Investment Insights

 — Steve Orr 

Snap

After seven up days, the middle of last week served up reminders that the Bears have not left the fall stock party. Friday’s S&P 500 and NASDAQ 1.5%+ rally may have muted some worries, but headwinds remain. Most of the big index gains were concentrated in tech like Apple and Nvidia. Several factors contributed to Friday’s snap rally. A number of sectors were in oversold conditions after the three-month correction. The Fed has not raised rates since June, and the big three stress indicators (oil, gold and the dollar) have moderated in recent days.

We have written several times recently about the S&P 500’s inability to break through the 4,400 barrier and reach for higher highs. Friday’s rally did the trick: The big index closed above 4,400. Now not to sound like bait and switch, but we need to explain the full process. In airplane terms, just breaking the sound barrier is not enough. Your wings may come off and you can find yourself reaching for the ejection handle. The 4,400 level was the setup to break the downtrend barrier by closing a prior chart gap created when the index was falling a couple of months back. The trigger was closing above that level. Now comes the follow-through. Three things can happen from here: breaking higher toward July’s 4,600 level, consolidating sideways into the holidays (boring), or resumption of the current downtrend (no thanks). So, two out of three positive steps completed to break out of the downtrend. 

Okay, now what?

Usually once a trigger is breached like last Friday, a stock or index will climb a small amount and then move back down to that trigger level. This is called a “throwback” and is not a negative sign. Generally, it is building energy for a renewed push higher. November historically is one of the best performing months of the year for stocks. Third quarter earnings should set the tone for holiday shopping and strength. But Friday’s action looks more to us like a consolidation move, rather than strength that would build through a throwback. This year’s bricks in the Wall Street Worry Wall — expectations, inflation, rates, wars and D.C. drama — make a very high wall to climb. 

Some good

Looking over our shoulder, we have enjoyed a pretty good earnings season. As of last Friday, 92% of the S&P 500 members had reported third quarter results. 81% beat earnings estimates and earnings grew an average of 4.1% year-over-year according to FactSet. If this level holds, it will be the first positive growth in earnings in four quarters. Energy firms’ earnings were hurt by lower oil prices during the quarter, and they pulled the averages down. FactSet reports that the Energy sector’s earnings fell by 37% y-o-y. If we exclude Energy from the S&P 500’s 4% growth, the index’s earnings growth would improve to 9.8%.

Earnings growth of nearly double digits looks like an improving business cycle, quite different from the news headlines. The fourth quarter today looks a lot like the third: around 3% growth. For the full year 2023, FactSet’s poll of analysts estimates earnings will grow +0.6%. I/B/E/S estimates from Yardeni Research come in at 0.9%. For all of 2024, Wall Street projects 11.6% y-o-y growth, a level that looks high to us.

This quarter’s earnings for consumer retail companies are the most important of the year The Christmas shopping season has already started in our neighborhood. We will check our calendar to see if Thanksgiving is still a holiday. Third quarter results and holiday forecasts are in the spotlight this week. This is retail week, the traditional last week of earnings season. Earnings reports are due from Home Depot, TJ Maxx, Target, Ross and Walmart. 

Expectations

“Okay today, but not tomorrow” reflects the tone of the latest University of Michigan Consumer Sentiment Index. The index got started in the 1940s and has been a fairly accurate gauge of consumer feelings and expectations about the future. Its inflation components have an impressive correlation with future inflation.

Last month’s survey showed consumers are growing more anxious. The current conditions index bottomed in the summer of 2022, when inflation hit 9%. Since then, it has recovered only a small amount and has dropped two months in a row. For current conditions to fall when gas prices at the pump are falling is rare. More worrisome for retailers should be the expectations and inflation surveys. Expectations for the economy and their personal situation over the next year are not improving. Big ticket purchase plans also have dropped over the last several months. Survey participants also expect inflation to be over 4% in the next year. 

Tuesday

October’s estimate of consumer prices should fall to 3.3%, thanks to lower pump prices last month. Tuesday’s release of the CPI data should show the  core measure, which includes home prices and medical costs, staying above 4%. The Fed has told us over and over that they focus on the core measure. A reading of 4.2% or 4.4% should give them pause about their decision in September to pause (pun).

We think given the strength in the economy and earnings last quarter, the Fed should have considered one more increase. Recent weakening in both jobs numbers and consumer expectations has lowered odds of an increase at the December 13 meeting. We expect the Fed to hold rates at least at these levels well into 2024 and think Wall Street’s calls for cuts next year should be moved until after the election. Longer term interest rates should hold around these levels over the coming weeks until Congress spending plans are known.

Popcorn

If you like watching politics, here comes D.C. drama again. This Friday the government runs out of money (again). Wikipedia lists over 90 of these episodes since Congress abandoned passing budgets on a regular basis. The stopgap bill we saw over last weekend had some parts of the government funded into January and some into February. No funding for Israel or Ukraine in that version. By our back-of-the-envelope calculations, there is almost no way to avoid another $2 trillion in debt by next summer. Expect plenty of noise on the airwaves starting mid-Thursday. Pass the popcorn.