This rarest of election years

The election was on everyone’s mind this week in Nashville and Wichita. One hundred people move to Music City every day, so the traffic is crazy. My first Uber driver has been hit twice on the road while working and my second bemoans the night shift “wild people” sullying his back seat. My third grew up here and would never leave—same for my beloved brother with whom I stayed who laughs as I pitch coming home to Pittsburgh. The people here and in Wichita are so friendly! But their faces sour as we discuss November 5. Hey, I’m just the messenger! The yield on 10-year Treasuries has risen roughly 60 basis points from 3.6% in mid-September to 4.2% today, reminiscent of the bond selloff last autumn. The market’s perception of the prospects of a Republican victory coupled with strong economic growth—the Atlanta Fed’s GDPNow was lifted recently to 3.4% for Q3—are likely causes for the shift. If anything, growth may be the larger cause. The 10-year could easily go higher still, since prices usually overshoot when they make a big move. Rates increased by 80bps after Trump’s win in 2016. Furthermore, Treasury auctions are nearly at a record while demand is mediocre with many investors looking at equities instead.  Current federal spending has been strong, and while this has helped keep a recession at bay, it may also be making core inflation sticky. Immigration is likely to be slowing whoever wins, a presumably inflationary development. Then, if (when?) deficits expand further under the next administration, watch out. The current bond selloff is not a US-only phenomenon but a global one and international bond markets may be looking at three years in a row of negative total returns. Meanwhile, equity prices make new highs. The market seems to concede that recession looks less likely than before as Fed tightening unwinds and real wages rise while the next administration promises further fiscal indiscipline.

The spike in bond yields is yet another gut punch to the beleaguered housing market. Existing home sales fell in September to their lowest level since 2010, and mortgage applications have dropped for four weeks. Mortgage rates have spiked lately, hampering sales. Are the bond vigilantes catching a whiff of inflation? Homebuilders are offering buyers discounted mortgage rates and yet the ratio between median new versus existing home prices is the lowest since the early 1980s. Even as mortgage rates rise and sales dry up, home prices continue their ascent, having increased now for 15 straight months to a median of $405K. Housing is in a tough spot: a stronger economy would keep mortgage rates high, while a weaker economy would hurt demand. Perhaps first-time home buyers will have to muddle through as apartment dwellers for the time being. And yet a glance around the globe shows that for all our difficulties, we’re doing pretty well. Maybe, not for the first time, we’re the cleanest dirty shirt! China has recently made an effort to get out of stagnation. The authorities may be sincere in their aim to fix things. The problem they face is that they’ve never moved beyond the idea of taking on debt to build up industrial capacity, a policy they share with Germany, Japan and even the old USSR. China’s new measures are not yet designed to spur consumption, which would lift growth over the longer term. Germany’s having a rough time of it, as well, partly because their heavy industry is exposed to China. In Germany, real GDP stands at 2019 levels. Productivity growth is negative, prompting unit labor costs to rise. The euro zone’s composite PMI remained in contraction, particularly manufacturing, while services expanded modestly. By contrast, the US has seen enviable GDP—and productivity—growth in recent years, even if it hasn’t yet done much for our mood, which remains downbeat. I see it in their faces.  

Meanwhile, the equity market has been resilient. Sentiment is bullish per investor survey data while credit spreads are narrowing. The VIX has been up; perhaps this indicates investors expect a jump higher? We are at a time on the calendar when the market often rallies into year-end, a phenomenon seen both in election and nonelection years. In 19 of 21 cases where the S&P 500 rose 30% in a year, there was no recession for at least a year. Gold has been on a tear, too, and indeed the S&P 500 and gold are both up more than 30% this year, something that’s happened only once in the last 50 years. A rare year indeed. As Q3 came to a close, 50 names in the S&P 500 traded at 10 or more times sales, a figure that would have been shocking not too long ago. Still, if the market is expensive, profit margins on the S&P 500 are at all-time highs and the return on equity is well above average. Breadth is good, too, with 80% of the S&P above their respective 200-day moving averages. Also, most of the Magnificent 7 is now performing in-line with the rest of the S&P 500. Earnings growth is expected to be strong going forward, so there’s a lot to like. But we haven’t had the typical (and much overdue) correction leading into the election, which historically led to a strong year-end rally. Still, I wonder if maybe in this rarest of rare election years we get that volatility after the election.

Positives

• Shoppers take heart The University of Michigan’s consumer sentiment index rose to 70.5 against an expected 69, making a six-month high. Lower rates were credited with the improvement. One-year inflation expectations remained unchanged at 2.7%. Longer term, expected inflation dropped to 3% from 3.1%.
• US activity ticks higher S&P Global’s US services PMI rose by 0.1 in October to 55.3, just above expectations. New business rose to 55.8 while employment remained at 49.7. Their manufacturing PMI rose above consensus in October, but remained below 50, at 47.8.
• Everything but airplanes Thanks to a sharp drop in aircraft orders, durable goods orders fell 0.8% in September. Excluding transportation, however, orders rose 0.4%. Non-defense, ex-aircraft capital goods orders reached a new all-time high.  

Negatives

• Bond yields are a headwind Existing home sales fell 1% m/m in September to an annual rate of 3.84 million units, just below consensus. Thirty-year mortgage rates are roughly 6.6%. Sales of existing single-family (off 2.3%) and multifamily (off 14%) are down y/y as well. New home sales rose 4.1% in September, above forecasts, though retracing the prior month’s declines.
• Regional Fed roundup The Richmond Fed’s manufacturing index rose in October but, for the twelfth straight month, remained in negative territory while their services index declined. The Philadelphia Fed’s nonmanufacturing index rose into positive for the first time since June but remains a bit weak for an expansion.
• Leading indicators drop The Conference Board’s Leading Economic Index continued to decline in September, falling 0.5% to 99.7 with four of 10 components down m/m. Weak factory orders amid a global manufacturing slump were blamed for the falloff. The US Fed’s Beige Book, for its part, showed a stagnant economy with participants awaiting results of the election.  

What Else

An interesting take Even if Trump wins, a Republican sweep may be less likely than supposed. For one thing, 17 GOP House seats are in districts Biden won in 2020, many in states such as California and New York. Also, Trump has been focusing more on his own race than down ballot, local GOP parties in many of the swing states are short on funds, and Harris is writing lots of checks. Finally, Senate candidate quality continues to be a mixed bag for the Republicans.

Is nothing safe from the inflation genie? The Girl Scouts, facing a net operating loss, voted to increase annual dues from their current $25 to $65 over the next several years. Cookie prices rose 20% last year. Still, the dues hike is less than the $85 originally planned, which happens to be the level at the Boy Scouts. Sorry, boys.

Might improve my chances of being on time! The Federal Aviation Administration put forth a set of rules pertaining to piloting air taxis, including training specifications, minimum altitudes and visibility standards. These “powered lift” vehicles, which take off and land vertically but fly like airplanes, will be the first new form of aircraft since the helicopter appeared in the 1940s. Operations may commence as early as next year.