At a policy forum focused on US-Canada economic relations, Federal Reserve Chairman Jerome Powell questioned whether the Fed would be able to lower interest rates this year prior to significant signs of an economic slowdown. This was not a huge shock to the equity market since the Fed futures markets had already signaled that there was little chance of a Fed rate hike before September. The culprit for this shift from multiple fed rate cuts to few if any rate cuts in 2024 was last week’s release of March inflation data.

Headline CPI for March rose 3.5% YOY, up from 3.2% YOY in February, and core CPI remained unchanged at 3.8% YOY. In general, March’s data reversed a fairly steady deceleration that has been seen in most inflation components since the June 2022 peak. The main exception to this was owners’ equivalent rent which did decelerate from 6% YOY to 5.9% YOY. See page 3.

The rebound in headline inflation was a disappointment to those expecting multiple Fed rate cuts this year; however, it was the underlying data that was truly worrisome. All the inflation indices excluding shelter, food, energy, used cars and trucks, and medical care, moved higher in March and service sector inflation accelerated. Prices in the broad service sector (which is 64.1% of the CPI weighting) increased from 5.0% to 5.3%. Hospital & related services prices rose from 6.1% to 7.7%. Tenants’ and household insurance rose from 4.1% to 4.6% and motor vehicle insurance rose from 20.6% to 22.2%. Medical care services, where prices were declining for most of the second half of 2023, reversed this trend and were up 2.1% YOY in March. See page 4. We continue to hear some market commentators state that headline inflation would be less than 2% if the housing component was eliminated. In our view, these comments will soon be silenced because inflation has become embedded in the system and is no longer tied to the price of oil or housing.

Nonetheless, oil prices are rising again, and this suggests that headline inflation could continue to rise in the months ahead. It is important to note that in 12 of the 13 months ended in January of this year, the price of crude oil was down on a year-over-year basis, and this was a significant factor in helping to slow headline inflation. For example, WTI was down 3.8% YOY in January 2024 and headline CPI was 3.1% YOY. In February, WTI was up 1.6% YOY and headline CPI rose 3.2% YOY. In March WTI was up 9.9% YOY and headline CPI was up 3.5% YOY. To date, in April, WTI is up 11.2% YOY and we expect headline CPI will also rise in April. What is more important is that energy is one of the few commodities that has the ability to drive prices higher throughout the broad economy. Higher energy costs increase transportation, manufacturing, and service costs, which then get passed down to the consumer (who is already burdened by higher gasoline, electric, and heating bills).  

Therefore, it was not surprising to hear Chair Powell temper expectations of rate cuts. In fact, interest rates have clearly been on the rise after the March inflation release.

Warnings from the CBO

Another factor impacting interest rates is the mounting level of federal debt. We agree with those who believe a day of reckoning is ahead for the debt markets. A steady stream of fiscal stimulus packages over the last four years has been both inflationary and a catalyst for higher interest rates. According to Congressional Budget Office (CBO) data, federal debt held by the public is expected to reach a record 107% of GDP in 2029 and reach 166% of GDP by 2054. And according to the CBO (the independent advisor on budgetary and economic issues providing cost estimates for current and proposed legislation), mounting debt will slow economic growth and raise interest rates.

2023 was an important turning point for the federal budget since it marked the year when the annual primary deficit (federal inflows minus outflows) equaled 3.8% of GDP versus interest outlays which represented 2.4% of GDP. According to CBO data, this balance will shift this year and the primary deficit is estimated to equal 2.5% of GDP and interest outlays rise to 3.1% of GDP. CBO forecasts show interest outlays growing to a shockingly high 6.3% of GDP by 2054. See page 5. At present, net interest costs are 13% of current federal outlays and this is estimated to rise to 23% by 2054.

Whether or not the Federal Reserve raises or lowers interest rates will impact deficits since 3-month Treasury bills now represent 14.5% of total federal debt and total Treasury bill issuance represents 25% of total Treasury debt outstanding. This is the highest level since 2009. And though Washington DC is at the center of this spending, inflation, debt, and interest rate spiral and it seems oblivious to it and all its consequences. It must be an election year…. 

In general, this combination of high interest rates, growing deficits, and interest payments on federal debt exceeding the primary deficit is reminiscent of the 1980-1990 decade when the combination of high debt levels and high inflation led to a series of rolling recessions.

Technical and Earnings Update

Charts of gold, silver, gasoline, and WTI crude oil are all technically strong. See page 7. Gold and silver may be breaking out of major base patterns due to concern of war escalating in Europe and the Middle East, which in turn impacts the price of oil and most commodities. But regardless of the reason, these four commodity charts are bullish, and that has inflationary implications.

Conversely, all four of the popular equity indices are trading below their 50-day moving averages this week and the DJIA and Russell 2000 are also trading below their 100-day moving averages. Given the huge advance seen from the October low, this appear to be a normal correction; however, the Russell 2000, which never got close to making a new record high, has fallen back into its long-term trading range of 1650 to 2000. See page 10.

The NYSE 25-day up/down volume oscillator is at negative 1.15 this week and neutral after recording a 90% down day on April 12. The prior 90% day was also a down day made on February 13, 2024. This oscillator reached overbought territory for two consecutive days on March 13 and 14 and March 20 and 21 and for three consecutive trading days on March 27, March 28, and April 1. These overbought readings followed the string in early January when the oscillator recorded readings of 3.0 or higher for 22 of 25 consecutive trading days ending January 5. Since a minimum of five consecutive trading days in overbought is required to confirm a new high, this means that, since early January, this indicator has not confirmed the new highs in the averages made in January, February, and March. See page 11. The S&P Dow Jones consensus estimate for calendar 2024 is $240.93, up $0.26, and the LSEG IBES estimate for 2024 is $243.04, up $0.01. Based upon the IBES EPS estimate for calendar 2024, equities remain overvalued with a PE of 20.8 times and inflation of 3.5%. This sum of 24.3 is above the 23.8 level that defines an overvalued equity market. The LSEG IBES earnings growth estimate for the current first quarter earnings season declined from 5% YOY to 2.7% YOY this week. Growth for calendar 2024 fell from 9.9% YOY to 9.2% YOY. We remain cautious.

Gail Dudack

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After last week’s strong jobs report for March, equity investors became a bit more concerned about the slew of inflation data that will be reported this week and with good reason. Although we have not heard anyone discuss it, for 12 of the 13 months ending January 2024, headline CPI has been benefiting from the weakness in the energy component of the index due to the negative year-over-year performance of the WTI oil future (CLc1 – $85.23). In February, the oil future reversed, but rose a mere 1.6% YOY. But in March it rose 9.9% YOY and in April, to date, it is up nearly 11% YOY. In short, while the Fed is currently focused on core and service sector inflation as the problems for 2024, headline inflation may be about to reappear.

And oil is not the only commodity moving higher. Our table of global markets and commodities on page 16 shows that of the 66 components in this table the six best year-to-date performances are seen in United States Oil Fund, LP (USO – $81.15), the WTI oil future, iShares Silver Trust (SLV – $25.72), the silver future (SIc1 – $27.89), Energy Select Sector SPDR ETF (XLE – $97.49), and the SPDR Gold Trust ETF (GLD – $217.67), in that order. The only commodity outlier is the gold future (GCc1 – $2795.10), which remains in the lower half of the table in terms of year-to-date price performance.

