US Strategy Weekly: Octobers Can Be Spooky

New data releases on US jobs and the PCE deflator will be important later this week. Treasury bond and note interest rates are currently at multi-decade highs and equity investors are eager for good news on both the economy and inflation. But it is important to note that the rise in interest rates is not only taking place in the US, it is a global trend. France and the UK are also struggling with excessive national debt and political disaffection. France’s woes have driven the yield spread between French and German bonds to multi-year highs just as French Prime Minister Sébastien Lecornu prepares to unveil a $61.5 billion spending cut to rein in a deficit expected to soon rise to 5.4% of GDP. France plans to sell a record $385 billion of bonds in 2027 as Covid-era debt comes due; meanwhile, French debt hit 119% of GDP in June. British Prime Minister Andy Burnham, at his first Labour conference speech as leader of the country and party, has promised to “break the old mold” and put the UK on a “new path of equitable growth.” UK Finance Minister John Healey will deliver the new Labour government Autumn Budget this week and it will be highly scrutinized since the country faces ballooning debt costs and slower economic growth. And this is all happening as sovereign debt markets are competing with massive bond sales by big tech to drive AI investments.

Treasury Bond Yield Curves

In the US, the 30-year Treasury bond yield spiked to 5.62% this week, the highest intraday level since June 2002. It was a 24-year high. The 10-year Treasury note yield rose to 5.29%, its highest level since June 2007. These sharp increases in interest rates are making financial markets nervous; however, we would point out once again that interest rates and the Treasury yield curve are simply moving toward their long-term averages. In fact, the 5- and 10-year Treasury note yields remain slightly below their long-term averages. See page 3. An upward-sloping yield curve is a normal sign of a growing economy. And while there are signs of weakness in the housing and auto sectors, there are healthy signals from US manufacturing and retail sales. Many investors are worried about rising rates since rates have been so low for so long. However, the inverted yield curves seen in 2023 and 2024, which seemed to be the norm, were the real anomalies. An inverted yield curve is usually a sign of a serious economic recession. In our view, the markets will eventually adjust to more normal, and somewhat higher interest rates.  

New Signs of Economic Growth

The Census Bureau’s business formation data shows a strong trend in new business creation. This data tracks applications for an Employer Identification Number (EIN), which is a unique federal tax identifier given to wage-paying businesses. (Sole proprietorships with no employees may not have an EIN.) The Census Bureau also categorizes business applications as “high propensity,” if they have a high likelihood of leading to a business with a payroll. Manufacturing, retail, healthcare, and food service all fall under this category. In our view, it is likely that AI is empowering new business formation, particularly single-person companies, known as solopreneurs.

This data on business creation dovetails with the fact that unemployment claims are trending lower, consistent with full employment. Initial unemployment claims have been averaging less than 220,000 per week all year, which is well below the long-term average of 365,000 per week. See page 4. 

Manufacturing Resurgence

Total durable goods shipments were unchanged in the month of August but rose 8.5% YOY. However, when excluding defense and aircraft shipments – a proxy for business investment – core shipments increased 11.4% YOY. Similarly, total durable goods orders were up 8.5% YOY; but core orders increased 14.1% YOY. This dramatic improvement in core durable goods orders is a major shift from the negative trend seen from February 2014 to January 2025. See page 5. In short, this sharp improvement in core durable goods shipments and new orders is in line with the strength seen in the ISM manufacturing survey this year as well as the growth seen in manufacturing payrolls. The current administration has placed a priority on bringing manufacturing back to the US and it appears to be working.

Residential Real Estate and Homeownership Continues to Weaken

In the month of August, new home sales were 684,000 units, up from July, but down 2.0% YOY. Weakness was concentrated in the Northeast and West, while sales increased in the South and rose significantly in the Midwest. Months of supply fell from 9 months to 8.5 months. The median price of a new home was $395,200, up slightly from July, but down 5.4% YOY and the average price of a new home was $478,700, down from July and down 8.6% YOY. Overall, data on new home sales corroborates the trend in existing home sales, which suggests the housing sector continues to slow. See page 6.

Homeownership was 65.0% in the second quarter, down from 65.3% in the first quarter. There was a large 1.6% decline in ownership for those under 35 years of age (now at 35.2%) which reinforces the view that young people are having a difficult time entering the housing market. In line with lower homeownership, the household debt service ratios also declined in the second quarter. The total debt service ratio (DSR), the ratio of total required household debt payments to total disposable income, eased from 11.16% to 11.11%. The DSR is divided into two segments, the mortgage debt ratio, which eased from 5.87% to 5.83% and the consumer debt service ratio which edged down from 5.29% to 5.28%. All in all, these numbers indicate that most households have sufficient income to cover their mortgages and loans. See page 7.

Earnings Growth and Technicals

For the first time since May, consensus earnings forecasts for 2026 and 2027 did not increase. The cuts were small and likely just accounting adjustments. However, third quarter earnings season will begin in mid-October, and we wonder if the equity market will be facing its first earnings season with fewer positive surprises. If so, how will investors react? FactSet indicates that analysts are currently forecasting earnings growth of 29% YOY for the third quarter, which would be the third consecutive quarter of growth greater than 25%. The bar for earnings growth continues to move higher. We may be worried about third quarter earnings season because it begins just before the midterm elections and pre-election markets tend to be volatile. Moreover, technical indicators have deteriorated in recent days, and this makes us cautious for the near term. The 25-day up/down volume oscillator is at negative 3.18, down from last week, and displaying its first oversold reading since October 2023. In 2023, the S&P 500 fell from 4588.96 on July 31, 2023 to 4117.37 on October 27, 2023, a decline of 10.3%. In the same general time period, the Dow Jones Industrial Average fell 9% and the Nasdaq Composite declined 12.3%. The equity market has not had a 10% correction since the first quarter of 2025 and is overdue for a pullback of 10% or more. Several technical indicators are now signaling that the underlying market is already experiencing an internal correction. The S&P 500 is apt to join in.

Gail Dudack

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