There has been a lot of volatility in recent days, yet there was very little progress in the popular indices. This is not surprising to us. There are almost too many variables and risks to monitor at the moment and so the indices are whipsawed by the ever-changing news of the day. Aside from the economic backdrop, the Israeli-Gaza war creates a frightening and unpredictable global environment, and the sad state of affairs in the US House of Representatives — which seems incapable of electing a new Speaker — has put a dangerous halt to US fiscal and foreign policy. (Shouldn’t we stop paying their salaries until they do their jobs?) US border officials have released thousands of migrants onto the streets of the San Diego area and Russia states that it no longer needs to obey the UN Security Council restrictions on giving missile technology to Iran since the restrictions will soon expire. It does make your head spin.
The Magnificent 7
In times like these, it is always important to monitor earnings and valuation. In this regard, Refinitiv IBES, in conjunction with Lipper Alpha Insight, released an interesting study on third quarter earnings season. It included information reminding investors that the S&P Dow Jones earnings estimates are share weighted, not market capitalization weighted. It then looked at what they called the “Magnificent-7”. These are Apple Inc. (AAPL – $177.15), Amazon.com, Inc. (AMZN – $131.47), Alphabet Inc. (GOOG – $140.99), Meta Platforms, Inc. (META – $324.00), Microsoft Corp. (MSFT – $332.06), Nvidia Corp. (NVDA – $439.38), and Tesla, Inc. (TSLA – $254.85).
IBES noted that these seven stocks have a market cap weighting in the S&P 500 index of 29.9% — an all-time high — but have earnings and revenue weights of 15.6% and 9.7%, respectively. The Magnificent-7 also has an aggregate forward PE of 27.6 times, which represents a 55% premium to the overall index. A table from this report is presented on page 11 with the 11 sectors of the S&P 500, their market cap weighting, earnings share weighting, revenue share weighting, and forward PE multiples. It basically shows that the technology sector is by far the most expensive segment of the S&P 500, while financials and energy are the least expensive. It is an interesting macro view of valuation.
Given their excessive weighting in the S&P index, the earnings reports from these seven stocks will be important to monitor. Tesla, Inc. will be the first to report on October 18, followed by Microsoft Corp. and Alphabet Inc. on October 24, Meta Platforms, Inc. on October 25, Amazon.com, Inc. on October 26. Apple Inc. and Nvidia Inc. report on November 2 and November 21, respectively.
Economics in Focus
There were many economic releases in the last week which we would summarize as showing weakness in business and consumer sentiment, stickiness in inflation, resiliency in retail sales, and better-than-expected industrial production led by autos. All in all, these reports would probably lead to another fed funds rate hike in November, if all things were equal. But all things are not equal in the Middle East or in the US and as a result, we do not expect the Federal Reserve to raise rates. Keep in mind that another debt ceiling crisis will materialize before the end of the year.
The NFIB small business optimism index fell slightly in September, from 91.3 to 90.8; however, the business outlook fell from -37 to -43 and “expected credit conditions” dropped from -6 to -10. See page 3. Preliminary data for October’s University of Michigan sentiment survey showed a decline in consumer sentiment even though gasoline prices had declined. The main index fell from 68.1 to 63.0; present conditions fell from 71.4 to 66.7; expectations fell from 66.0 to 60.7. Conference Board indices fell in September and October data will be released at the end of the month. See page 5.
Industrial production rose a better-than-expected 0.3% in September. Nonetheless, total IP was barely above the level seen a year ago, nondurable production was down 0.3%, but durables, led by auto production, rose 1.7% YOY. However, auto and truck production appears to be rolling over after its May-June peaks. See page 4.
Advance estimates for September’s retail and food services sales were $704.9 billion, up 0.7% for the month, and up 3.8% YOY. This was much better than the consensus expected; yet, after inflation, real retail sales in September were up only 0.1% YOY. At the end of August, real retail sales had been negative on a year-over-year basis for nine out of ten consecutive months. We believe this is an important point since year-over-year declines are typically seen only during recessions. See page 6.
The key reports last week were related to inflation. The PPI is usually a leading indicator of the CPI, and the good news was that core PPI, while still high at 3.4% YOY, appears to be decelerating. On the other hand, headline PPI, after being negative for months, has begun to uptick again and reached 2.5% in September. Similarly, core CPI, still high at 4.1%, appears to be decelerating, but headline CPI rose slightly in September to 3.7%. See page 7. Most of the major components of the CPI rose more than headline, both on a monthly and a yearly basis, and all items less food and energy rose 4.1% YOY. Stemming an even bigger jump in inflation in September were the declines seen in fuels & utilities and medical care. Still, since transportation costs typically lag the price of oil which has been rising, there is an upward risk to future inflation numbers. See page 8.
The Federal Reserve is most concerned about service sector inflation which eased only slightly from 5.39% to 5.16% in September. Owners’ equivalent rent inched down from 7.3% to 7.1% and rents of primary residences eased from 7.8% to 7.4%. Medical care pricing was negative for the third consecutive month falling 1.4% YOY. However, other services, with a 9.4% weighting in the CPI, are trending higher and were up 4.4% in September. See page 9.
The biggest risk to future inflation could be higher crude oil prices. This is likely given the chaos in the Middle East. After months of YOY declines, WTI rose 14.2% YOY in September and to date, is up 1% YOY in October. Equally important, the chart of WTI turned bullish once the price broke above the $80 resistance level. See page 10. Again, if it were not for all the domestic and global political risks, the Federal Reserve would likely be raising rates in November.
Technical Guides The Russell 2000 continues to trade below its 200-day moving average, the Dow Jones Industrial Average broke below its long-term average before recovering in recent sessions. The S&P 500 rebounded after an intra-day test of its 200-day average, which was technically impressive. The Nasdaq Composite, led by the Magnificent-7, continues to trade well above its long-term average. But overall, the patterns of the major indices remain characteristic of a long-term neutral trading range. This is best represented by the 1650-2000 range in the Russell 2000. If the Russell were to break below the 1650 support, it would be bad news for the broader market, in our view, but this is not our expectation. Our 25-day up/down volume oscillator was oversold for three of five trading sessions in early October but is now neutral. In short, it too suggests the market remains in a long-term trading range.
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