For a variety of reasons, equity prices do not always reflect the performance of underlying fundamentals or of commodity prices; however, in terms of S&P 500 sector performance, energy has been moving steadily higher in ranking this year and is currently in second place after communications services. The materials sector has been sitting at the bottom of the price performance rankings for a long time, but it is now improving and currently sits in the sixth slot, directly below the S&P 500 index.

In our opinion, it is wise to be wary of all future inflation reports; but this week could also be interesting since it includes Treasury auctions of $60 billion of 17-week bills on April 10^th, and $70 billion of 4-week bills and $75 billion of 8-week bills on April 11^th. It will be interesting to see how this impacts interest rates. Plus, first quarter earnings season begins in earnest with five major financial companies reporting on Friday. There is a lot of news to digest this week.

The Impact of the March Job Report

Immediately after last week’s jobs report the consensus view regarding Fed rate cuts began to change. Earlier this year the consensus was expecting six rate cuts! This was recently cut to three, and now there are whispers about one, two, or maybe no interest rate cuts in 2024. In our view, the equity market can adjust to the number of, or lack of, rate cuts by the Fed this year, but it might react poorly if inflation and/or interest rates begin to move higher. Much of the enthusiasm for equities in the last 12 months has been based on the expectation of lower inflation and lower interest rates. When the cost of money is low, the ability to invest or speculate in stocks increases; conversely, higher interest rates will lift the risk bar for investors and slay speculation. It is impossible to know how much of the rally from the October low is based on the expectation of lower interest rates, but it appears to be an essential factor.

The March employment report depicted a job market with solid momentum, and this implied that not only was a Fed rate cut unnecessary at this time, but it could be reckless. March’s job growth of 303,000 in the establishment survey, a decline in the unemployment rate to 3.8% in the household survey, and a rise in the participation rate to 62.7%, were all signs of strength. We had been concerned about the deceleration in the household survey’s job level, and though it inched down to 0.4%, it remains above the worrisome zero level. Ironically, the ISM employment indices for March remain below 50, a sign of job contraction, but this has been true for several months. See page 3.

Last week we noted that the unemployment rate for men aged 16-64 had been rising; but this may have been seasonal. Although the rate remains above the total unemployment rate of 3.8%, it fell from 4.3% in February to 3.9% in March, which is good news. This improvement may be linked to the big decline in the unemployment rate for those 25 and older with less than a high school diploma. This rate fell significantly from 7.7% to 5.8% in March, which suggests the lower end of the job market is experiencing good growth. See page 4.  

Average hourly earnings rose 4.2% YOY, down from 4.6% in February, but well above inflation of 3.2%. Average weekly earnings also rose 4.2% YOY and average weekly hours in the private sector rose 0.1 of an hour. Manufacturing weekly hours rose 0.1 to 40.7 hours indicating overtime. See page 5. All in all, March data depicted a solid job market.

Multiple job holders rose to 8.6 million in March, down only slightly from the peak level of 8.7 million seen in December. Part-time workers for noneconomic reasons (in nonagricultural industries) rose by 572,000 in March to 22.5 million. Part-time workers for noneconomic reasons exclude those who wanted to work full-time but could only find part-time work. This increase in part-time workers reflects the number of new people entering the workforce and is another sign of a healthy job market. See page 6.  

We do not typically read economic comments on social media, however, @RealEJAntoni wrote that in the last 12 months, 651,000 native-born Americans lost jobs, while 1.3 million foreign-born workers have gained jobs. This seemed crazy to us, but we looked at BLS data and found it to be true. Keep in mind that this data comes from the household survey (BLS Table A-7) which is an anonymous voluntary survey conducted by the US Census Bureau. It is not from the establishment survey which is derived from state payroll data. Nevertheless, the household survey includes much more information about households and captures an important segment of the job market, i.e., workers who may not receive a W-2, gig workers, homeworkers, entrepreneurs, and illegals. See page 7.

Small Businesses

The NFIB small business optimism index fell 0.9 points to 88.5 in March with six of eleven components falling in the month, two were unchanged, and three improved slightly. Seven of the eleven components of the index remained in negative territory. Plans to expand, invest, or increase employment fell. See page 8.

The NFIB survey showed that reports of positive profit trends were a net negative 29% in March, up two points, but still a very poor reading. The net percentage of owners who expect real sales to be higher decreased eight points from February to a net negative 18%. Owners indicating that sales were the single most important problem rose to 8 in March, a trend that historically mirrors the unemployment rate. Much like the ISM employment indices, this report was difficult to square with the March jobs report. There were no significant changes in fundamental or technical indicators this week. Equities remain near extreme valuations and momentum indicators are mixed with prices showing solid momentum but volume failing to confirm. We remain cautious.

Gail Dudack

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Last week we stated that we thought the stock market was overly fixated on the Fed’s dot plot forecasts while waiting and hoping for a Fed pivot and lower interest rates (which we believe are unnecessary). Meanwhile, this is overlooking the fact that monetary policy already has been and remains very accommodative. The Fed’s current balance sheet of nearly $7.6 trillion, remains 90% above the $4 trillion seen in normal times before the pandemic. The real fed funds rates relative to the current PCE deflator is 290 basis points, high after being negative for nearly 2 ½ years, but still short of the 400 basis points, or more, seen at the end of most Fed tightening cycles. In other words, the Fed is accommodative.

It is this persistent combination of fiscal and monetary stimulus that has kept both the economy and the stock market afloat in recent years, defying a string of challenges and indications of a pending recession. The 2024 surge in Bitcoin (BTC= – $65,466.00), driven primarily by the initiation of multiple ETFs on the spot market, has also been supported by the consensus view that interest rates are headed lower. The market’s obsession with the Fed’s dot plot reveals that inflation and interest rates are the Achilles heel to both the economy, the stock market, and possibly Bitcoin.

This explains why the stock market reacted badly to a number of Fed governors, as well as Chair Powell, indicating that rate cuts may not come in June. A slew of good economic news also implied Fed cuts in June may be premature. We are not surprised.

Earnings Season Approaches

The stock market may adjust to the fact that rate cuts are not imminent, but to do so would require good corporate earnings in the first quarter. First quarter earnings reports will begin in a few weeks and LSEG IBES consensus estimates show S&P 500 earnings growing at a rather uninspiring 5% in the quarter; if the energy sector is excluded, this percentage rises to 8.1%. The communications services sector is currently forecasted to have the best earnings growth of 26.8% in the quarter, followed by technology with growth of 20.9%. Surprisingly, the utilities sector is expected to have the third best earnings performance in the first quarter with growth of 19.8% YOY.* The worst earnings expectations are for energy (-25.2%) and materials (-23.7%), but a recent rise in oil and commodity prices could offset the results of a poor earnings season. This certainly has been true for energy, which is currently the second-best performing S&P sector year-to-date. See page 15.

This has been a quiet week for earnings releases and the S&P Dow Jones consensus estimate for calendar 2024 is relatively unchanged at $240.30, up $0.07 and the estimate for 2025 is $273.79, down $0.21. The LSEG IBES earnings estimate for 2024 is $242.91, up $0.02 and for 2025 is $276.07, up $0.17. Based upon the LSEG IBES EPS estimate for calendar 2024, equities are overvalued with a PE of 21.4 times and inflation of 3.2%. This sum of 24.6 is above the 23.8 level that defines an overvalued equity market. Note: based upon the S&P estimate, the 2024 PE is 21.7 times. See page 9.

