US Strategy Weekly: Where is Goldilocks?

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. (

As of February 9th, 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 13th 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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US Strategy Weekly: A Bubble, or Not a Bubble? That is the Question

We recently wrote that we thought the equity market was richly valued and equities would either see a pullback to lower levels or the equity market could be on the verge of a bubble. Recent market activity leads us to believe that a bubble is indeed in the making. And the mania appears to be evolving and spreading.

This week, according to the Wall Street Journal, Eli Lilly and Company (LLY – $705.03) is a possible replacement for Tesla, Inc. (TSLA – $185.10) in the Magnificent Seven stocks. Some analysts believe there might be parallels between obesity drugs and the early days of electric vehicles and this made Lilly a beneficiary of the ‘mass-culture hype” that is dominating the equity environment. This hype has driven a few stocks to valuations that are well beyond that of their peers. For example, Tesla trades at 57 times forward earnings, according to FactSet, and Lilly trades at 55 times forward earnings. For comparison, in the auto industry Ford Motor Company (F – $12.07) trades at a 6.6 multiple and in the drug industry Johnson & Johnson (JNJ – $158.06) carries a PE multiple of 15 times. In an environment where earnings growth is slowing, investors seem to be flocking to a small group of companies believed to have little competition and massive growth potential. These stocks, including the Magnificent Seven, were huge outperformers for most of 2023, and it appears they may outperform again in 2024, but with some additions and deletions along the way.

Assuming this is true, we are making a number of sector weighting shifts this week.

Sector Shifts

If the stock market is in the midst of a bubble, the strategy for most portfolio managers will have to change. Unfortunately, to keep up with the popular indices money managers will be forced to shift their focus from value to momentum. This shift is risky and not permanent; however, it is necessary if one’s equity performance is measured against benchmarks like the S&P 500. The stocks that are likely to outperform in the months ahead will be those driven by the theme of the bubble, and in the current environment this would be artificial intelligence. Artificial intelligence can take many forms in terms of companies providing AI, using AI, or being components of AI, but right now these stocks are concentrated in the technology and communication services sectors of the S&P indices. Since we believe the equity market is displaying signs of being in a bubble, we are changing sector weightings and shifting technology from neutral to overweight and communication services from underweight to overweight.

Healthcare has been performing better in recent weeks and also benefits from and uses many aspects of artificial intelligence. Moreover, the public appears to view the growth potential of obesity drugs as a significant earnings growth driver. In sum, we are upgrading the healthcare sector from neutral to overweight. The financial sector has already been among our overweight recommendations, and it currently remains there. However, within the financial sector we would focus on large money center banks and try to avoid growing problems seen in commercial real estate, credit card delinquencies, and auto loan delinquencies.

To balance out our sector recommendations we are downgrading industrials and consumer discretionary from overweight to neutral. Staples and energy are also rated neutral. Utilities, REITS, and materials are currently our recommended underweights. See page 14.

We are not comfortable being momentum followers, and would rather use fundamentals for our sector weightings, but history shows that at the core of a bubble is a disregard for fundamental value and a belief that a new era of growth is emerging. Keep in mind that in a bubble, only a small universe of stocks will take the averages higher, and a majority of stocks (in all industries) will underperform the S&P 500. More importantly, when a bubble bursts, the top-performing stocks that drove the market higher will also fall the hardest. Once a bubble bursts value stocks will also decline, but less than the overall market, and thereby outperform.

All in all, the decision to invest in and follow a bubble is an individual choice. One strategy in a bubble could be to own a collection of ETFs that mirror the indices rather than trying to outperform the portfolio benchmark. Or, for some investors, the wisest path could be to remember the story of the tortoise and the hare and stick to a slow and steady policy of value investing. This would mean weathering some subpar short-to-intermediate term performance and focusing on the longer term.

The history of bubble markets like those seen before the 1972 and 2000 peaks indicates that such markets can persist far longer than most people expect. Equities became overvalued in 1997 and did not peak until early 2000. Notice that there were 28 years between those two peaks, and we are 24 years past the last peak. In short, this is a new generation of investors. American humorist and writer Mark Twain is credited with the aphorism: “History doesn’t repeat itself, but it often rhymes.” This seems to be an appropriate warning in the current environment.

If valuation does not apply in a bubble, there are only a few tools one can use to gauge when a bubble may be about to come to its end. Bubbles are fueled by both liquidity and leverage and monitoring these can help define the age of a bubble. In terms of liquidity, there is $6 trillion in money market funds ($2.35 trillion in retail money market funds and $3.65 trillion in institutional) suggesting there is plenty of fuel to keep prices moving higher. Leverage changes in every cycle and the current cycle may be fueled more by investors leveraging equity ownership through ETFs than by using margin debt. But only time will tell.

Technicals Look Bubbly Too

The charts of the popular indices have not changed much in the past week. The Dow Jones Industrial Average and the S&P 500 recorded new all-time highs and the Nasdaq Composite is less than 3% from its record high. The Russell 2000 index, however, is more than 20% below its record peak. Moreover, after breaking out of the 1650 to 2000 range that contained price action in this index for two years, the Russell 2000 dropped back below the 2000 resistance level. See page 10. This underperformance is in line with the NYSE cumulative advance/decline line and reflects a two-tiered market.

The 25-day up/down volume oscillator is at negative 1.15 this week and is closer to an oversold reading than an overbought reading. To confirm the recent highs in the SPX and DJIA, this indicator should reach and stay overbought for a minimum of five consecutive trading sessions. If not, it suggests that investors are selling into the recent highs. This week we also have comments on economic releases including January’s employment report, weekly and hourly earnings, the ISM indices, and consumer confidence surveys. See pages 3 through 7.

Gail Dudack

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US Strategy Weekly: Earnings, FOMC, and Jobs

The S&P 500 and the Dow Jones Industrial Average recorded a series of new highs in recent sessions, triggered by the US Treasury’s announcement that funding in the first quarter would be less than previously expected and the International Monetary Fund releasing its global forecasts and announcing that a “soft landing” is in sight. (Should we worry?) But the week is far from over since on the horizon are results from many of the Mag 7 stocks, an important FOMC meeting, and January’s job report.

The Importance of AI Earnings

This is also a peak week for earnings announcements with 86 of the S&P 500 companies expected to report. To date, fourth-quarter earnings results have been mixed. And as we go to press, the stock market is trying to digest results from Microsoft Corp. (MSFT – $408.59), Alphabet Inc. A (GOOGL – $151.46), and Advanced Micro Devices, Inc. (AMD – $172.06) which failed to impress investors.

