“Hey, here is where I am, and I’m here because I steered my horse here” ... Chris Gardner, author of “The Pursuit of Happyness”
In China, property markets remain in a brutal state. While Chinese Industrial Production and Retail sales are lagging behind historical growth trends. Here in the US, manufacturing activity still looks weak and results aren’t much better in the Eurozone. Financial conditions have slowed activity further, and the full effects of tightening in the US “have yet to be felt”. Even though monetary policy is starting to ease up around the world, that comes with slow economic activity amidst restrictive policy rates for huge areas of the global economy.
Here in the U.S.;
• Economic Growth Will Slow In The Coming Quarters
While 3Q23 growth showed the economy expanded at a 4.9% annualized rate, it is important to remember that the GDP report is backward-looking. From my vantage point, many real-time indicators I follow suggest that economic growth is decelerating, and tighter financial conditions will only exacerbate this trend. I’m not alone in that view as the Conference’s Board’s forecast calls for GDP to fall to 0.8 percent in 2024.
Why? First, manufacturing activity remains sluggish. The latest ISM Manufacturing Survey reported that activity remained in contractionary territory for the 12th straight month, falling to its fourth lowest level (ex-COVID) since 2009.
Second, consumer confidence fell for the third month to its lowest level since April. This weak data represents a downtrend that has been in place for months and is now in its second year.
I’ve been saying it for a while, (and I’ve been wrong) but poor sentiment will eventually spill over into consumer spending. The National Retail Federation expects holiday spending to rise 3-4%—its slowest pace in five years. Third, elevated interest rates are hampering the interest rate-sensitive sectors of the economy. Housing affordability is at the lowest level since the early 1980s.
Then there are the new concerns over consumer debt. During the pandemic, pauses on required repayments basically ended delinquencies on student loans. Those repayments have now almost entirely restarted, but serious delinquency rates on student loans remain low (repayments didn’t resume until September). Other serious delinquencies are rising though. Credit card serious delinquency rates are below pre-COVID norms but rose 1.4% quarter over quarter and 1.8% year over year. 90-day+ delinquency rates for “other” lending (consumer credit categories not counted in the other categories) are at the highest levels since 2015.
Total serious delinquency rates for auto lending remain constructive, while mortgages are similar. But trouble is brewing. The share of loans that are newly delinquent is rising broadly. For credit cards, it’s the highest since Q3 of 2011. For auto and “other” loans, newly delinquent loans are back to pre-COVID norms while they’re historically low for HELOCs and mortgages (with the latter rising).
Credit utilization (owed debt as a percentage of the available balance) is rising steadily for credit cards, a sign of a consumer that is taking on more debt than is healthy, while HELOC utilization is also starting to rise for the first time since the mid-2000s (albeit from much lower levels).
Existing home sales have slowed to the weakest level since 2010 and loan demand fell for the fifth consecutive quarter in the latest Senior Loan Officer Survey.
- Labor Market Strength Is Fading
Despite the Fed’s aggressive rate hikes, the labor market has remained resilient. Corporations are loathed to fire workers they had such a hard time acquiring after the pandemic. There are cracks forming that signal weakness ahead. First, the employment subsector within the ISM Manufacturing report declined into contraction territory for the third time in four months as commentary within the report suggested that businesses are having an easier time finding prospective employees.
Initial jobless claims hover near cyclical lows, continuing claims have risen to a six-month high, and the duration of those unemployed is climbing, suggesting that it is taking longer to find jobs. The percentage of consumers who viewed jobs as “plentiful” declined to the lowest level since March 2021. The slowdown in hiring should continue, with the potential for job growth turning abysmal in 2024.
- Disinflationary Trend Remains Intact
Inflation has eased considerably from its peak last year. While it’s trending in the right direction, Fed policymakers are not ready to claim victory given ‘core’ inflation remains above their 2.0% target. The FOMC keeps harping on that message yet it appears some are doubting their stance. I’ve been saying this since inflation appeared on the scene, The FED is not going to back off of their target. In addition, they aren’t going to cut rates until months after the target is reached.
Suffice it to say this entire issue should have less of an impact on stocks going forward. That assumes the “market” has digested the “higher for longer” environment for interest rates. However with forecasts for rate cuts as part of the commentary for next year, that is debatable.
The list of global issues dwarfs the problem the US is facing.
At the top of that list is the potential for “recession”. Europe’s CPI and GDP are rolling over as higher interest rates are working globally. The Eurozone is nearing or already in recession. European CPI was in line to slightly lower than expected, while Europe-wide GDP was barely above zero for 3Q year over year and down slightly quarter over quarter. Canada is also trending towards recession. China services and manufacturing PMI came in slightly weaker than anticipated as well, though many expect China to re-accelerate a bit heading into 2024 due to fiscal spending. This global backdrop won’t be positive for the U.S. corporate earning picture, and earnings drive stock prices.