The 2024 Economy is Improving

Fourth quarter GDP rose 3.4% (SAAR) according to the “third” estimate, up from a previously reported 3.2%, which matched the long-term average for GDP. Increases in consumer spending, state and local government spending, exports, nonresidential fixed investment, federal government spending, and residential fixed investment drove growth, which was partly offset by a decrease in private inventory investment and an increase in imports. Money velocity (nominal GDP divided by M2) shows how quickly a dollar moves through the economy. Velocity has been on the rise since its 2020 low which is a positive sign of an economy gaining momentum. See page 3.

GDP corporate profits before and after taxes grew 4.1% and 3.9% respectively, which was the best growth seen since the second quarter of 2022 – a quarter boosted by fiscal stimulus. Residential investment only increased 1.7% YOY, but this follows four consecutive quarters of declines. In short, the economy appeared to be gaining momentum at the end of the year. Nominal GDP grew 5.9% YOY down slightly from the 6.2% YOY seen in the third quarter, however, it was led by a solid 5.6% YOY increase in personal consumption expenditures. See page 4.

The pending home sales index rose from 74.4 in January to 75.6 in February; but was below the 78.1 recorded in December. The ISM manufacturing index was surprisingly strong at 50.3 in March, hitting its first reading over 50 after 16 months of contracting. Five of its 10 components were higher, three were unchanged and two were lower. The University of Michigan sentiment index was 79.4 in March, its highest level since July 2021. The survey showed that both current and future expectations were improving. See page 5.

The Fed’s preferred inflation measure, the PCE deflator, had something for everyone in February’s release. Headline PCE increased 0.3% for the month, down from the 0.4% seen in January – however, January’s figure was revised up from 0.3%. The core PCE deflator rose 0.3% as expected. On a year-over-year basis headline PCE increased slightly to 2.45% in February versus 2.43% in January and core rose slightly less at 2.78% versus 2.88% in January. In short, February’s changes were minimal and essentially trendless. Goods (Auto and nondurable) inflation rose while service inflation fell. See page 6.

Employment data for March will be reported at the end of the week and we will be watching for two worrisome trends. First, there was a sharp decline in household survey job growth in February to 0.4% YOY. The importance of this is that year-over-year declines in employment are a key characteristic of a recession. Second, the unemployment rate for men aged 16 to 64 was 4.3% in February, down from 4.6% in January, but still higher than the overall unemployment rate of 4% in February. The unemployment rate for women aged 16 to 64 was 3.8% and for all workers aged 65 and over was 3%. The high 4.6% for men in January may be due to seasonality or could be a precursor of a weaker job market. We will be analyzing March data to see if these trends improve or worsen. See page 7.

Technical Update

The 25-day up/down volume oscillator is 2.82 and neutral after being overbought for three consecutive days at the end of March. This follows two consecutive overbought days on March 13 and 14 and again on March 20 and 21. The last significant overbought reading took place early in January 2024 when the oscillator recorded readings of 3.0 or higher for 22 of 25 consecutive trading days ending January 5. In sum, since early January this indicator has not confirmed new highs in the market. Conversely, the NYSE advance/decline line made a new high on March 28 and the 10-day average of daily new highs has expanded to 450. A level of 500 is typically seen in bull markets but this is close to confirming. See pages 11-12. The AAII sentiment poll showed 50% bullishness and 22.4% bearishness which is close to the negative combination of 50/20 that warns of a top. We remain cautious. *Proprietary Research from LSEG: This Week in Earnings (March 28, 2024)

Gail Dudack

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Non-defense capital goods orders excluding aircraft, which is a good proxy for capital spending plans, rose 0.7% in February after falling in January. This was an encouraging sign for the economy. The Conference Board Consumer Confidence index changed little for March, although February’s data was revised downward. This was the second consecutive month with substantial downward revisions to earlier data. And there was a clear pattern in the survey that showed consumers are feeling a bit better about their current conditions but worse about future prospects. A similar result was found in the University of Michigan Consumer Sentiment indices reported last week.

This week should be a calmer time for the stock market after last week’s FOMC meeting. There are few important economic releases, but ironically, the most important data of the week, the PCE deflator, will be reported on Friday when the stock market is closed for Good Friday. Friday data will also include personal income and personal spending.   

Dot-Plot Mania

There was a near-obsessive focus on the Federal Reserve’s meeting last week. Perhaps this was due to the fact that not only was the Fed reporting on Mach 20, but the Bank of Japan and the Reserve Bank of Australia met on March 19, and the Bank of England and Swiss National Bank reported on March 21. The equity market celebrated the fact that there was very little change in the Fed’s statement or the dot plot from the December meeting. To us, this suggests there was significant, but hidden, anxiety about February inflation data and the fact that inflation has been stickier than many anticipated. In our view, the market’s response to Chair Powell’s statement and news conference was overdone. The focus on the dot-plot survey is also extreme. For example, if just one participant projecting three rate cuts this year had shifted to two cuts, the median forecast would have moved from three cuts to two cuts and the dot-plot would have been a major disappointment to the consensus. Only a very slim margin implied three rate cuts. More importantly, the dot plot could be one of the Fed’s tools to temper or deliver messages to the market when it feels it is necessary. In simple terms, it is not an absolute projection of policy. We see it as a point of information and nothing else. Moreover, if Chair Powell is waiting for a majority of FOMC voting members to agree to three rate cuts this year before changing policy, he will be facing an uphill battle. In our opinion, the market’s reaction to the March FOMC meeting is another example of the market finding a pearl in every oyster.

However, while the stock market is waiting and hoping for a pivot and lower interest rates — which we believe is unnecessary — it is overlooking the fact that monetary policy is already very accommodative. Government yield curves may be inverted — and this has been the longest inversion in history without a recession – but if there is a difference this time it is due to the very stimulative fiscal and monetary policies implemented in recent years. See page 3.

The Federal Reserve has been shrinking its balance sheet which as of March 20, 2024 was $7.7 trillion, down from a peak of $9.0 trillion in April 2022. But the current $7.7 trillion remains well above the $4 trillion seen in normal times before the pandemic. In short, the Fed’s balance sheet provides considerable liquidity to the economy. Not surprisingly, there is plenty of liquidity in the system as seen by the near-record level of total bank assets now at $23.2 trillion. Commercial bank deposits as of mid-March were $17.5 trillion, down only modestly from the record $18.2 trillion seen in April 2022. This liquidity has been offsetting the Fed’s interest rate hikes and the inversion of the yield curve, in our view. If the Fed should cut interest rates, we hope it is accompanied by substantial quantitative tightening. If not, it could open the door for another round of higher inflation. See pages 3 and 4.

Technicals are Trying

The main equity indices made new highs in the past few trading sessions and the Nasdaq Composite finally bettered its November 2021 high of 16,057.44 in early March. The Russell 2000 is trading above the key resistance level of 2000 for the first time in two years but has retreated back toward the 2000 level in recent sessions and remains nearly 15% below its all-time high of 2442.74 made on November 8, 2021. See page 10.

The 25-day up/down volume oscillator is at 2.69 this week and neutral after being overbought for two consecutive days on March 13 and 14 and again on March 20 and 21. These were the first overbought readings since early January when the oscillator was in overbought territory for 22 of 25 consecutive trading days ending January 5. Nonetheless, this indicator has not yet confirmed the string of new highs seen in the S&P 500 index, Dow Jones Industrial Average, and Nasdaq Composite index in January, February, and March. To confirm, this oscillator must remain in overbought territory for a minimum of five consecutive trading sessions which would indicate that volume is concentrated in stocks that are moving higher. This is a classic sign of a bull market.