Earnings results will be important for the equity market, particularly for companies in the technology and communication services sectors, which have been leading the advance. Note that the S&P communications services sector includes highflyers like Alphabet Inc. C (GOOG – $153.05), Alphabet Inc. A (GOOGL – $151.46), Meta Platforms, Inc. (META – $400.05), and Netflix, Inc. (NFLX – $562.85), which dominate the market capitalization of the group. It also includes AT&T Inc. (T -$17.53), Verizon Communications Inc. (VZ – $42.47), Walt Disney Company (The) (DIS – $96.94), and Omnicom Group Inc. (OMC – $91.83). Given the lofty PE multiples in the Mag 7 companies, earnings results will be more important than ever. Moreover, any disappointment in the growth prospects for AI-related stocks would be a big negative for the overall marketplace.  

The S&P Dow Jones consensus estimate for 2024 of $240.08, was lowered by $0.61 last week. The LSEG IBES estimate for 2024 was $242.61 down $0.56. Keep in mind that based upon the IBES earnings estimate for this year, equities are very richly valued with a PE of 20.3 times. This is particularly high with inflation currently at 3.3%. The sum of this PE and inflation equals 23.6 and is just below the 23.8 level that defines an extremely overvalued equity market. If one uses the S&P Dow Jones consensus estimate, the current 2024 PE is even higher at 20.5 times. See page 9.

It has been our view that the equity market is at an important junction in 2024. Either earnings surge and justify current multiples, or equity prices will stall or decline until earnings improve. Another option is for equity prices to continue to rise, particularly in AI-related stocks, and to simply disconnect from fundamentals. This would be the start of a bubble market similar to those seen prior to the 1972 and 2000 peaks. This helps to explain why potential in AI-related growth is a key element to stock performance this year.

FOMC on Hold

Meanwhile, the economy appears to be stronger than many expected, and this could keep the Fed on hold for at least the next few months. We do not anticipate any significant change in policy this week, but it will be interesting to see how Fed Chairman Jerome Powell handles the press conference which could be lively. It would be unwise for the Fed to lower interest rates in view of recent economic reports. Real GDP grew 3.3% in the fourth quarter, down from the unsustainable rate of 4.9% seen in the third quarter, but strong, nevertheless. The most impressive feature of this fourth quarter growth was that all components were additive, including trade which is typically a drag on GDP. The main strength was the consumer, which was 1.9% of the quarter’s 3.3% increase. It is important to note that the 3.3% rate seen in the fourth quarter, although down on a quarter-over-quarter basis, remained solidly above the long-term average GDP growth rate of 3.2%. See page 3.

In December, personal income grew 4.7% YOY, disposable income grew 6.9% YOY and real disposable income grew 4.2% YOY. This last number is down from 4.4% in November; nonetheless, it is the 12th consecutive month of positive real income growth. This string of positive real income follows 21 consecutive months of weak or negative real income growth seen from April 2021 to December 2022. This 21-month stretch of negative real income growth was the first time negative real income did not translate into an economic recession. See page 4.

The personal savings rate fell from 4.1% to 3.7% in December. Both savings rates were well below the 22-year average of 5.8% or the long-term average of 8.5% and this could mean that many households dipped into their savings for the holidays. Recent data from the St. Louis Federal Reserve helps to explain why good economic data has not had a substantial impact on consumer sentiment. Real personal median income peaked in 2019 at $40,980, fell in 2020 and has been flat ever since. In short, despite a surprisingly strong job market, and a rise in wages, inflation has taken a toll on many households and real median income has not increased. And it helps to explain why some consumers are still struggling despite a recent deceleration in inflation. See page 5.

To understand why consumer sentiment has hovered near recessionary levels, one needs to dig deeper than just the headlines. Household spending has been concentrated on necessities. For example, in the last 3 years spending on gasoline has increased nearly 90%, transportation services spending has increased 77%, and food services and accommodation spending has increased 71%. After being confined to their homes due to COVID mandates, consumers increased spending on recreational services by 78% in the last three years. Plus, we were quite surprised to find that wages in the government sector rose over 8% in 2023, which was far more than the 5% seen in most other industries. See page 6.

Interest payments are another area that has pressured many households. Personal interest payments, increased as much as 66.5% YOY in June 2023, and were still high at 37% YOY in December. Personal taxes were down in 2023 after substantial increases in 2021 and 2022. And what may prove to be the most significant data point in 2024 is the decline in government stimulus. The chart on page 7 shows that while “other” government stimulus is steadily trending lower, it is still well above normal. The surge in fiscal stimulus in 2021 helped boost consumption and the economy and may be the single reason many recessionary signals proved to be either wrong or too early.

Technical Update

A new set of breakouts materialized in the S&P 500 and the Dow Jones Industrials this week generating a series of new all-time highs. The Nasdaq Composite is running to catch up. However, the Russell 2000 remains the most interesting index. After beating key resistance at 2000, it retreated below this level early in the year, and failed at another breakout attempt this week. There is still time for a breakout, and if the Russell succeeds, it would be bullish for the overall equity market. See page 10. The 25-day up/down volume oscillator is at 0.13 and neutral this week after being in overbought territory of 3.0 or higher for 22 of the 25 consecutive trading days ending January 5. To confirm this week’s advance the indicator should reach and remain in overbought territory for a minimum of five consecutive trading sessions in coming weeks.

Gail Dudack

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US Strategy Weekly: Stocks, Bonds, and Primaries

A Primary Thought

As we go to print, the New Hampshire primary is in progress, and it is getting an amazing amount of news coverage both domestically and globally. Perhaps this is because the New Hampshire primary is shaping up to be “the real beginning” or the actual end of former South Carolina Governor and former UN Ambassador Nikki Haley’s race for the Oval Office. Haley spent more money in New Hampshire than any other candidate and has the governor of the state supporting her. She has an impressive resume and did well as the US Ambassador to the United Nations. However, her campaign has received huge donations from multiple Democratic supporters which complicates her Republican standing. Either way, it feels like this primary is the real start of the 2024 presidential election campaign.

New Hampshire is a small state, but an interesting one. Forty percent of voters are registered as independent, and as such, can choose which party primary they want to participate in. On the Republican side, 22 delegates to the Republican National Convention will be awarded on a proportional basis. And though this is a small portion of the 1,215 delegates needed to clinch the nomination, New Hampshire’s early spot on the calendar has given the state an outsized role in the nominating process.

