Investment Insights

 — Steve Orr 

Bounce & hang

The mega-cap S&P 500 put on quite a show over the last three months. Recall the recent low on Saturday, August 5, nearly 5% below the index’s 50-day moving average. Over the next two months, the big index rose nearly 12% from that 5,186 level on the back of improving economic news. Stocks then took most of October to consolidate gains, waiting for Halloween treats and election tricks.

Halloween did not disappoint, using weaker than expected results from Microsoft to snap a five- month win streak and closing down 2% on the day. Election day gapped higher 2% to 5% depending on the index, and gains continued Wednesday and Thursday. History suggests a Republican win sees gains for about three days, and then a week or two to consolidate gains. That fits Friday’s and Monday’s price action as the S&P 500 and NASDAQ are hanging at their Thursday highs.

Tis the season

No; — stop. No Christmas until Saturday after Thanksgiving. No Celine Dion, no hiding that stu___ elf. This is the season for stock gains. Most years see gains in November as third quarter earnings are released. Then post-Christmas the Santa rally usually appears, driven by companies buying stocks for their pension plans.

Election years tend to rally through year–end celebrating the end of campaign ads. This year may be a repeat of 2016 for different reasons. 2016 was a Trump surprise. 2024 is hopes for regulatory and tax relief. Regardless, a good chunk of the rally happened last week. Eric Johnston from Cantor Fitzgerald reports that election year or not, the S&P 500 has gained 17% or more through early November 17 times since 1954. In all 17 cases, the S&P 500 added to its gains through year-end.

More on earnings in a moment, but once companies report, if they have a buyback plan, can resume buying their stock. Now that 90% of the S&P 500 companies having reported earnings, stock buybacks are turning back on for the next two months. This also supports stock prices.

A minor yellow flag is cash positioning. Consistent reports of consumer balances show high cash positions. In the trading days since the election, over $36 billion has flowed into equity ETFs. This is one of the highest three days on record. So, if consumers have cash, they are putting it into stocks. We are more concerned with hedge and macro fund investors. They are fully long at this stage and more likely to sell stocks to raise cash than borrow cash to invest more. We will be watching their flows through year-end.

Three more?

Lost in the election noise was the Wednesday-Thursday Fed meeting. As expected, the FOMC cut its Fed Funds range by a quarter of one percent to 4.5% — 4.75%. What was unexpected was Chairman Powell providing a new rationale for the rate cut. Recall the half percent cut on September 18 was justified by rising unemployment and substantial progress toward the Committee’s goal of 2% inflation. This cut relied on the Fed’s search for the “neutral Fed Funds rate.” That unknowable rate is where monetary policy is not too easy to spark inflation (like 2020—2022) or too hawkish to slow the economy into recession (like almost every recession since WWII). We certainly do not know what that rate is. We do know this: -CPI at 2.8% + a real rate of 2.5% (theoretical) = 5.3% for the 10-year Treasury Note. The 10-year is currently trading about 1% below that level today.

We think the Fed has set a course to lower rates at least three more times over the next year. Perhaps the next two inflation reports (CPI this Wednesday) and the November jobs report on December 6 will be solid enough to justify another cut. We think the Fed is looking for any justification to “stay the course” and get borrowing rates as close to inflation or below as possible. We wrote after the Fed meeting last week:

• We remain a bit wary of the Fed’s goals in cutting interest rates. With over $35 trillion in Federal debt, the Fed has an interest (pun) in keeping interest rates below the rate of inflation. With inflation at 3% and Fed Funds at 4.5%, they have a way to go. With rates below inflation, in the long term, paying back that debt slowly gets easier. In the short term, lower rates help keep interest expense down.
• Fully $15 trillion of our federal debt matures by the end of 2026. Its average interest rate is 2.6%. Two-year Treasury notes today are trading at 4.2%. Refinancing that $15 trillion today would raise its interest costs by roughly 60% or about $240 billion. More borrowing is not the answer.

We are sticking with our base case of another cut at the Fed’s December meeting, followed by only two rate cuts in 2025. Our bias is toward fewer cuts as hopes for deregulation and tax cuts fuel optimism about future earnings.

More please 

Home Depot is the most recognized name among the S&P 500 companies reporting this week. It’s third quarter results were 3% ahead of estimates. HD said their same store sales were the best since 4Q21 and raised guidance for this year. Sounds like they are expecting lots of inflatable elf sales this month.

We mentioned earlier that 90% of the S&P 500 members have reported. Through last Friday the earnings growth rate for the index is running at 8.6% over 2023’s third quarter. If the energy sector is excluded, the growth rate jumps to 10.8%. Yes, the Magnificent 7 are contributing an outsized 25% growth to those numbers. 

Looking ahead to next year, Wall Street consensus is stuck at 15% year-over-year growth for the S&P 500’s earnings. Same for top-line sales. A 15% growth in earnings at this point in the business cycle would be very outside the norm. To reach that level, we would expect to see improvement in energy and industrials earnings. For that to happen, crude oil and natural gas prices would have to rise. Higher commodity prices would, in turn, worry the Fed about inflation rising. Ugh, see how this is a circular firing squad? If S&P earnings hit that level next year, paying a multiple of 22 times implies mid 5,900 levels or very near where we are now. So, markets will need a boost from a business-friendly Fed and Congress to keep the earning momentum going.

What next?

Speaking of Congress, and only when we are forced to, they come back on the 12th for their lame-duck session. We expect President Trump will ask for recess appointments from the Senate and a resolution on the debt ceiling that expires in January.

Drops in crude oil and gold prices suggest traders are marking down the risks of geopolitical issues, especially in the Middle East. Fully 40% of the world’s population had national elections this year. The 10 major countries north of the equator and India all reduced or defeated incumbents. According to the ParlGov database managed by the Foundations for European Politics, this has never happened in the 120 years of their data. The U.S. has led this generational trend. Since 2009 in our 10 national elections, we have changed power nine times. History says upheaval should give way in the next five to seven years to a more stable environment. As long as that means a Bull market, we are in.