The 10-day average of daily new highs is 387, down from more than 500 in recent weeks, and new lows have been consistently around the current level of 55. This combination of new highs above 100 and new lows below 100 remains bullish, but not demonstrably so given the new highs in the popular indices. The NYSE advance/decline line made a new record high on March 21, 2024 for the fourth time since November 8, 2021 which is a confirmation of the recent highs in the S&P 500. See page 12.

Housing

On a seasonally adjusted basis, new home sales for February were essentially unchanged for the month, but up 5.9% YOY. The price of a new single-family home fell to $400,500 in February, down 3.5% from January and down 7.6% YOY. See page 5.

February’s existing home sales were 4.38 million units (SAAR), up 9.5% versus January, but down 3.3% YOY. The median price of a single-family house was $388,700 in February, up 1.5% from January and up 5.6% YOY. However, prices remain 7.7% below the June 2022 peak price of $420,900. See page 6.

Despite rising mortgage rates and housing affordability being near its lowest level in forty years, the housing market has remained resilient. This is due to a slow, but steady rise in median family income and the lowest level of inventory in forty years. See page 7. However, none of this data reveals the fact that many households and young families have been shut out of the housing market after the price gains and interest rate increases seen in the last four years. If the stock market is forming a bubble, and we think it is, it is in the early stages. PE multiples are exceedingly high at 24.2 times trailing 12-months and 21 times forward 12-months. Yet during the 1997-2000 bubble, the financial crisis of 2008, and even the post-COVID-19 peak, the trailing 12-month PE reached 26 to 30 times earnings. See page 8. 

Gail Dudack

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A Landmark Shift

This week, just as the Federal Reserve begins to debate a possible reversal of tight monetary policy, the Bank of Japan implemented its first interest rate increase in 17 years. Considered by many to be a landmark shift, this rate hike marked the end of a long era of ultra-easy monetary policy and eight years of negative interest rates. However, the Bank of Japan remains behind most central banks which have been combating inflationary pressures by hiking rates at an unprecedented speed in recent years. In most developed countries policymakers are still wrestling with post-Covid distortions created by policies of negative interest rates (Europe and Japan) and fiscal stimulus. This combination has left the global financial system awash in cheap money — with most of this liquidity parked at central banks earning an easy no-risk profit.

But the move by the BOJ suggests that the era of low interest rates and low inflation is probably over. In addition to increasing rates, Japan’s central bank announced it will cut back on its limit of buying Japanese government bonds in order to manage the yield curve and will also end purchases of riskier assets such as ETFs to support the Japanese stock market. The Japanese stock market was shaky after this news but closed with a small gain. Although not gathering much attention, the Japanese stock market has been an outperformer in 2024. The iShares MSCI Japan ETF (EWJ – $70.92) is up 10.6% year-to-date versus the 8.6% gain in the S&P 500 Composite. See page 13. It will be interesting to see if the Japanese stock market can continue its solid performance since the move by the BOJ means that banks in Japan will raise ordinary deposit rates for the first time in 17 years.

The Federal Reserve is meeting this week, and the current consensus is for no change in policy. We believe Fed Chair Jerome Powell when he says that the Fed will be data driven, but the data is not always, or often, truly clear. The real fed funds rate has been averaging 200 basis points for most of the last nine months, which is a major change from the negative real rates seen for much of the last twenty years. Nonetheless, it is still below the long-term average of 233 basis points. See page 3. In our opinion, the current real fed funds rate is not high enough to expect a rate cut in March, or until headline inflation falls closer to the Fed’s 2% target. Nevertheless, the FOMC will have its hands full as it debates a combination of strong headline retail sales (but weak real retail sales), slowing inflation, falling consumer confidence, and rising oil prices.

Economic Releases

Headline retail sales for February rose 1.5% YOY, and retail sales excluding motor vehicles and parts and gasoline stations rose 2.2% YOY. But after inflation, real retail sales fell 1.6% YOY. This was the 12^th year-over-year decline in the last 16 months, a pattern in retail sales that is typical of an economic recession.

The best year-over-year gains were seen in nonstore retailers (6.4%), food services and drinking places (6.3%), and miscellaneous store retailers (3.2%). Since December 2019, the percentage of total retail sales has increased substantially for nonstore retailers, food service & drinking places and miscellaneous stores, but declined for all other categories. This means for many retailers the pie is not growing and growth comes from taking sales from your competition. It is a survival of the fittest scenario in the retail industry. See page 4.

Consumer confidence was on the rise at the end of 2023, but it seems to have peaked in January. The University of Michigan consumer sentiment survey for March was 76.5, down from February’s negatively revised reading of 76.9. Present conditions were unchanged from a negatively revised reading of 79.4 in February. Similarly, expectations fell to 74.6 from February’s negatively revised reading of 75.2. According to the University of Michigan report, rising gasoline prices weighed on inflation expectations and reversed recent gains in confidence. The Conference Board Consumer Confidence survey was down in February and results for March will be released next week. See page 5.

The National Association of Home Builders (NAHB) confidence index rose 3 points to 51 in March, surpassing the breakeven point for the first time since July. All components increased with sales, sales expectations, and traffic each up 2 points; but absolute levels in the index remain well below 2020 peaks. However, this confidence from home builders may be a result of February construction trends. New residential construction jumped in February with permits and starts up nicely from January levels in all categories, including single-family, multi-family, and condominiums. Nevertheless, some of the increase in February could be a recovery after poor weather in January. See page 6.

PE ratios keep rising

A strategist on CNBC stated this week that fundamentals are not good timing devices and do not work in the short term. We agree with that statement, but we disagree with the thought that they should be disregarded. The S&P 500 trailing 4-quarter operating multiple is now 24.0 times and well above all its long- and short-term averages. The 12-month forward PE multiple is 21.9 times and when added to current inflation of 3.2% sums to 25.1. The importance of this is that this sum is well above the top of the normal range of 14.8 to 23.8. By all measures, the equity market is at valuations seen only during the 1997-2000 bubble, the financial crisis of 2008, or the post-COVID-19 earnings slump. However, for the bulls, we would point out that the 12-month trailing PE ratio reached 26 to 30 before these market peaks. See page 7.

Technical Indicators

The S&P 500 made a new high this week, but the Dow Jones Industrial Average made its last high on February 23. The Nasdaq Composite index made its high on March 1, but did manage to fractionally beat its November 2021 high of 16,057.44. The Russell 2000 had been trading above the key resistance level of 2000 for the first time in two years but has since retreated closer to the 2000 level. The Russell 2000 index remains nearly 17% below its all-time high of 2442.74 made on November 8, 2021. See page 9. The 25-day up/down volume oscillator is at 2.22 and neutral after being overbought for two consecutive days on March 13 and 14. These were the first overbought readings since the string of overbought readings of 3.0 or higher in 22 of 25 consecutive trading days ending January 5. Nevertheless, this indicator is yet to confirm the string of new highs seen in the S&P 500 index in recent weeks. To do so, this oscillator must remain in overbought territory for a minimum of five consecutive trading sessions, See page 10. The 10-day average of daily new highs is 402 and new lows are 52. This combination of new highs above 100 and new lows below 100 remains bullish, but the new high list is down from a week ago when it was well above 500. The NYSE advance/decline line made a new record high on March 13, 2024 for the 3rd time since November 8, 2021. Overall, technical indicators are mixed.