On the Democratic side, 33 delegates will be sent to the Democratic National Convention from New Hampshire, but their vote will not be bound by the primary results due to a dispute within the party. President Joe Biden is not on the ballot because the Democratic National Committee decided to make South Carolina its first voting state. Meanwhile, Dean Phillips and Marianne Williamson have been actively campaigning for Democratic votes in the state. As a result, the Biden campaign began only recently, an active movement to get voters out to vote and to write-in Biden’s name. This could make the Democratic primary, which was expected to be a nonevent, also interesting. Interviews with early voters suggest that the border and immigration is a major focus for voters in the state, which could also make the New Hampshire results more important than the actual number of delegates it sends to the respective conventions.

Newscasters are indicating that if former President Donald Trump wins the New Hampshire primary he will be the first Republican candidate to win the first two primaries in Iowa and New Hampshire since Gerald Ford in 1976.

Stocks and Bonds

The stock market has shrugged off several hurdles this week, including Monday’s 6% decline in the Chinese stock market and mixed fourth quarter earnings results. Interest rates are inching higher due to a week of heavy debt issuance. This will be the first of many debt auctions this year since the Treasury is expected to issue nearly $2 trillion of debt in 2024. Nonetheless, in recent sessions the S&P 500 index joined the Dow Jones Industrial Average by recording an all-time high.

Although the S&P 500 has now recorded a new high, our technical indicators are yet to confirm the move. The Russell 2000, after beating the key 2000 resistance, has now dropped below this level, which neutralizes the December breakout. See page 7. The NYSE cumulative advance/decline line is performing better than the Russell 2000 index, but it too, is not confirming the S&P 500, and remains 11,643 net advancing issues below its all-time high. See page 9.

The 25-day up/down volume oscillator is at minus 0.53 and neutral this week after being in overbought territory of 3.0 or higher for 22 of the 25 consecutive trading days ending January 5. The oscillator did confirm the December uptrend as “significant,” however, it has not yet confirmed this week’s advance. To confirm this week’s move in the S&P 500 to record highs, this oscillator should move into overbought territory for a minimum of five consecutive trading sessions. The current neutral reading is not surprising, but the oscillator needs to reach overbought territory in the next 5 to 10 days to confirm the January 19 and January 23 closes. See page 8. We remain cautious on equities until we get this confirmation.

Improving Economic News

Sentiment indicators improved at year end with the NFIB small business optimism index rising from 90.6 to 91.9 in December, its highest reading since July. The gains came from economic expectations and earnings trends which were less negative than a month earlier. The University of Michigan consumer sentiment index jumped 9.1 points to 78.8 in January, due to a 10-point gain in present conditions and an 8.5-point gain in expectations. However, note that both surveys remain well below long-term average levels. See page 3.

Retail sales rose 0.6% in the month of December and were up 5.6% YOY. Excluding auto & gas sales, core retail sales increased 5.8% YOY, which indicates that holiday shopping ended on an upbeat note, with growth led by department stores, apparel stores, and nonstore retailers. The 2.2% YOY gain in real retail sales was the best seen since February 2022 and it follows, and possibly reverses, a long period of negative real retail sales in 10 of the 12 months ending November 2023. A long stretch of negative real retail sales is characteristic of a recession. See page 4.

The National Association of Home Builders (NAHB) home builder survey increased 7 points to 44 in January, showing gains in all components including current single-family sales, sales expectations over the next 6 months, and traffic of new potential buyers. The National Association of Realtors (NAR) Affordability index rose in November to 94.2 from 91.4, due to a decline in mortgage rates from 7.7% to 7.5%, a modest rise in median family income to $99,432 and a slight decline in the price of a median single-family home to $392,100. Nonetheless, affordability remains near its lowest level since data began in 2007. See page 5.


It has been our view that the market is currently richly valued. This means that the December rally could be the beginning of a liquidity-driven advance similar to those seen at the peaks made in 1973 or 2000. In both of these cases, the stock market disconnected from fundamentals due to the expectation of a new era of growth. Investors became enthralled by the Nifty Fifty stocks in 1972-1973 and by the dotcom craze of 1997-2000. Clearly, the buzz around artificial intelligence has a similar potential. Time will tell. Meanwhile, the S&P Dow Jones consensus estimate for 2024 is $240.68, down $0.56 this week. The LSEG IBES estimate for 2024 is $243.17 down $0.34. Based upon this IBES EPS estimate of $243.17 for this year, equities remain overvalued with a PE of 20.0 times. This multiple coupled with inflation of 3.3% sums to 23.3 and is just below the 23.8 level that defines an overvalued equity market. See page 6. If one uses the S&P estimate of $240.68, the 2024 PE is 20.2 times. In short, the stock market has already factored in a substantial decline in inflation and the next 12 months of earnings growth into current prices. As we noted last week, the bond market may be a better barometer of risk in 2024 than equities and rising interest rates are not factored into current equity prices.  

Gail Dudack

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US Strategy Weekly: Bonds May Hold the Key

The December rally seems to have run out of momentum early in 2024, and despite three attempts by the S&P 500 index to better its all-time record, it is yet to do so. And while the financial media talks about the market being in record territory, only the Dow Jones Industrial Average managed to eke out a new high recently. Our favorite barometer, the Russell 2000 index, dropped back below the critical 2000 resistance/support level making the bullish December breakout questionable.

Federal Reserve Policy Expectations

There have not been any new developments to stop the advance. However, the December rally was driven by the consensus view that multiple Fed rate cuts were on the horizon and interest rates would begin to fall in March. The new year has tempered these expectations a bit, but we are concerned that those expecting rates to fall at the long end of the curve may also be disappointed. It is not new news that Treasury issuance is expected to nearly double to $2 trillion in 2024. Given this huge increase in supply, prices may have to fall and yields rise to entice demand for this flood of new debt.

It was not long ago that a credit rating downgrade by Fitch fueled a bond selloff that saw the 10-year yield reach 5%, its highest level since 2007. Signs that inflation is stickier than expected could also complicate the supply/demand picture for Treasury issuance. To offset these fears, some economists are theorizing that the central bank may end its quantitative tightening policy earlier than expected in order to improve the supply/demand balance in the marketplace. In the last 18 months, the Fed has reduced its balance sheet by over $1 trillion through quantitative tightening. But some Fed officials, perhaps in response to these fears, recently said the central bank should start considering slowing down and ending the shrinkage of its bond holdings.

Also working against the bond market is the fact that fiscal deficits remain historically high, and the 12-month total deficit was 8% of GDP in December. See page 3. At the end of 2023, the deficit was due in large part to a 7.2% YOY decline in receipts, or government revenues. Revenue declines of this size are worrisome since they represent a decline in income or corporate profits and are usually associated with a recession. In short, this could be a warning for the economy as well as the bond market. It is also worth noting that the current deficit at 8% of GDP is greater than the average 12-month deficit seen prior to the COVID-19 shutdown. Deficits normally run high during recessions but decrease during economic expansions. The fiscal stimulus policies maintained throughout 2023 did boost the economy, as seen in third quarter GDP, but it came at the cost of increasing federal debt to high levels.