The Economic situation here in the US and abroad is ever-evolving. If things go just right and the U.S. economy doesn’t weaken too much then the cautionary forecasts can be adjusted to a more positive stance. However, the obstacles are still there and by some accounts are mounting up. There remains a contingent that believes ALL of the issues will disappear when the Fed is out of the picture. The concerns and constant chatter about the Fed borders on absurdity, as it dismisses all of the other problems that the economy is facing.
While rising interest rates and aggressive monetary policy have been a headwind for the equity and bond market over recent months, investors believe all will be well when the Fed ends the tightening cycle. Market participants should be wary of what they wish for. First, history shows the stock market is typically trendless between the last rate hike and the first rate cut.
Secondly, after the first rate cut stock prices tend to weaken. According to Credit Suisse, the S&P 500 usually falls in the six months after the Fed’s first rate cut. There is a multitude of factors that will dictate market action before, during, and after rate cuts so trying to get positioned for this eventuality today is pointless. That is why I’m not interested in joining the parade of analysts who are literally begging for the Fed to cut interest rates.
There are a number of scenarios where all could go right and change the storm clouds to a more tranquil scene. Given the uncertainty there is but one way to approach this investment landscape — STAY BALANCED.
The Week On Wall Street
After two weeks of gains (7% for the S&P) that took all of the indices well off of their three-month lows, the S&P 500 started Monday in the red. The dip-buyers showed up and turned the entire market around. The S&P closed the session flat on the day by posting a modest 3-point loss.
A lower CPI print changed the entire near-term sentiment picture. A strong Gap Up opening set the stage for an advance that took the S&P to a 2+% gain. That made it 10 out of the last 12 trading days with gains. However, this Tuesday was something different. Every index and all eleven sectors were higher. 93% of the S&P 500 was in the green, advancers led declined 15 to 1, and the Russell 2000 added 5+% for the day.
There was no giveback in the last three trading days of the week as the indices did a good job of digesting the gains. The S&P 500, DJIA, and the NASDAQ ran their weekly winning streak to three.
CPI was unchanged in October, and the core rate was up 0.2%, cooler than anticipated. Those compare to respective gains of 0.4% and 0.3% in September and 0.6% and 0.3% in August. The 12-month rate slowed to 3.2% y/y on the headline, versus 3.7% y/y previously. The core slipped to a 4.0% y/y rate from the prior 4.1% y/y pace. A lot of progress has been made since hitting 40-year highs of 9.1% y/y in June 2022, and 6.6% y/y for the core in September 2022. But the mission has not been accomplished yet, and the talk that is surfacing about any rate CUTS is premature. If/When inflation gets to 2%, the FED will sit on that for months. They do NOT want to be caught cutting rates and then see inflation return. That would be a disaster and they aren’t going there.
Two caveats — the economy crumbles and or the administration puts enormous pressure to cut rates during an election year. Without a crumbling economy, the latter would be a huge mistake.
Nevertheless, this is a positive development in the short term that will probably keep the Fed on the sidelines until next year, and that is a tailwind for the market in Q4.
More upbeat news on Inflation
PPI undershot assumptions in October with a 0.5% headline drop and a lean 0.1% for the core, leaving a downside surprise after three consecutive upside surprises in Q3. Today’s weak PPI figures follow the reported flat October CPI headline with a lean 0.2% core gain.
NFIB Small Business Optimism Index decreased 0.1 points in October to 90.7, marking the 22nd month below the 50-year average. The last time the Optimism Index was at or above the average was December 2021. NFIB Chief Economist Bill Dunkelberg;
This month marks the 50th anniversary of NFIB’s small business economic survey. The October data shows that small businesses are still recovering, and owners are not optimistic about better business conditions. Small business owners are not growing their inventories as labor and energy costs are not falling, making it a gloomy outlook for the remainder of the year.”
The Empire State manufacturing index bounced 13.7 points to 9.1 in November, better than expected, after dropping 6.5 points to -4.6 in October. It is the best reading since April. However, the components were mixed and not as optimistic as the headline suggests. Although the current conditions index improved, expectations dropped a massive 24 points month over month.
Initial claims climbed to a 3-month high of 231k in the second week of November from 218k, versus a 9-month low of 200k in the October BLS survey week. Continuing claims rose 32k to a 2-year high of 1,865k from a 6-month high of 1,833k versus an 8-month low of 1,658k in September. The rise in initial and continuing claims since the October survey week implies downside risk for analyst estimates of 140k November nonfarm payrolls.
Retail sales slightly undershot assumptions, with a 0.1% October headline drop.
The Global Scene
China Data: Monthly activity numbers for October in China showed that while industrial output is growing, it’s trending below 5% annualized over the last four months.
That’s with retail sales values barely growing over that period including a sub-1% annualized rise in October. As for investment, nominal growth was only 1.2% in October and is more or less flat this year.