Gail Dudack

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Inflation

The financial press reacted to February’s CPI report this week with headlines like: “Gasoline, shelter costs boost US prices; inflation still slowing.” This may be part of February’s inflation story, but not all of it. Headline CPI rose 3.2% YOY in the month, higher than consensus expectations, and up from the 3.1% pace seen in January. Core CPI rose 3.8%, down slightly from the 3.9% seen in January, but still higher than forecasts which expected core inflation to ease to 3.7% YOY.

Housing, which has a 45.2% weighting in the CPI, rose 4.5% in February and transportation, with a 15.7% weighting in the index, rose 2.7%. In the post-COVID economy, travel and entertainment have been booming. This means food away from home, which is 5.4% of the CPI index, is relevant to most consumers. It rose 4.5% YOY in February. In addition, the Federal Reserve has stated they are most concerned about service inflation. In that regard, “other goods and services” which is 2.9% of the index, increased a hefty 4.7% YOY in February. However, these were some of the most concerning components of the CPI. Many other components of the CPI grew 2.7% YOY or less. See page 3.

Economists can take solace in the fact that most major inflation indices are decelerating. The pace of prices for headline, core, services, and owners’ equivalent rent of residences, in the CPI are trending lower. However, many segments of the service sector are not. In recent months we have pointed out the huge rise in motor vehicle insurance prices and this continued in February. There are also rising trends in hospital & related services, medical care services, and services less rent of shelter. Since most of these services are household necessities, rising prices in these areas impact most consumers and are most damaging for lower-income families. See page 4.

From a forecasting perspective, we are most anxious about healthcare. Healthcare pricing has been muted for most of 2023 and in fact prices were declining for the overall medical care index with an 8.02% CPI weighting, and particularly for the medical care services category (a 6.54% weighting). These declines helped contain core CPI in recent months. But this appears to be changing and healthcare prices are now rising. See page 5.

Moreover, while prices for “rent of primary residence” are increasing at a slower rate, prices for tenant & household insurance, fuels & utilities, and water/sewer/trash collection services are now trending higher. The increase in these services explains why many consumers remain worried about inflation and are not responding favorably to the slower pace of headline inflation or solid GDP reports. It also explains why the Fed is focused on service inflation which tends to lag goods inflation. These underlying trends also suggest that inflation may be more difficult to manage than many economists expect. In this case, Fed Chairman Jerome Powell may be right by attempting to dampen expectations of a fed rate cut in the near future.

The impact of inflation is seen in many parts of the economy. The NFIB Small Business Optimism Index fell to 89.4 in February, marking the 26^th consecutive month below the 50-year average of 98. The survey was generally weak, and most components moved lower in the month. Not surprisingly, inflation was noted as the single most important business problem according to 23% of small business owners, up three points from last month, and now replacing labor quality as the top problem. See page 6.

Consumer Credit

We also read headlines about January’s consumer credit outstanding which highlighted January’s annualized growth rate of 4.7% for the month — an acceleration from a downwardly revised gain of 0.9% in December — that mirrored other positive economic data from January. In simpler terms, total consumer credit grew by $19.5 billion in January, to $5 trillion, but this was a 2.5% YOY pace and down from the 2.6% YOY rate seen in December. Nonrevolving increased $11.1 billion in the month, which was a 0.5% YOY increase, and revolving credit grew $8.4 billion, which was an 8.8% YOY increase. But more importantly, all these YOY rates are decelerating sharply from a year ago. It is curious to us that the press would suggest credit expansion is accelerating when it is clearly decelerating, particularly nonrevolving credit. Perhaps more importantly, the senior loan officer survey indicated that banks are planning to tighten credit standards beginning in the first quarter.

It is also interesting to see that the federal government is now the second largest owner of the $3.7 trillion in nonrevolving consumer debt. The government currently owns $1.48 trillion of nonrevolving consumer credit, which is largely student loans that originate from the Department of Education. See page 7.

Fundamentals No Longer Matter

Although February’s inflation report was disappointing, the equity market shrugged it off this week. We are not surprised since economics and fundamentals do not matter in a bubble. We are amused by the many discussions in the financial media about whether the current stock market is a bubble or not. Few of today’s prognosticators have lived through a bubble, and even if they had, a bubble is nearly impossible to analyze. But in our view, this is a bubble, perhaps best exemplified but the massive move in Bitcoin. Both equities and bitcoins are being propelled higher by the popularity of ETFs which is this bubble’s form of financial leverage, in our opinion. Nonetheless, it is prudent to point out that the S&P 500’s trailing 4-quarter operating earnings multiple is now 24 times and well above all long- and short-term averages. The 12-month forward PE multiple is 21.3 and when added to current inflation of 3.2% sums to 24.5. This is well above the top of the normal range of 23.8. See page 8. By all measures, the equity market is at valuations seen only during the 1997-2000 bubble, the financial crisis of 2008, or the post-COVID-19 earnings slump. Still, prices could go higher since those previous market peaks hit sums that were well above 30!

Technicals: all good except for dow theory

There is plenty of good news on the technical front. The 25-day up/down volume oscillator reached 3.47 on March 12 and is overbought for the first time since early January. This oscillator needs to remain in overbought territory for at least five consecutive trading days to confirm the new highs in the indices, but this is the best performance we have seen in over two months. See page 11. The NYSE cumulative advance decline line has made a record high confirming the market highs. The 10-day average of daily new highs is currently at 511 and above the 500 level that we like to see on new market highs. See page 12. Last week’s AAII readings showed bullishness increased 5.2% to 51.7% and bearishness rose 0.5% to 21.8%. The 8-week bull/bear spread rose to 20.8% and is back into negative territory of 20.6% or greater. However, sentiment indicators tend to be early warning signals and are not good at timing peaks or troughs in the market. The only negative one can point to in the technical arena is Dow Theory. The lack of a new high in the Dow Jones Transportation Average is, to date, a nonconfirmation.

Gail Dudack

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Bitcoin (BTC= – $63,770.00) touched a record high this week based on a view that global interest rates will soon fall. In many ways, bitcoin is a good illustration of the speculative nature of today’s stock market. According to LSEG data, net flows into the ten largest spot bitcoin funds reached a stunning $2.2 billion in the week ended March 1. The cryptocurrency has soared nearly 160% since October and jumped 44% in February alone. February’s action followed the Securities and Exchange Commission’s approval of 11 spot bitcoin ETFs in late January. Most crypto analysts believe these ETFs should give the current rally a boost. The underlying assumption is that institutional investors are more likely to commit long-term money to exchange-traded crypto products than they would commit to Bitcoin directly. This may prove to be an important viewpoint. ETFs represent a relatively new form of leverage, and the importance of this is that new forms of leverage have been major factors behind every financial market bubble.

Bitcoin is representative of today’s financial markets for several reasons. It has the backing of a new generation of investors and there are no underlying fundamentals. Bitcoin has no assets, earnings, or revenues to analyze, yet it is soaring based upon the belief that it will go higher. Likewise, momentum, liquidity, and leverage drive an equity bubble, not fundamentals.

Housing, Income, and Employment

Fundamentals may not be driving the current market, but it was a week full of economic data. The pending home sales index fell to 74.3 in January from 78.1 in December and remains well below the long-term average of 100. Census Bureau data showed the median price for a new single-family home fell 2.6% YOY in January; and though this may appear to be a negative, it was an improvement over the 13.9% decline reported in December. This data reveals the impact rising mortgage rates have had on the homebuilding industry.

