We are reaching maximum convergence in so many ways right now, from the Macro-economic landscape to the Micro (individual company earnings), key components of fiscal policy, monetary policy updates, and political events. All are affecting, in some form, the Economy moving forward. The breadth of things we must pay attention to can’t be understated; there are a lot of moving parts.
So, let’s dig right into some of the important items from this week.
Gross Domestic Product
Let’s start with the big GDP report for the 3rd quarter. It came in at +4.9% Quarter-over-Quarter or +2.9% Year-over-Year, surprising estimates to the upside. Would you believe the markets would sell-off -2.5% the same week a better-than-expected GDP report came in? This is another example of News vs Noise. It’s what lies beneath the report that’s important, and the fact that it’s rear-view looking. The Market is sniffing out that last quarter was very likely as good as it gets on the economic front for the time being.
Consumption, Government Spending and Inventories were the strength in the headline numbers:
Consumption (C): Consumption was up a solid 4% (best since 4Q 2021). But we anticipate a significant slowdown in 4Q into ’24. Many of our leading indicators project this. The challenges of depleting excess savings, tighter credit, and declining real incomes (meaning inflation is higher than wage growth) put the consumer on tougher footing moving forward. In other words, this looks a lot like the last hoorah from the consumer. Very similar consumption print in the 4th quarter of 2007 occurred, so it’s not uncommon to see a big uptick prior to major slowing.
Government Spending (G): Big government spending component remains a huge contributor to the headline number and has had a huge positive effect this year on growth. This is likely to continue (big spending, albeit at a slightly slower pace), but at what cost? More on that later.
Investment (I): Non-Residential investment fell to zero contribution while Residential flipped to modest positive contribution. Inventories were the primary contributor on the investment side.
Notable: Auto Inventories were up 14.6% Quarter-over-Quarter through the latest August data and up 80% Year-over-Year, mostly representing purposeful inventory build ahead of expected strikes. The September data is likely to show similar strength. Auto inventories will give back a lot of that strength in the subsequent month(s) while also dragging on 4Q growth and beyond.
So yes, on a headline basis, the GDP for 3Q looked great, but moving forward, it will most likely be lower into Q4 and early ’24. Stay tuned.
Interest Rates & Debt
The 10-year Treasury had a volatile week, closing down -7 bps on the week. Notably, it had 2 days of 10 bps or larger moves, which is not normal action historically speaking for the long-end of the Bond Market.
Year-to-date, the long-end of the Treasury curve (10s and 30s) has been moving up as our Treasury Debt continues to expand, almost in lockstep. The big government spending above in the GDP calculation continues to come at a higher cost, and that’s the interest rate charged with this continued borrowing.
Beginning of 2023:
$31.41 Trillion in debt
10-year Yield: 3.87%
Today:
$33.67 Trillion in Debt (up $2.26 Trillion)
10-year Yield: 4.84% (up nearly 1%)
This is a huge macro story that we continue to watch very closely and is definitely impacting the Bond Market.
Eurozone: Likely in Recession
The European Central Bank (ECB) kept rates steady at 4.50% for its main refinancing rate, and 4.00% for its deposit facility, which was widely expected. The EU’s Consumer Price Indexes slowed in October, with headline down to 4.3% year-over-year and core to 4.5%, clearly still way above ECB’s 2% target. So why the pause if inflation is still so high?
The Eurozone PMIs came out weaker than expected this week, with both Manufacturing and Services sitting at cycle lows at 46.5 (Services) & 43.0 (Manufacturing). 50 is the distinguishing mark for expansion/contraction. Manufacturing has been in contraction for well over a year!
Europe’s data and slowing growth are ratcheting up recession fears. There is a good chance we will look back at this time and find Europe entered and is in a recession, which is what the ECB fears right now and the pause in the rate hiking cycle.
European Markets are now back to flat on the year-over-year average after rising 13% into Summer. Since then, it’s been a bigger sell-off abroad than here domestically. Important for us to stay on top of.
Market Breadth Continues to Deteriorate
Breadth continues to deteriorate, with the % of stocks trading above their 50 and 200 daily moving averages falling to the lowest level since last October.
The traditionally more cyclical areas of the Market that lead Bull Market price action are faltering. Small Caps & Financials coming out of Bear Markets are traditional early Bull Market leaders signifying the strength across the Economy. We just aren’t seeing that at all today. In fact, these areas have been some of the worst-performing spots of the Market. This needs to improve to get a continuation of earlier in the year positive price action. Small Caps are down over -7% on the year, Financials are down over -8% on the year. Small Caps are below their low points last year, trading at new cycle lows.
Earnings
So far, we are seeing the continued trend of raising prices by companies to manufacture revenue growth. Companies are boosting 3Q revenues via raising prices. Higher prices mean less real consumer purchasing power over time, and weaker unit sales. Stocks are starting to notice these price hikes aren’t sustainable.
Some companies have been able to do it better than others, but the Market is starting to notice raising prices isn’t sustainable at this point as volumes are starting to decline.
We also learned that the business models of the likes of META and GOOGL are seeing signs of volatility early this quarter due to the Middle East conflict, as was reported on conference calls. It was enough to put pressure on the Markets this week. It’s undeniable they are cash cows, and generate tremendous earnings, but are they going to see a slowdown given the macro-environment? We shall see. We didn’t see the usual raising of guidance from the Big Capitalization names we’ve been accustomed to. More of muted guides by management.
Earnings Estimates for this year continue to flat-line as it’s becoming more apparent that the 3rd and 4th quarters won’t be enough to overcome the negative growth from the 1st half.
However, estimates are still quite optimistic for 2024 sitting at $246, which would be nearly 12% growth over this year. They’ve definitely come down a bit from where they started ’23 at $254.
Gold Continues to Shine
Up nearly 10% Year-to-date, outperforming just about all equity indexes across the globe. The chart is currently trying to knock through 3 years’ worth of resistance at the top of its trading range. If it can chew through, it has some open field to continue to run higher.
Fun fact, Gold is one of the few places since 2021 ended that has a positive return.
All Equity Markets globally are down since then. All Bond Markets globally are down as well. It’s been a tough cycle, to say the least! What are the other places that have been up since ’21? Commodities and the US Dollar, that’s it.
The FED: Likely to Keep Rates Steady at 5.25-5.50%
All heads turn to Fed Chair Powell next Wednesday. It will be more about what he says about the path for monetary policy. A lot has changed since their September decision and economic data release. Market expectations are nearly at 0% for a hike at this meeting, so it’s all about the press conference.
Market in Correction:
With the further selling in Markets this week, the S&P 500, Russell 2000, Nasdaq, Mid-Cap 400, World Index (ACWI), Developed World Markets (EFA) are now all in correction territory, declining more than 10% from their July highs. Most of the hot starts to the year through Summer have now completely been erased. Our defense and active moves have had us holding in much better during this correction. On the bond side, our shorter duration continues to provide a lot of value in a negative Bond Market with rising rates. We will continue to battle through. Our strategies are working.
It’s a marathon, not a sprint. Have a nice weekend. We will be back dark and early on Monday.
Mike Harris
