 in August to 98.7, near the bottom of the range held over the last three years. The present conditions survey tumbled from 134.6 to 124.3, the lowest level since March 2021. The expectations index fell from 86.3 to 81.7, but remained above the 80 level for the third consecutive month. Consumers have become more pessimistic about the outlook for business conditions, the labor market, and future incomes. We reported University of Michigan data last week. That sentiment survey showed a small bounce in September, but all three indices — overall, present, and expectations — remained near recessionary levels. See page 8.  

This week China announced its largest stimulus package since the pandemic, which included, among other things, lower central bank rates, lower mortgage rates, minimum down payments on real estate transactions, and a 50 basis point decline in the RRR (reserve requirement ratio). Although analysts warned that the weakness in the economy would require more fiscal stimulus, China’s stimulus program was the catalyst for a global equity market rally. It also triggered a small increase in crude oil prices and a rise in US interest rates. With the 10-year Treasury yield currently at 3.74% and the 2-year Treasury yield at 3.49%, the yield curve inversion has been unwound. And inversions are unwinding in many parts of the world including the UK, Germany, and Canada. Some economists warn that the unwinding of a yield curve inversion represents the most vulnerable time for an economy. This may be true once more. If so, the unemployment rate will be key in the months ahead. See page 9.

The broadening participation in the equity market helped the Dow Jones Industrial Average reach a record high on September 24, 2024. Moreover, the DJIA gained 7.9% in the quarter to date versus the 5% gain seen in the S&P 500. See page 14. Stocks are responding favorably to the Fed’s rate cut and China’s stimulus program and this has resulted in much-improved readings in breadth data. For example, the 25-day up/down volume oscillator is 2.33 and was overbought for seven of the eight days ending September 19, and the last six 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 lasting at least 5 consecutive days. If the rally which began in October actually was a new bull market advance, it should also include several extreme overbought readings of 5.0 or better, which are typical of the first stage of a major advance. To date, the 4.07 reading is the best seen since December 2023 which is encouraging. This six-day overbought reading was not overly impressive, but it was the best demonstration of volume following prices seen since the end of last year. It is clearly positive for the near-term outlook. See page 11. In addition, the 10-day average of daily new highs is 600 and new lows are 44. This combination of new highs above 100 and new lows below 100 is positive. The NYSE advance/decline line made a new record high on September 24, 2024, confirming the rally. See page 12. In sum, for the first time in a long while, all the broad breadth indicators are uniformly optimistic.

Gail Dudack

Click to Download