However, the National Association of Realtors (NAR) survey indicated that the median price of an existing single-family home rose nearly 5% in January and the FHFA purchase-only house index showed an even better price gain of 6.6% YOY in December. See page 3. The stability in existing home prices may be due less to increasing demand and more to a low level of inventory, however, homebuilding stocks have been one of the best performing sectors of 2024. One reason for this was the breakout in the SPDR S&P Homebuilders ETF (XHB – $103.44) in late 2023 and the attention this technical chart received on several social media platforms. Price momentum, charts, and social media are important drivers of the new age of investing.  

Personal income increased a healthy 4.8% YOY in January and disposable income increased 4.5% YOY. However, real personal disposable income only grew 2.1% YOY, which was the slowest pace in twelve months. Personal consumption expenditures grew 4.5% YOY, which was impressive given the pace of personal income, yet it was the weakest pace in nearly three years. January’s consumption slowdown was predictable since spending had been exceeding income at the end of 2023. But in general, personal income trends appear to be slowing. See page 4.

The slowdown in consumption resulted in a modest increase in the savings rate, which inched up from 3.7% to 3.8% in January. Last month we pointed out an interesting trend in government workers’ wages. It continued in January. Government wages grew at an 8% YOY pace whereas most other sectors experienced wage growth of 4% to 6%. This disparity in wages between government and private workers is historical! See page 5.

January’s relatively low consumption pace was also due to an increase in personal taxes, which is typical of the first quarter. Also weakening household consumption is the massive jump in personal interest payments which has been a direct result of rising interest rates. An additional negative for households is the fact that government transfer payments are no longer supporting income. For all these reasons, Friday’s payroll data will be noteworthy. The household survey had a sharp decline in job growth in January and we will be looking to see if this was a one-off event or the beginning of a trend. This could be important since the household survey captures many lower-income workers that are not included in state payroll data. For this reason, it is often a leading indicator of employment trends. See page 6.

The ISM manufacturing index fell from 49.1 to 47.8 in February with six of its ten components falling, or remaining, below the 50 breakeven level. The ISM nonmanufacturing index rose from 55.8 to 57.2, with four of its nine components registering below 50. It was also notable that both surveys show employment contracting in February, with the manufacturing index at 45.9 and the nonmanufacturing index at 48.0. This could be an omen for future jobs data and therefore personal income. See page 7.

The best piece of economic news in the past week was the PCE deflator for January which eased from 2.6% YOY to 2.4% YOY. Core PCE edged down from 2.9% to 2.8%. The stock market celebrated this report since it supports the view that inflation is slowly decelerating and if so, interest rates may soon decline. With this in mind, February data for the CPI and PPI will be released next week and both could be market moving events. See page 8.

Fundamentals and Technicals

The S&P 500 trailing four-quarter operating multiple is now 23.5 times and well above all long- and short-term averages. The 12-month forward PE multiple is 21.4 times and when added to inflation of 3.1% sums to 24.5. This is well above the top of the normal range of 23.8 and it helps to explain why equities are hoping to see inflation fall to 2%. By all measures, the equity market is at valuations seen only during the 1997-2000 bubble, the financial crisis of 2008, or the post-COVID-19 earnings slump. See page 9.

Conversely, technical indicators improved this week. The S&P 500 and Dow Jones Industrial Average have continued to make a series of new highs while the Nasdaq Composite index finally rose above its November 2021 high of 16,057.44 on March 1st. The Russell 2000 also definitively broke above the 2000 resistance level for the first time in two years. As we have been stating in recent weeks, this move bodes well for the overall equity market. However, the Russell 2000 remains 16% below its all-time high of 2442.74 made on November 8, 2021. See page 11. But in line with the Russell index, the NYSE cumulative advance/decline line made a record high on March 1. Most technicians are stating that the market is overbought, but our 25-day up/down volume oscillator is at 1.18 and neutral this week. This indicator is based on volume, not price, and as such, it reveals the conviction behind price moves. Our oscillator has not come close to recording an overbought reading since the 22 of 25 consecutive trading days of overbought readings that ended January 5. This means volume in advancing stocks has not been impressive and the indicator is yet to confirm the string of new highs seen in the S&P 500 index and Dow Jones Industrial Average in January, February, or March 1st. To confirm the current advance, this indicator needs to reach and remain in overbought territory for a minimum of five consecutive trading sessions. In sum, we remain cautious.

Gail Dudack

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A Government Shut Down Looms

In normal times, investors would be worried about the possibility of a government shutdown by the end of this week, but these are not normal times. Two months ago, Congress agreed to $1.59 trillion in discretionary spending for the fiscal year that began on October 1. Nonetheless, in-fighting by House Republicans is making it difficult for House Speaker Mike Johnson to pass funding bills. As a result, the first batch of government funding, for agencies that oversee agriculture and transportation, will run out this Friday at midnight. Funding for other agencies including the Pentagon and the State Department will expire on March 8. The main issues appear to be that Republicans want to see spending cuts and policy positions that address migration along the Mexican border. President Joe Biden is arguing for funding for Ukraine. It seems reasonable that both sides could find a mutual solution to these issues; but then again, nothing is reasonable or logical in Washington DC, particularly during an election year.

In addition, the market is also shrugging off a report from Moody’s Analytics stating that the banking sector faces $441 billion of CRE loans maturing this year and Moody’s forecasts the share of troubled loans will increase. The Department of Justice has launched an antitrust investigation into UnitedHealth Group (UNH – $513.42). Russia has ordered a six-month ban on gasoline exports as of March 1 and the Organization of the Petroleum Exporting Countries, led by Russia, agreed to extend voluntary cuts totaling about 2.2 million barrels per day into the first half of this year.

Bubbles are Not Bull Markets

These are not normal times for equity investors for a number of reasons. The most important of these is the possibility that equities are in the early stage of a stock market bubble. Last week’s response to Nvidia Corp.’s (NVDA – $787.01) fourth-quarter earnings report increased the odds that equities are indeed forming a bubble. We were asked if this means we are now bullish, which is not an easy question to answer. Although we expect stock market indices will move higher, perhaps substantially higher, this is different from being truly bullish, in our view. To us, being bullish means stocks represent good value and have excellent long-term potential. A bubble is quite the opposite. It means stocks have disconnected from fundamentals and are driven purely by sentiment, liquidity, momentum, and leverage. To us, this kind of stock market is like a boat at sea without a rudder.

In terms of fundamentals, the trailing four-quarter operating SPX PE multiple is now 24 times and well above all long- and short-term averages. The 12-month forward PE multiple is 21.7 times and when added to inflation of 3.1% sums to 24.8, well above the top of the normal range of 23.8. By all measures, the equity market is at valuations seen only during the 1997-2000 bubble, the financial crisis of 2008, or the post-COVID-19 earnings slump. See page 8.

Bubbles are usually fueled by a theme that supports the concept that “it is different this time” and therefore fundamentals no longer matter. The current bubble’s theme is generative AI. In our opinion, AI is less transformative than the Nifty Fifty stocks were in the early 1970s era that preceded the January 1973 peak. Beginning in the late 1960s, Baby Boomers began to enter the workforce and were the source of a massive wave of consumption of new products like cameras from Polaroid Corp. (delisted), film from Eastman Kodak Co. (KODK – $3.53), drinks from Coca Cola Co. (KO – $60.34) and burgers from McDonald’s (MCD – $293.76). These consumer stocks did represent the growth segment of the stock market, but they eventually rose to unsustainable prices.