The composition of federal debt issuance is directed by the Treasury Secretary, and some have noticed that an increasing portion of debt has been issued at the shorter end of the yield curve, in Treasury bills. This makes sense if interest rates are close to zero, but after Fed tightening lifted short-term interest rates over 5%, this shift has contributed to the problem of rapidly rising interest payments on the debt. Data from the St. Louis Federal Reserve showed that at the end of 2023, government payments on the debt reached 11% of total government outlays. See page 4.

We think some economists believe this rise in government interest outlays may force the Federal Reserve to lower rates earlier than they may want to do so. This may be true, but for that to happen inflation must also fall.  

Economists will be watching every Treasury quarterly refunding announcement in 2024, not only to analyze the supply of debt coming to market but also its composition. The Treasury Borrowing Advisory Committee recommends that short-term financing not be more than 20% of federal debt in order to keep financing manageable. But the 20% level was exceeded in 2020, and at the end of 2023 Treasury bills represented 17% of federal debt and the trend was rising. See page 5. In sum, Treasuries could exceed 20% in coming quarters, and this would increase government interest payments even more. All in all, the bond markets need to be monitored closely this year, since the equity market has already discounted lower interest rates in 2024 not higher interest rates.

Inflation Expectations

The December CPI report showed headline inflation rising from 3.1% to 3.3% in December, with core CPI falling a bit from 4.0% to 3.9%. Our work uses non-seasonally adjusted data, and it shows a slightly different scenario of headline inflation falling 0.1 in December to 3.4% and core CPI increasing 0.1 to 3.9%. But more importantly, most underlying components of the CPI were rising faster than the headline index on a month-to-month basis. See page 6. Overall, most inflation measures show prices decelerating from their 2022 peaks and we think this should continue if energy prices remain stable.

What is a concern is that while headline and core inflation seem to be decelerating, several components of the CPI appear to be rebounding. See page 7. Transportation is the greatest concern for us, but in the service arena, components like motor vehicle insurance are rising 20% YOY. Note, while motor vehicle insurance only has a 2.9% weighting in the index, it is a service that impacts a majority of US households. We think it is items like this, the 5.0% YOY increase in personal care products, or the 5.1% YOY increase in pets, pet products and services, which keep many households concerned about inflation. See page 7.

Technical Update

December’s bullish breakouts in all four of the popular indices were perpendicular and dramatic, but weeks later only the Dow Jones Industrial Average recorded an all-time high. The S&P 500 remains interesting at this juncture since it has been fractionally away from a new record three times in the last month but is yet to better its January 3, 2022 high of 4796.56. The Russell 2000, after beating the key 2000 resistance, has now dropped below this resistance/support level, and this neutralizes the December breakout. See page 9.

The 25-day up/down volume oscillator is at 1.02 and neutral this week after being in overbought territory of 3.0 or higher for 22 of the 25 consecutive trading days ending January 5. This indicator needed to remain in overbought territory for a minimum of five consecutive trading sessions to sanction the advance, which means that the oscillator has confirmed the December uptrend as “significant.” January’s pullback in prices may simply be a short consolidation phase, but it may last longer than some think, since we believe the equity market needs a new catalyst to propel stock prices higher. The obvious catalyst would be better-than-expected earnings, but to date, that has not materialized. As we wrote last week, December’s rally was driven by liquidity, not by valuation. At present, based on the LSEG IBES earnings estimate of $243.51 for this year, equities remain overvalued with a PE of 19.6 times. Adding 19.6 and the inflation rate of 3.4%, sums to 23.0, or just below the 23.8 level that defines an overvalued equity market. Based on the S&P estimate of $241.25; the 2024 PE is 19.8 times and even higher. We remain cautious.

Gail Dudack

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US Strategy Weekly: The Underpinnings of Targets

How much potential or risk there is in stock prices is best explained by current and forecasted fundamentals, in our opinion. Momentum and sentiment can drive stock prices over the short-to-intermediate term, but over the longer term, earnings growth, or lack thereof, always underlies the trend of the equity market. For this reason, we sought to understand the underpinnings of the many S&P 500 forecasts of 5100 or 5700 for this year.

There are two simple components to any S&P forecast: the appropriate PE multiple and the earnings estimate. However, it is never that simple because both can be moving targets. As we noted in our 2024 outlook, our valuation model is a PE forecasting model derived from our expectations for inflation and interest rates. Our assumptions for 2024 are that inflation will ease to 2.75%, short-term interest rates will fall to 4.25%, and Treasury bond yields stay relatively stable at 3.6%. These are optimistic forecasts in our view; however, they fall well within the range of consensus forecasts. With these estimates, our valuation model indicates that the average PE for this year should be 18.5 times and the maximum PE multiple could be 21 times. A 21 PE multiple would be a possibility if inflation falls to 2% or less, since this would imply earnings growth is more “real.” In short, the model provides a broad range of possibilities.

When we take a multiple of 18.5 times and apply it to our 2024 earnings estimate of $234.00, a 10% increase from S&P Dow Jones 2023 estimate of $213.55, the result is an SPX target of 4330 for this year. If we use a maximum PE multiple of 21, we get an SPX target of 4914.

If we assume our earnings forecast is too pessimistic and use the IBES consensus estimate of $243.98 for this year, we get an SPX target of 4514 with an 18.5 multiple. To get to an SPX target of 5123, we need to use a maximum PE of 21 times and the IBES 2024 earnings estimate. This is a good explanation of why several strategists are using a 5000+ target for this year.

However, for those looking for even higher SPX targets, the forecaster must use not only a maximum PE of 21 times, but also the IBES 2025 earnings forecast of $274.59. This combination equates to a target of SPX 5766. In short, this exercise explains how one gets to an SPX target of 5100 or 5700, but it also reveals how much risk there is to these targets.

First, both targets assume stocks will reach and maintain a maximum PE which is likely only if inflation falls to 2% or less later this year. Second, an SPX 5100 forecast assumes that the IBES consensus earnings estimate for this year is correct. The risk here is that consensus earnings forecasts tend to peak early in the year, start to decline in March and then during each reporting season thereafter. This declining trend is rarely absent unless the economy is coming out of a recession. Analysts tend to be too pessimistic after a recession; and as a result, consensus earnings estimates are usually too low and increase during each quarterly earnings season.