Government Funding Deal: A roughly even split within the GOP caucus led to the passage of a two-track government funding bill during the week. The result is that some government funding is extended through January with the rest of the government funded an additional couple of weeks. Both the Senate and the President agreed to the measure and that takes an imminent government shutdown off the table. Also, note that the bill did not include military aid funding for either Israel or Ukraine. That doesn’t mean it won’t happen, it suggests they will now become separate authorizations.
With the 2024 election now less than a year away, the probabilities suggest a 2020 rematch between President Biden and former President Trump as the most likely scenario; however, many wildcards remain, including the potential addition of independent candidates like Joe Manchin (D-WV) to the race. It would also not be shocking if another candidate emerged for either party. For Biden, it is a discussion of lagging approval ratings vs. strong Democratic performance in this week’s election. For Trump, it is a debate over his overwhelming lead in polls vs. his legal troubles.
From a market perspective, while the market generally sees +0.54% average monthly returns in a presidential election year, we could easily see pockets of weakness during key periods of uncertainty. These periods of weakness are most pronounced in the January – March timeframe when voters are coalescing around nominees and in the immediate runup to the election in October. After the election, we usually see this reverse with average monthly returns of +1.28% in the year after the election.
The takeaway for today – This topic is going to dominate the scene next year, but there is no reason to put too much emphasis on it now.
Food For Thought
While the market celebrates the near-term success in the fight against inflation, the MACRO scene continues to pose issues. We’ve covered the spending issues and what a drag each and every one of them is on the US economy going forward. One hot issue continues to be illegal migration. I mentioned that no matter what side of the argument you are on, the costs associated with what has happened and what continues to occur with this scene are undeniable.
According to a report released by the U.S. House Homeland Security Committee, the influx of migrants across the country’s southern border could cost taxpayers $451 billion each year. Since this issue isn’t resolved and like all costs it’s a HIGH probability that these annual expenses will continue to balloon and be a burden on the U.S. economy.
Exxon and other major oil firms don’t want to be known exclusively as an “oil” or “fossil fuel” company, instead, their latest endeavor will characterize them as an “Energy” company. As part of their LONG TERM transition strategy, the company plans to start producing lithium from subsurface wells by 2027 to provide supplies of the key metal used in electric car batteries and advanced electronics. It will be a 2 Billion dollar investment to become a leading supplier here in the U.S.
It’s a win-win situation as it will cut into the need for paying outside sources for the materials needed to ensure the energy transition. There is no escaping the need to excavate, drill, and mine to produce “energy”. Perhaps this will bring the reality of what is required to pull off this transition to the forefront. At the end of the day, it is always FREE market capitalism that leads the way.
The notion that these game-changing corporations are the “enemy” should be put to rest.
Dividend stocks, which now have lots of competition from higher-yielding fixed-income products, continue to have just an awful 2023. As shown below, the 100 highest-yielding S&P 500 stocks at the start of the year are down an average of 7.94% YTD on a total return basis compared to an average gain of 8.94% for the 100 stocks that had no dividend yield at the start of the year.
All in all it’s been a difficult year for dividend income investors. It demonstrates why the “New Era” we have discussed, an era that includes higher interest rates, changes the scene dramatically. That makes it necessary for market participants to remain flexible in their approach.
When the rally off the lows kicked off it was board-based with every sector and notably the small caps rallying as well. The market quickly transitioned back to what we have seen for most of the year. Equities were up in an extraordinarily narrow fashion. Once again investors watched the scene turnaround again this week as market Breadth improved dramatically. The Small caps (IWM) and other sectors like the beaten-down Biotechs are now part of the playing field.
However, there is a distinct possibility that the momentum names and mega caps will continue to carry the freight into year-end. At the sector level, it’s Technology, Consumer Discretionary, and Communication Services leading the gains. Within Tech, the Semiconductors which have led for most of the year are also posting a strong Q4. As measured by Barclays Aggregate Bond Fund (AGG), bonds are showing their first positive monthly return since April.
On the flip side, Energy remains flat. The general market has seen intraday dips being bought as the prevailing mindset is ‘risk-on”.
The Daily chart of the S&P 500 (SPY)
Up, Up, and away. The S&P gapped higher on Tuesday and did not look back.
The index is now contending with resistance around the late August highs. The S&P is extended and a dip back to near-term support wouldn’t be out of the question. However, IF the index can’t get through this 4500-4550 range convincingly, it will bring this rally off the lows into question. The BULLS do not want to see the index put in another lower high, instead, their next goal is to get to July highs (4588).
The short-term trends in the 10-year Treasury and the US Dollar have been broken and those headwinds have now turned into tailwinds. That adds more evidence that this Q4 rally can continue. It is what happens after this near-term change and lift in sentiment abates. There are analysts who believe this latest push higher confirms their view that this “new” BULL market has a long way to go.
Yet, other forecasts analysis suggests nothing has been resolved on both the fundamental and technical front. Q4 and more importantly 2024 will be defining periods of time and are going to separate the professionals from the amateurs. An investor needs to use all the tools they have at their disposal. Just ask the folks that were BEARS and “short” this market based on their fundamental views entering November.
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