Some strategists have said the current market is nothing like the dot-com bubble that led to the January 2000 peak, because today’s AI stocks have earnings and the dot-com stocks of the late 1990 era did not. It is true that companies like Global Crossing inflated their reported earnings figures and ended up being acquired by Level 3 Communications, and then CenturyLink Communications, LLC in 2017, and is now part of Lumen Technologies (LUMN – $1.54). But the dot-com bubble also included Amazon.com (AMZN – $173.54), Microsoft Corp. (MSFT – $407.48), eBay Inc. (EBAY – $44.39), and Cisco Systems (CSCO – $48.31). These stocks clearly had earnings. In fact, the current environment is very similar to the dot-com era and perhaps one could say this might be the second act of the dot-com bubble!

We have written about the three strategies one can employ during a bubble: 1.) jump on the bandwagon and follow the momentum stocks. For many money managers who are measured against the S&P 500’s performance, this is the only possibility. However, one has to remain diligent about monitoring the market for weaknesses that may suggest the bubble is about to burst. 2.) own a blended portfolio of stocks with good long-term potential and add ETFs that mirror the indices. 3.) own a portfolio based on good fundamentals and simply wait out the bubble. One’s strategy is an individual choice.

Election Year Seasonality

This is an election year and stock performance in an election year ranks third in the four-year election cycle. In short, it is in the middle of the pack. In an election year, the fourth quarter usually provides the best performance in the Dow Jones Industrial Average. The second and fourth quarters are the strongest in the S&P 500 index, and the second quarter has the best record in the Nasdaq Composite index. In general, the best performance tends to come in the last three months of the year. See page 5.

But what we find most interesting about election year performances is that monthly performance is different based upon whether an incumbent president wins or loses. Normal seasonality suggests that April, November, and December are the best-performing months of the year. But analyzing election years since 1944, we find that incumbent wins are preceded by strength in June, March, and December, in that order of magnitude. Incumbent losses are preceded by the best equity performance materializing in November, April, and May, which is closer to normal seasonality. (Note that the weakness seen in March 2020 correctly indicated a Trump loss.) See pages 5 and 6. However, the rally seen in February to date is not typical of a normal or an election year. So far 2024 is far from typical!

Confidence After what seemed like an improvement in confidence in January, The Conference Board confidence indices took a negative turn in February. Moreover, the January indices were revised substantially lower. The Conference Board expectations index dipped back below 80, the threshold typically associated with recession. Across age demographics, consumers younger than 35 and older than 54 saw the greatest deterioration in confidence and many respondents indicated jobs were harder to find. This was an interesting shift from earlier. The University of Michigan sentiment data will be released Friday. See page 7. The most important economic release of the week will be the PCE price deflator on February 29. The December data showed the PCE deflator unchanged at 2.6% YOY and core down 0.3% to 2.9% YOY. The market is hoping (expecting?) that inflation will continue to moderate.

Gail Dudack

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The equity market is in the early innings of a stock market bubble, in our view. For bubbles to form there is normally a new generation of investors, excess liquidity, and an underlying development, discovery, or invention, which makes the economic backdrop “different this time.” The concept of being “different this time” is important since it is at the crux of how the equity market can disconnect from underlying fundamentals.

In the current environment the most obvious new “invention” is generative artificial intelligence, or AI. Today’s economic backdrop is seen as accommodative for equities based upon the consensus opinion that inflation is trending toward a benign 2% level, a pivot in monetary policy from tightening to easing is ahead, and there is no significant recession on the horizon. Any challenges in any of these areas could derail the bubble. However, of these three criteria Federal Reserve policy is the least important. It is likely that investors can, and will, adjust to the fact that a Fed rate cut may not materialize any time soon.

Eyes on Nvidia

What would be a shock to the market would be if generative AI does not become the earnings driver that analysts expect it to be. This helps to explain why earnings results for chipmaker Nvidia Corp. (NVDA – $694.52), which controls 80% of the high-end chip market, will be a critical barometer for the market and for the bubble. Nvidia earnings are released on Wednesday which makes this the most important day of the week. The 40% gain in Nvidia’s stock price this year has driven NVDA’s market capitalization past that of Amazon.com, Inc. (AMZN – $167.08) and Alphabet Inc. (GOOG – $142.20), placing the stock in third place behind Microsoft Corp. (MSFT – $402.79) and Apple Inc. (AAPL – $181.56) in terms of size. The company has also replaced Tesla, Inc. (TSLA – $193.76) as Wall Street’s most traded stock by value after $30 billion worth of its shares changed hands, on average, over the last 30 sessions. This turnover was greater than Tesla’s average of $22 billion per day in the same period. With a forward PE ratio of 32 times, many analysts expect a blow-out earnings quarter for NVDA.

While in the World

The focus on Nvidia’s earnings release has overshadowed a number of other events this week including the $80 billion merger of Capital One Financial (COF – $137.39) and rival Discover Financial Services (DFS – $124.42), Walmart Inc. (WMT – $175.86) buying smart-TV maker Vizio Holding Corp. (VAIO – $11.08) for $2.3 billion, Russia taking over the Ukrainian town of Avdiivka in a chaotic bloody battle, the United States being the only veto to a United Nations Security Council resolution demanding an immediate humanitarian ceasefire in the Israel-Hamas war, and the US announcing a major package of sanctions against Russia in response to the death of opposition leader Alexei Navalny while he was in prison.

Economic Results

The National Association of Home Builders confidence index rose 4 points in February to 48, driven entirely by expectations which rose 1.3 points to 78.4. These results are up nicely from recent lows but remain well below pre-Covid-19 levels. The Census Bureau released data showing total housing starts fell 14.8% YOY in January, while single-family starts rose 22% YOY. Similarly, new housing permits rose 8.6% YOY and single-family permits rose a much stronger 35.7% YOY. This data seems to suggest that the boom in multi-family construction may be slowing. See page 3.

In January and on a seasonally adjusted basis, total retail and food services sales increased a modest 0.6% YOY. Excluding motor vehicles & parts, retail sales rose a slightly better 1.2%, and excluding motor vehicles & parts and gas stations, sales rose 2.2% YOY. However, based on 1984-84 dollars, retail sales fell 2.4% YOY, making January the 11^th time in 15 months that real retail sales were negative on a year-over-year basis. This has been one of the longest stretches of negative real retail sales not accompanied by an economic recession. See page 4.

In the post-COVID-19 era there have been only two components of retail sales that consistently gained market share, and these are nonstore retailers and food services & drinking places. In other words, in a period of negative real retail sales coupled with gains in nonstore retailers and food services & drinking places, many other areas of the retail sector have been suffering greatly. Auto sales are a large component of total retail sales; and while autos had a healthy rebound from their COVID lows, it was not sustained, due in large part to increases in interest rates, gas prices, and auto insurance costs. See page 5.

The University of Michigan sentiment index for February was 79.6. This was little changed from January’s 79.0 reading, but it was up nicely from November’s 61.3 survey. Expectations led the gain, rising from 77.1 to 78.4. Current conditions fell from 81.9 to 81.5. The University of Michigan often includes political affiliation in its sentiment surveys, and this can be interesting to monitor. What is seen on page 6, is that one’s confidence tends to rise or fall depending upon which party you favor, and which party is in power. Democrats have displayed higher levels of consumer confidence during President Biden’s term in office, although even Democrats have shown less confidence in recent years than during President Trump’s term. Nonetheless, in February, sentiment improved substantially for Republicans and Independents, but fell for Democrats. See page 6. It will take time to see if this sentiment shift has any meaning for the November election.