Nonetheless, an SPX target of 5700 discounts not only a perfect year of low inflation but all the optimistic earnings growth expected over the next 24 months. There are many risks to these assumptions, the most obvious being that the economy may slow, revenues will decelerate, and earnings growth could disappoint. The first few days of 2024 have already been an adjustment to the overly optimistic view that there will be multiple interest rate cuts beginning in early 2024. And after analyzing the basis of the bullish targets for 2024 it becomes clear that every earnings season, every inflation report, and every FOMC meeting will be very important to substantiate the bullish forecasts for this year.

Employment Data

The 216,000 increase in payrolls in December was stronger than expected, but the unemployment rate was unchanged at 3.7%. Note that the unemployment rate for those with less than a high school degree has been rising and was 6% in December. Clearly, the lower-income worker was experiencing a more difficult job market at the end of the year. The household survey showed roughly a 1.5 million increase in people no longer counted in the labor force in December; meanwhile, there was a 460,000 increase in the number of people not included in the workforce but who indicated they want a job. Job growth was 1.75% in December, which is above the long-term average of 1.7%. However, job growth in the household survey was 1.18% and this was below the 1.5% long-term average for the first time since March 2021. In short, there were some signs of stress in the jobs data. See page 3.

Economic Data

The ISM manufacturing index improved slightly from 46.7 to 47.4 in December; however, the services index fell from 52.7 to 50.6. Since 50 is the breakeven level, the December services survey was indicating only modest economic activity. Perhaps more importantly, the services survey saw the employment index fall from 50.7 to 43.3 in December, the lowest reading since July 2020 and a sign that job growth has slowed or is declining in the service sector. The employment index in the manufacturing survey has been below 50 (neutral) since September. See page 4.

When we look at a variety of components in the ISM manufacturing index, it is obvious that most have been below 50 for most of 2023, a sign of weak economic activity. In the services survey, the overall trend was above 50 but slowly decelerating. The drop in the employment index may be a bad omen for 2024. See page 5.

The small business optimism index improved slightly in December, rising 1.3 points to 91.9. However, this reading was still the 24th consecutive month below the long-term average of 98 and a sign of recession. In December, businesses indicated they were generally unhappy with the level of their inventories and indicated a reluctance to increase capital expenditure. Hiring plans also continued to decline. On a hopeful note, plans to raise prices appear to have peaked for most entrepreneurs. See page 6.

Technical Update The breakouts in all four of the popular indices were perpendicular and dramatic at the end of 2023, but only the Dow Jones Industrial Average managed to record an all-time high. The S&P 500 is most interesting since it has been fractionally away from recording a new high but is yet to better its January 3, 2022 high of 4796.56. The Russell 2000, after beating the key 2000 resistance, has now dropped below this level, which neutralizes the breakout seen at the end of the year. See page 9. The 25-day up/down volume oscillator is at 1.76 and neutral this week after being in overbought territory of 3.0 or higher for 22 of 25 consecutive trading days ending January 5. This indicator needed to remain in overbought territory for a minimum of five consecutive trading sessions to confirm the recent uptrend as “significant.” This is positive, however, weakness in the early part of a new year is often a warning sign of fading demand for equities. In sum, 2024 is apt to be a volatile and unpredictable year.

Gail Dudack

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US Strategy Weekly: History, Liquidity, and Valuation

A Bit of History

The media is filled with headlines stating that the S&P 500, the Dow Jones Industrial Average, and the Nasdaq Composite Index have booked nine consecutive weekly gains — the longest weekly winning streak for the S&P 500 since January 2004, and the longest stretch for the Dow Jones Industrial Average and the Nasdaq Composite Index since early 2019. Many in the media have then suggested that this strong run means more gains are ahead. Indeed, double-digit gains in the equity indices don’t suggest a bear market … unless there are three years in a row of double-digit gains. But as you can see from page 7, the full year 2004 had a fairly mediocre performance after its early advance. In 2019 an early advance in the first quarter stalled, then rallied, and in November, COVID-19 became a global pandemic, making comparisons difficult.

However, the parallel between 2004 and 2024 is not only due to the nine weekly gains, but that both are presidential election years. And they are years ending in “4.” Depending upon which market index one uses, the presidential election year has the third or fourth best performance of the four-year cycle. In short, election years tend to be mediocre. The pre-election year is the year with the biggest stock gains in the four-year cycle. This is probably due to fiscal stimulus done early in the year to help the economy and to help the incumbent president win votes due to a strong economy. This pattern seems to fit the current cycle, even though it is a most unusual economic cycle.

However, one of the most interesting things about an election year is that it has some ability to predict the outcome of the presidential election. When the incumbent is about to win, equities tend to be weakest in May in July. The May decline sets up a classic summer rally which is followed by a weak July. Typically, July is the fourth best performing month of the year, so this works against seasonality. In years when the incumbent loses, the weakest months of the year tend to appear in January, February, September, and October. January has a history of being the sixth best performing month, on the heels of good gains in November and December. So, this too, goes against seasonality and weakness early in the year is a bad omen for an incumbent president. In both cases, or most election years, the strongest months tend to be November and December. See page 8.

This is also a year ending in 4, and the decennial pattern suggests it will be a year with an average gain of 7.1%, leaving it tied for fifth place in the 10-year cycle. Still, “4” years have produced gains in nine of the last 14 cycles, so there is a bullish bias to years ending in 4. See page 6. All in all, history points to an up year, but more in line with a single-digit gain than a double-digit gain.


The dramatic gains seen at the end of 2023 were driven by the widely held belief that interest rates are coming down in 2024. Federal Reserve Chairman Jerome Powell attempted to dampen these expectations in subsequent days, however, his comments after the last FOMC meeting did indicate that rate cuts were likely in 2024. This suggestion triggered a swift decline in long-term interest rates and a rush out of cash and into equities. The momentum of the equity market is strong, and this is seen in our technical indicators. However, behind good momentum tends to be good liquidity. For this, we looked at Federal Reserve data on commercial banks. What we found was that banks hold nearly $19 trillion in customers’ liquid short-term assets. This number is the sum of $4.99 trillion in demand deposits, $1.7 trillion in retail money market funds, $1.0 trillion in small-denomination time deposits, and nearly $11 trillion in other liquid deposits. See page 4. In recent years, money flowed into short-term assets as interest rates rose and the threat of recession was looming. Powell’s “pivot” on interest rates created a “pivot” in investor sentiment and their opinion of cash. In a Cinderella world of falling interest rates, declining inflation, and no recession, $19 trillion is a substantial amount of potential demand for equities. Moreover, we know that the cash held at commercial banks is a majority, but not all inclusive, of household cash coffers.

