The week after

I traveled to Chocolatetown and Music City this week and was warmly welcomed. I received compliments on my Tory Burch sweater twice before 6 am (!), by my hotel checkout and airport security check-in early birds—classy, both! Tariff and deficit worries—the most common questions I’ve received post-election and all year long, respectively—were voiced by bankers at our annual Hershey meeting.  Attendees at another annual meeting, this year in Nashville, laughed during my post-election presentation “don’t shoot the messenger” remarks, seemingly having absorbed the results. They wanted to see my shoes (!)—this time, the sensible Pradas. Sensible or otherwise, the market has been on a roll. Much of it justified by earnings: five of the six largest mega-cap tech companies (Nvidia comes a bit later) have released quarterly reports, with an aggregate 10.4% beat to earnings between them. S&P 500 operating earnings for Q3 are set to rise 7.2% to a record high. At current prices, the S&P 500 looks set to post back-to-back 20% return years, something it hasn’t done since the 1990s (and before that the 1950s). But the first quarter century of the 2000s (i.e., 2000-24) will likely show the weakest real return (4.9%) for equities of any of the nine quarter centuries since 1800. Somewhat unusually, investors held onto equities heading into this election. Since then, we’ve seen solid buying of cyclicals, especially Financials. But it wouldn’t be a surprise if the market had a little indigestion for the balance of the year. Before an audience in Dallas, Chair Powell said that the economy “is not signaling a need for the Fed to hurry rate cuts.”  Currently, a December rate cut is viewed as only a little better than an even chance. Only a few months ago, many feared recession; increasingly, the worry is that the Fed will grow more hawkish. Par for the course in this rarest of rare election years. If inflation reignites, we might see 10-year Treasuries above 4.5% once again spelling trouble for the housing market. Now, if 10-year Treasury yields hit 5%, you’ll likely see selling of stocks and buying of bonds. Volatility next year is quite possible, given the tight credit spreads, high equity valuations and uncertainty regarding rates.

Whither tariffs in the Trump administration #2? Everyone talks about their inflationary potential, but they could easily have an unwelcome deflationary impact if global growth stalls. That happened in 2018, when Trump imposed tariffs on numerous items such as washing machines, steel, aluminum and solar panels. Biden continued many of these tariffs but adjusted them to soften the blow to Europe while making the impact on China harsher. Imports since March 2018 have fallen, particularly from China. Trump could impose blanket tariffs (of 10%? 20%?) via the International Economic Emergency Powers Act, though they’d probably be thrown out by the courts and, besides, it has been reported (and seems plausible) that Trump intends to use tariffs as a negotiating tactic—“escalate to de-escalate” in the words of one of his economic advisers. Another area that has received media attention is the whimsically acronymed DOGE (funny, don’t you think?), or Department of Government Efficiency. To be chaired by Elon Musk and Vivek Ramaswamy, the DOGE will be not a cabinet department but an external advisory board. They can propose efficiency all they want; enacting spending cuts goes through Congress. Or, most of the time, doesn’t go through Congress. The Simpson-Bowles commission of 2010 generated considerable attention but most of their recommendations were ignored by Congress. Finally, a note on the Fed. Never before has the central bank cut rates amid such a pronounced bull market. The S&P 500 was up 35.8% from the year before when it cut this month. In December 1995 and January 1996, it also cut with the market up more than 30% in the preceding 12 months, the only other time it has done so. But, the forward P/E multiple was 14 then versus 22 today.  

The markets have been absolutely giddy in the wake of the election. Investment grade corporate credit spreads are the tightest they’ve been since 1998, while high yield bond spreads are approaching their narrowest-ever level, set in May 2007. Growth expectations for the Magnificent Seven seem hard to square with their increased size and the AI capex spending—maybe the market is a little giddy. This ebullience puzzles some onlookers, considering the potential for Trump’s policies to spur further inflation. Partly, the rally looks to be a standard post-election bump, owing to the removal of uncertainty. But with business-friendly policies on the horizon and the Fed cutting rates, maybe it’s more than that. Small businesses particularly, whose sentiment has been feeble for a long time (more below), may finally show some animal spirits. Small business optimism rose 10.9 points from October to December 2016. Perhaps we’ll have a repeat this year given Trump’s stance towards taxes and regulation. Hiring and investment should benefit. If small business’ mood has plenty of room to improve, the same cannot be said for the broader public; the Conference Board reports that consumers have never been so confident that stocks will go up over the next year. The S&P looks overbought; perhaps it’s time for a little caution? The week after may start to look (and feel) like the morning after a wild party. Still, history is clear that it has always been a very bad idea to sell just because your party lost. Inasmuch as it is wise to separate church from state, so too with politics and portfolios. Profits matter most for stocks. So, as we turn to the holidays, and the gatherings, best keep your sense of humor near. One thing I’m sure of, I won’t be disinvited from Thanksgiving—I’m the host! 

Positives

• The consumer is on the job Retail sales increased by 0.4% in October as inventories-to-sales ratios remain well below pre-pandemic norms, both healthy signs. Restaurant spending growth was strong, an excellent read on service spending, and the whole report raises hopes for strong Q3 spending.
• Small looking more beautiful The NFIB Small Business Optimism Index rose to 93.7 in October. The NFIB’s measure of uncertainty jumped in October (typical before an election). Next month’s readings are likely to show improved sentiment, given the election’s resolution. Also of note: the survey showed an increase in the percentage of small business owners with job openings.
• New York factories are suddenly busy The Empire State manufacturing index jumped in November, with increased new orders and shipments, though a decrease in the employment component. Likely causes of the spike upwards: post-election clarity and the conclusion of the port strike.

Negatives

• Not bad but not good either The October CPI numbers were in-line with expectations, as core CPI rose 0.3% m/m while headline rose 0.2%. Unfortunately, the report shows inflation is stuck above 2%, and supercore inflation, rents and wage growth all rose in October. Strong productivity growth is likely to ride to the rescue, though, increasing GDP while tamping down unit labor costs. Also noteworthy: the inflation comparables for January-March of next year are easy.
• Bad for now The October core Producer Price Index rose slightly above expectations on the month, at 0.3% m/m versus 0.2% forecast. Maybe it won’t matter, but this does raise the possibility that a report which goes the wrong way could keep the Fed from cutting in December.
• Industrial production slammed Severe hurricanes and a nasty strike (Boeing) can do a number on industrial production and that’s what’s happened, sending it down 0.3% for October. Separately, industrial production for the euro zone fell 2% m/m, versus -1.3% expected, with Germany’s struggles particularly troublesome.   

What Else

Santa looks to be in a good mood this year The National Retail Federation expects holiday spending to rise about 3% y/y, while Visa says expenditures will go up 4%. Bank of America’s Holiday Survey asked consumers, and they say they plan to spend $2100, up a full 7% from last year.

Multifamily to the rescue? Given the ills in the single-family housing market, it’s understandable that apartment demand has been very strong. Absorption of these units is at 488K through the third quarter of this year, near an all-time high.

Why are barbers especially poignant indicators of inflation? As the saying goes, inflation is paying $15 for a $10 haircut that you used to pay $5 for when you really had hair.