Valuation

After slight declines in both the S&P 500 index and consensus earnings estimates, the trailing operating PE for the SPX is 23.3 X this week and remains above all short and long-term PE averages. The sum of the S&P’s 12-month forward PE of 21.2 and January’s CPI of 3.1% YOY equals 24.3, which is above the fair value range for equities, i.e., more than 23.8. In short, the market is richly valued. We are focused on this year’s earnings forecasts, but it is curious to note that the LSEG IBES consensus earnings estimate for last year was lowered by $2.71 to $221.84 this week. The S&P Dow Jones 2023 earnings estimate is unchanged at $211.10. See page 8.

Technicals

The S&P 500 and Dow Jones Industrial Average continue to make new highs while the Nasdaq Composite index inches closer to its November 2021 high of 16,057.44. Meanwhile, the Russell 2000 remains the most interesting index as it struggles to better, and stay above, the key 2000 resistance level and move out of the 1650 to 2000 range that has contained prices for two years. If the Russell can stay above this range successfully, it would be bullish for the overall equity market. Conversely, if the Russell fails to stay above the 2000 level and/or if the Nasdaq fails to move into new high ground, it could be a negative for the broader market. See page 9. The 25-day up/down volume oscillator is at 0.43 this week and neutral. However, it is rising from the lower end of the neutral range. This indicator should reach and remain overbought for a minimum of five trading sessions to confirm new highs in the marketplace. The last string of overbought readings ended on January 5.

Gail Dudack

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Last week in our strategy weekly “A Bubble, or Not a Bubble” (February 7, 2024) we outlined the three possible strategies to employ during a stock market bubble. They are 1.) participate in the bubble and buy stocks displaying the best upside momentum, 2.) add ETFs to your portfolio that mirror the market leadership in order to boost short-term performance, or 3.) continue to invest in good value stocks and weather underperformance in the near term, understanding that value will outperform in the long run and in the event that the bubble bursts. All equity bubbles eventually burst. In line with these strategies, we shifted our sector weightings last week to favor the current momentum seen in communication services, technology, and healthcare.

This week, January’s CPI report is posing the first real threat to the Goldilocks/bubble scenario. January’s inflation data showed headline CPI rising 3.1% YOY, down from December’s 3.4%, but still above the June 2023 level of 3%. This small dip in headline inflation was particularly disappointing because energy costs fell 4.6% on a year-over-year basis. The report was not only a setback to the consensus, but it also challenged the concept that the Fed will make five or more rate cuts this year. Adding to the pain was the fact that the core CPI was unchanged from December’s 3.9% YOY pace. This was distressing for the consensus which was looking for lower CPI numbers to support the view that inflation would fall to, or close to, the 2% level later in the year.

Lower inflation is an important piece of the Goldilocks scenario for several reasons. Not only does it imply a Fed pivot by mid-year, but lower inflation is vital in terms of supporting the high PE multiples seen in the current market. Moreover, stock market rallies and stock market bubbles are driven by liquidity and liquidity does not increase in an environment of rising inflation and rising interest rates. In short, inflation is pivotal to the consensus view.

However, we strenuously disagree with those who believe that owners’ equivalent rent (OER) is the main reason inflation is so high and that without OER the CPI would be growing at a pace closer to 2% YOY. As seen on page 3, owners’ equivalent rent has a 26.8% weighting in the CPI, and it rose 6.2% YOY in January. On the surface, one might conclude that OER is the main reason headline CPI remains so high. But we disagree. The weighting of OER seems appropriate since rent is often 25% to 30% of a person’s monthly income. Moreover, while rents are coming down, so is the trend in OER which was rising 8.8% YOY in March 2023. The 6.2% YOY pace reported in January was substantially down from its peak.

In addition, the calculation for OER is based on a 12-month moving average of rents. This seems fitting since rental agreements are usually renewed on an annual basis and not everyone is getting the advantage of lower rents at present. As a result, the trend in rent expense will move slowly through the CPI and the economy on the way up and on the way down. It has always been this way and only now that inflation and the Fed are major economic issues has this become a major discussion point for the bulls.

And lastly, the OER is not the only issue driving headline inflation. January’s inflation report showed big price increases in tenants’ & household insurance, water & sewer & trash collection, motor vehicle insurance, personal care, and hospital & related services. See page 4. These categories of the CPI represent necessities for most households and the price rises in this list represent a burden on home finances. This explains why the average consumer is not feeling optimistic about the strength in recent GDP and employment data. For those who do not understand why average Americans are not happy with the current economy, we say, “just look at the data” and not just the headlines.

Entrepreneurs are also feeling the pressure. The small business optimism index dropped 2 points in January to 89.9. The significance of this is that it was the 25th consecutive month below the 50-year average of 98, which is typically a sign of a recession. Six of the 10 components decreased in the month; the biggest decline was seen in sales expectations, which fell 12 points to negative 16. Actual earnings changes fell 5 points to negative 30 and hiring plans fell 2 points to 14. See page 5.

It has been an interesting week, and, in our readings, we found these interesting nuggets of information:

The top 10 holdings in the S&P 500 now make up over 32% of the index, the highest concentration seen in data going back to 1980. (https://twitter.com/charliebilello/status/1756721141547196867).

As of February 9^th, the S&P 500 rose for the 14th out of the last 15 consecutive weeks. According to Dow Jones Market Data, the last time this index recorded a comparable stretch of weekly gains was March 10, 1972 (a major market top). This 2024 stretch marked the 13th time it has happened since the index’s inception in 1957.

The current market capitalization of NVIDIA Corp. (NVDS – $721.28) of $1.78 trillion is greater than the GDP of South Korea ($1.71 Trillion – IMF 2023). South Korea is the 13^th largest economy in the world.

In an interview on CNBC earlier this week, Jason Trennert of Strategas, noted that the earnings for the Mag 7 stocks rose 59% YOY in the fourth quarter. The remaining 493 companies in the S&P 500 had an earnings loss of 3%.

Since inflation is in the headlines this week, we would point out that the WTI future (CLC1 – $77.68) might be about to break out above a tight cluster of moving averages. The 50-day moving average is $73.42, the 100-day is at $77.97 and the 200-day moving average is at $77.41. A break above these three moving averages would be bullish and imply higher energy prices, which would not be good for future inflation reports. The next important inflation release will be the PCE deflator scheduled for February 29.

Prior to this week’s pullback, the S&P 500 and the Dow Jones Industrial Average made a series of new record highs. The Nasdaq Composite came close to breaking its November 2021 high of 16,057.44. Still, the Russell 2000 remains the most interesting index as it struggles to better the key 2000 resistance and decisively move out of the 1650 to 2000 range that has contained prices for two years. If the Russell can break above this range successfully, it would be bullish for the overall equity market.  See page 8. The 25-day up/down volume oscillator is at minus 1.14 and neutral this week after a 524.63-point decline in the DJIA on February 13. This indicator has not come close to recording an overbought reading despite the string of record highs in the two main indices in January and February. The last favorable overbought readings of 3.0 or higher took place during 22 of 25 consecutive trading days ending January 5. To confirm the recent string of new highs in the S&P 500 index and Dow Jones Industrial Average, this indicator needs to reach and remain in overbought territory for a minimum of five consecutive trading sessions. This seems unlikely. In short, remain cautious.

Gail Dudack

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