Nevertheless, we have experienced liquidity-driven markets in the past and have learned that it is important to put any “liquidity cache” in perspective to the size of the overall market. If we compare current cash assets to total US market capitalization, we find that it represents 38% of total US market capitalization. This is a substantial, but not historic ratio, of cash. See page 4. Most secular bull cycles began when cash equals 50% or more of market capitalization. In short, cash levels support a strong momentum-driven market for a while, but do not suggest this is the start of a major secular bull market.


If the equity market is on the verge of a bubble market, we will know fairly quickly since bubbles are driven by sentiment, liquidity, and leverage, not by earnings or fundamentals. At present, the fundamentals are not supportive of the bulls. There are many ways to measure valuation, but most show the market to be richly valued today. On page 9, we show the Rule of 23, which implies that when the sum of the trailing PE and inflation exceeds 23.8, the stock market is extended and overvalued. The current trailing PE is 22.3 times and the S&P PE based on 2024 earnings estimates is 19.6 times. With inflation at 3.2% and potentially easing, when coupled with the trailing PE of 22.3, the sum of 25.5 is well above the dangerous 23.8 level. Perhaps more importantly, if we add the estimated 2024 forward PE ratio of 19.6 times to inflation of 3.2%, the sum of 22.8 is only two points below the 23.8 danger level. In short, the stock market’s valuation has already discounted a substantial decline in inflation and all of this year’s potential earnings growth. This implies that every CPI report and every earnings reporting season has the potential to be a market-moving event.

Bullish Technicals

What keeps us from getting too negative about valuation too soon is the significant change in our technical indicators. The breakouts in all four charts of the popular indices are both perpendicular and dramatic, but to date, only the DJIA has managed to make a new all-time high. The SPX is most interesting at this juncture since it has been fractionally away from a new record high for several sessions but is yet to better its January 3, 2022 peak of 4796.56. The Russell 2000, after beating key resistance at the 2000 level, is now testing this level as support. If the Russell begins to trade below 2000 once again, it could neutralize what is now a very bullish technical pattern. See page 11. The 25-day up/down volume oscillator is at 3.45 this week and has been in overbought territory of 3.0 or higher for 19 of the last 22 consecutive trading days. To confirm the recent advance this indicator needed to remain in overbought territory for a minimum of five consecutive trading sessions, which means the oscillator has definitely confirmed the recent uptrend as “significant.” The current 19-day overbought reading is far better than the 11-day reading seen between January 25, 2022 and February 8, 2022. The only missing ingredient to the current strength of this indicator is an overbought reading in excess of 5.0. Extreme overbought readings of 5.0 or more are often seen at the start of a new bull market cycle. However, this is not a requirement for a significant advance. What will be important is that any pullback in the equity market ends once this indicator approaches an oversold reading. In a bull market oversold readings tend to be brief or nonexistent.  

Gail Dudack

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US Strategy Weekly: Great Expectations

The yield on the 10-year Treasury note plummeted over 50 basis points during November and expectations for a fed funds rate cut shifted from late in 2024 to the first quarter of the new year. This sentiment shift supported a rally in US equities and in gold since gold tends to move inversely to interest rates. In other words, the market has been pricing in a Goldilocks scenario that consists of lower inflation, a soft landing or non-recession, Fed easing early in 2023, and a rebound in corporate earnings in 2024. However, as Mohamed El-Erian noted on CNBC this week, believing this scenario is possible in the current complicated environment is the equivalent of believing a pilot could land a jumbo jet without any passenger feeling any landing at all. The risks are therefore high, that the consensus will be proven wrong.


Perhaps if the US were functioning on its own, a soft landing might be possible. But there are risks on the horizon. The largest of these could be China. We have often written about the problems facing the Chinese economy in terms of its property crisis, but this week Moody’s lowered its rating on China’s A1 debt rating from stable to negative. This was the first rating shift on Chinese debt by Moody’s since 2017 and the company commented that the costs to bail out local governments and state firms while controlling its property crisis would weigh heavily on China’s massive economy. China’s total outstanding off-balance sheet debt is estimated to be somewhere between $7 trillion and $11 trillion, according to the International Monetary Fund. This figure would include corporate bonds issued by thousands of local government financing vehicles which borrowed money to build roads, bridges, and other infrastructure. According to a senior economist at UBS, most local government financing vehicles currently depend on capital injections from local governments, government subsidies, and external funding because they do not generate enough cash from their operations to cover the interest payments. The longer-term risk is that this massive debt problem becomes systemic to the Chinese banking system and becomes a global banking problem.

Meanwhile, China’s CSI 300 Index (000300.SS – 3,394.26 CNY) is trading at its lowest level in nearly five years. This backdrop of falling real estate prices, risk of debt defaults, falling stock market prices, and a weakening currency, explains why Chinese consumers are actively buying gold (GC=F $2038.30). According to the latest Chinese retail sales data, gold and silver jewelry have been among the best-performing consumer goods in China this year, with a 12% rise in value year-on-year in January-October and outpaced only by garments. A Chinese consumer survey released in late October found that 70% of consumers between the ages of 18 and 40 intend to purchase pure gold jewelry. Together, China and India, the world’s two biggest gold buyers, account for more than half of total global demand. And according to commodity analysts, China is the world’s top buyer of physical gold has been an increasingly important driver behind this year’s rally in global spot gold prices. Gold has clearly become the safe haven trade for Chinese investors. Perhaps the rally in bitcoin (BTC – $43,886.05) is also a result of Chinese investors looking to protect themselves from a weakening currency and falling stock and property prices.

Pivotal Points in Technical Indicators

As we noted last week, the technical charts of the popular equity indices remain bullish with the first level of resistance encountered at the July highs and the second, and most important resistance, found at the all-time highs. Only the DJIA has exceeded its July high on the recent advance, touted by many to be the start of a new multi-year bull market. The July highs of 4600 in the SPX and 14,500 In the Nasdaq Composite have not been bettered and stock prices retreated as they tested those levels. The Russell 2000 index, which is our personal favorite for defining the broad marketplace, broke above its 100-day and 200-day moving averages last week, but the index remains neutral in its long-standing trading range between 1650 and 2000. In sum, the recent uptrend is unconfirmed. See page 8.

The 25-day up/down volume oscillator is at a positive 3.49 reading this week and has been in overbought territory of 3.0 or higher for four consecutive trading days. This is a positive development, but to confirm the recent advance this indicator should remain in overbought territory for a minimum of five consecutive trading sessions. In short, this indicator is close, but has not yet corroborated the recent uptrend as a significant trend. To date, both downtrends and uptrends have failed to sustain oversold or overbought readings for a minimum of five consecutive trading sessions. See page 9. However, this is in line with our long-held view that the stock market is in a broad trading range, which is a substitute for a bear market. We expect this range, best seen in the Russell 2000 index, to remain in force until inflation has been clearly brought under control.

The American Association of Individual Investors (AAII) survey showed a 3.5% increase in bullishness (48.8%), and a 4.0% decrease in bearishness (19.6%) last week. Bullish sentiment remains above average for the fourth consecutive week and bearishness is also below average for the fourth consecutive week. But more importantly, bearishness is at its lowest level since the January 3, 2018 reading of 15.6%. This extreme bearish reading in 2018 was followed by a 10% decline in the S&P 500 by February 8, a 13.6% advance by September 20, and a 19.8% decline by December 24. For the full year, the S&P 500 fell 6.2% in 2018. This too supports a view of a volatile trading range marketplace.

An Economic Mix

The headline ISM manufacturing index was unchanged in November, but six of the 10 components fell. The backlog of orders component declined to 39.3, its lowest reading since May 2020. The non-manufacturing index rose from 51.8 to 52.7, but the rise was mostly due to a buildup in inventories to 55.4. Order backlog also fell from 50.9 to 49.1. Readings below 50 indicate a contraction. See page 3.

The 5.2% GDP pace in the third quarter was the fastest rate recorded in nearly two years. Inventory build was a big contributor, consumption rebounded from a weak second quarter, and trade was a drag. However, this was the fourth consecutive quarter of negative real retail sales, which is typically associated with a recession. The key risk factor for the 2024 economy will be the strength of the consumer. See page 4.

Personal income rose 4.5% YOY in October, down from 4.8%. Disposable income rose nearly 7% YOY, down from 7.4%. Real disposable income increased 3.85% YOY, unchanged from September. Personal savings were $768.6 billion, up $19.6 billion, and the savings rate rose from 3.7% to 3.8%. But this remains well below the average long-term savings rate of 5.7%. See page 5.

Personal consumption expenditures rose 5.3% YOY in October and personal disposable income rose nearly 7% YOY. This marked the tenth consecutive month in which income exceeded consumption and it follows 21 consecutive months of consumption exceeding disposable income. Note that wage growth is decelerating for most employee sectors of the economy, except government, where wage growth was 8% YOY in October. See page 6.

Gail Dudack

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US Strategy Weekly: Oh Media!

Media Hyperbole

It is widely known that there is political bias in the mass media, but we continually see signs of bias in the financial press as well. The bias tends to be bullish or optimistic, which may seem constructive and comforting, but it can also be dangerous if it is misleading to the public and/or investors. We have pointed out several situations in the past and there was more this week. In particular, we just read a headline from an international news source that shouted in bold letters “US consumer confidence rebounds, house prices maintain upward trend.” We had just finished writing the back pages of this report, so we knew what these economic releases contained, and this headline did not match what we learned from the data.

This headline sounded like the economy was on the verge of an economic rebound. However, within the article it did state that “the Conference Board said its consumer confidence index increased to 102.0 this month from a downwardly revised 99.1 in October. Economists polled by Reuters had forecast the index dipping to 101.0. The improvement in confidence was concentrated mostly among households aged 55 and up. Consumers in the 35-54 age group were less optimistic about their prospects.”

The fact that the 35-54 age group was less optimistic than those over 55 is noteworthy since this age group is of prime working age and has children in school, a combination that makes them core consumers and important drivers of the economy.

What was not made transparent in this article was that October’s index had initially been reported to be 102.6. This means the consensus estimate for November was 101.0 implying a decline in sentiment. And the only reason November’s index of 102.0 was better than forecasted was the large negative revision in October’s index, to 99.1. In our opinion, there is a bit of a sleight of hand to say that November’s confidence was a positive surprise and/or represented a rebound. Plus, the University of Michigan consumer sentiment index for November showed consumers were clearly worried, especially about higher inflation. The main index fell 2.5 to 61.3, present conditions were 2.3 lower to 68.3, and expectations fell 2.5 to 56.8. All in all, none of this supports a headline that says consumer confidence is rebounding, in our opinion. See page 6.

In terms of suggesting there is an upward trend in house prices, it is more of the same. The article was referencing housing data from the Federal Housing Finance Agency (FHFA) which does not measure home prices but calculates an index (1991=100) which is defined as a weighted repeat-sales index, meaning that it measures average price changes in repeat sales or refinancings on the same properties. It is a broad-based index but does not represent actual home prices. We doubt that the journalist understood this. Moreover, the FHFA index is released a month later than most other home price data, i.e., the article was referencing September data when data for October and surveys for November had already been released. See page 5.

As for the trend in new home sales and prices, according to data from the Census Bureau, sales were lower in October versus September, but up 17.7% YOY. New house inventories were at their highest level since January and the total months of supply of housing was 7.8, back to August’s level. But in terms of home prices, Census data showed that the average new single-family home price fell 10.4% YOY to $487,000 while the median price fell nearly 18% YOY to $409,300. This data does not support the international news article, but it does support the negative NAHB survey results reported for October and November. See page 4. In sum, do not believe everything you read.

Media Neglect

Not getting much attention by the media are the risks appearing in the Chinese economy. Most investors know about China’s property crisis and its impact across China is immense and ongoing. However, foreign investors have been souring on China for most of this year, and recent data shows strong evidence that the global trend of diversifying supply chains and other de-risking strategies are having a negative impact on the world’s second-largest economy. In the July-September period, China recorded its first-ever quarterly deficit in foreign direct investment, a sign of capital outflow pressure. See page 7. According to Rhodium Group (, the value of announced US and European greenfield investment into China dropped to less than $20 billion last year, from a peak of $120 billion in 2018, while investment into India shot up by some $65 billion or 400% between 2021 and 2022.

Given this backdrop, it is not surprising that Chinese President Xi Jinping recently met with President Biden at the Asia-Pacific-Economic-Cooperation (APEC) Summit in San Francisco. Investment in China has dropped to historic lows, and President Xi attended the Summit in San Francisco to promote China’s economy. However, the data suggests that foreign firms are not only refusing to reinvest their earnings in China but are selling existing investments and repatriating funds. This trend could put further pressure on the yuan and dampen China’s economic growth in the long run. It also reduces China’s need to invest dollar inflows, which helps explain China’s decreasing demand for US Treasury bonds.

In terms of China’s economic activity, a survey released by The Conference Board showed that more than two-thirds of responding CEOs indicated that China’s demand has not returned to pre-COVID levels. Forty percent of respondents are expecting a decrease in capital investments in China and a similar proportion are expecting to cut jobs. In sum, corporations will become more dependent upon US consumers for top-line growth in the future.

Market Update

Not much has changed this week. The charts of the popular equity indices remain bullish with the first level of resistance seen at the July highs and the most important resistance found at the all-time highs. The near-term levels to monitor are 4600 in the SPX (July high) and the 1820-1827 area of the Russell 2000 index where the 100-day and 200-day moving averages merge. These short-term challenges are yet to be tested. However, while moves above these levels would be favorable for a year-end rally, the all-time highs are the real source of resistance. In our view, the longer-term trading ranges remain intact. See page 10.

Beware What You Wish For The consensus believes rate hikes are over and rate cuts, accompanied by a soft landing are in store for 2024. Yet, today’s rapid Fed tightening cycle would be most comparable to the early 1950s or the early 1980s. In both cases, Fed tightening led to multiple recessions. And while the stock market is currently rallying based upon the view that rates have peaked and will soon decline, the decline in interest rates following a tightening cycle has usually appeared in tandem with a recession. In short, the current stock market rally appears to be celebrating the onset of a recession, whether it is aware of it or not.

Gail Dudack

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US Strategy Weekly: A Tale of Two Cities

Happy Thanksgiving to all! We are grateful for many things, but most of all the friendship and loyalty of our clients. Wishing you the best that Thanksgiving represents gratitude, family, friendship, and great food!!

Momentum Shift

After a strong four-week advance off the October lows, US equities retreated this week. Part of the retreat was due to a string of weak earnings reports from retail companies, but stocks also stalled from a lack of news that could move stocks higher. Even a positive earnings report from chip designer, Nvidia Corp. (NVDA – $499.44), failed to impress, and the stock traded lower in after-market trading. Nvidia noted in its earnings report that it faces challenges in both Israel, where employees are being called up for active duty, and in China, where sales will be affected by US export controls. The release of FOMC minutes confirmed the consensus view that the Fed is apt to be on hold, barring any bad news on the inflation front. This is a positive factor, but it has already been discounted by rising stock prices.

However, the technical condition of the market did improve in the last week. Trading on November 14 recorded a 91% up day, i.e., volume in advancing stocks represented 91% of total NYSE volume. In addition, the NYSE total volume for the day rose above the 10-day average. This combination displayed a positive shift in conviction. (Note that our indicators use NYSE volume versus composite volume to separate day trading and professional hedging from actual buyers and sellers.) The 10-day average of daily new highs rose to 122, above the 100 benchmark that helps define an uptrend, while the 10-day average of daily new lows fell to 79, below the 100 benchmark. This combination also reversed a negative trend that had been in place since mid-September. See page 12.

Nevertheless, our 25-day up/down volume oscillator is at a negative 0.40 reading this week and neutral. See page 11. This lackluster response, despite several strong days of upward momentum, does not surprise us since it is in line with our view that the market is long-term trendless. Our view that the equity market will remain in a wide trading range, a substitute for a bear market, has not changed.

The charts of the popular equity indices continue to be bullish with the first level of resistance seen at the July highs and the second level of resistance found at the all-time highs. The key levels to watch in coming days are 4600 in the S&P 500, which is roughly the July high and the 1830 area of the Russell 2000 index where the 100-day and 200-day moving averages merge. These levels pose near-term challenges for these equity indices and will help define the strength of the current advance. The favorable seasonality of the November, December, and January months are in the stock market’s favor, but it was disappointing that the Russell 2000 index was the worst performing index in this week’s pullback. We do not expect year-end strength to carry the indices to new highs and this suggests that the long-term trading ranges will remain intact.

The Economy is a Tale of Two Cities

Strategists can be broken down into two distinct groups of those looking for a recession and those looking for a soft landing. However, the underlying data drives this division.

The positive factors include October’s headline CPI showing a 3.2% YOY rise, the PPI for finished goods falling 0.4% YOY, and the price of crude oil down 3.8% YOY. This combination makes a lower inflation outlook seem probable. Some inflation benchmarks are still higher with core CPI at 4% and core PPI at 3.2%, but overall, most inflation benchmarks are now below the long-term CPI average of 3.4% YOY. In short, inflation is lower, and if not yet at 2%, it is still below average. See page 3. This coupled with a job environment that is neither robust, nor weak, makes a soft landing credible.

However, this would be the first time in history that inflation at or approaching a double-digit pace, was not followed by a series of recessions. And it would be the first time that the real fed funds rate did not have to rise to 400 basis points before an inflationary trend was reversed. See page 4. We believe the jury is still out whether the current 200 basis points in the real fed funds rate will cure inflation. See page 4.

Neither the last recession nor economic recovery were normal business cycles. The recession was the result of a mandated shutdown of the economy and the recovery was the result of historic stimulus policies by both the administration and the Fed. Does this mean it will be different this time? It is difficult to tell. Inflation is a cruel tax on the lower end of the income spectrum, and this is what sparks a recession. We can see this in the current economy, which is a tale of two cities, i.e., the wealthy and the poor.

Retail sales were down slightly in October, but up 2.5% YOY. However, if adjusted for inflation, real retail sales fell 0.7% YOY in October and were negative for 10 of the last twelve months. Negative real retail sales is typical of a recessionary economy. See page 6.

Consumer credit growth has been decelerating all year, which is not a surprise given the rise in interest rates and interest costs. However, the most disturbing development is the increase in the number of people taking hardship withdrawals from their 401k plans. Wells Fargo & Co. (WFC – $42.60) reported a rise in such withdrawals last week and Fidelity National Information Services Inc. (FIS – $53.90) reported a similar trend this week. These withdrawals are a sign that many households are in very poor financial shape. Moreover, it suggests that future consumption trends will likely slow in the US. This is in line with weak reports from retailers in the third quarter. See page 7.

The housing market had been a boost to the economy in the first half of the year, but that has changed in recent months. Existing home sales were 3.79 million in October, the slowest pace in 13 years. Housing affordability is at its lowest level since 1985 and the NAHB survey is at its lowest levels since the start of the year. It is clear that rising rates are taking a toll on housing. See page 8. The 2023 economy has been a division of the haves and the have-nots, and the question is will higher income families keep the economy afloat in 2024, or not? It is an important question since the recent rally has carried the averages back to a relatively rich level. S&P Dow Jones consensus estimates for 2023 and 2024 are $214.65 and $242.73, respectively, down $0.53, and $0.60, respectively, this week. LSEG IBES estimates for 2023 and 2024 are $220.38 and $244.98, down $0.24, and $0.33, respectively. Based upon the IBES EPS estimate of $220.38 for this year, equities remain overvalued with a PE of 20.6 times and inflation of 3.24%. This sum of 23.84 is fractionally above the 23.8 level that defines an overvalued equity market. Note: based upon the S&P estimate of $214.65, the 2023 PE is even higher at 21.1 times.  

Gail Dudack

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