All about the earnings

Off to San Antonio this week, delivering my election presentation to advisors, some of whom found the humor in my remarks. But most appeared exhausted with it all, and only afterwards was I asked who I thought would win. (My gut is telling me…). The chatty, elderly Butler, PA passenger next to me on our late-night flight went to both of Trump's rallies there. "We stood for 13 hours, but I would do it again even if I weren't a supporter of his." A phenomenon he is, indeed. Per Real Clear Politics, the betting market currently (with an emphasis on currently) has Trump winning, with the prospect of a GOP sweep rising. The Trump trade has begun to come back in earnest. Mid and small caps have broken out of a three-year range in recent days. The Russell 3000 posted a new cumulative breadth high this week as sentiment data put the bulls at 58%, not yet a worrisome number. If investors are, in fact, betting on a Republican sweep, any other outcome might be negative for stocks in the immediate aftermath to Election Day. The market skipped over the traditional October volatility. This, too, could mean that consolidation is in order before much more of a rally can be expected. Perhaps this occurs after the election, which historically is strong regardless of outcome? But after the election drama…

…It's all about earnings, which have been strong-and for this bull to carry on, that must hold up. Unlike the tech boom of the late 1990s, today there are just a handful of the 50 largest firms trading at 50 or more times earnings whereas more than a dozen of them did in March 2000. Still, with the S&P 500 at a multiple of 21.7 times next year's earnings, the market is not cheap and could be vulnerable to earnings surprises. Speaking of which, earnings have been revised sharply lower in advance of this reporting season. Is this just a matter of lowering the bar or does it point to a deteriorating outlook? The downward revisions may have been largely a result of energy companies seeing oil prices staying low (before recent news prompted them to rise). Q3 earnings reports have been good so far, with most of the big banks delivering strong earnings boosted by increased mergers and acquisitions and healthy profits from trading and wealth management. Importantly, forward guidance from the banks was strong. Earnings, for their part, are all about sales. So far this earnings season, corporate revenues are up 5% even as inflation has fallen sharply. This means that real revenue growth is picking up! It remains dangerous to bet against the American consumer. One area of weakness: seasonal retail spending. Halloween may be a fright night this year for retailers, with sales growth due to be down 5% y/y per the National Retail Federation. Worse yet, the same group expects the holiday season to be up a scant 2.5%-3.5%, the weakest rate since 2018 and a bit below the 4% average sales growth rate of the past 20 years.

In a consumer economy, sales are all about jobs. Payrolls rose by a substantial 254K jobs in September, although growth was concentrated in "catch-up" sectors of leisure and hospitality, education, health, and government which have brought more than three-fourths of all job gains in the past year. The consumer is the decisive factor in GDP growth and earnings. Here's hoping job gains keep up. The number of unemployed workers has risen 14% over the past year; an increase of 10% is considered recessionary. In 10 of 11 instances since 1956 where the ranks of the unemployed grew so quickly, the economy was already in a recession. In the eleventh case (1969), the economy entered recession three months later. Disconcerting odds! Now, the Bureau of Labor Statistics says average hourly earnings through September have risen 4% y/y, for a real increase of 1.6% y/y. If inflation were to reignite-something it usually does after a spike such as we've had-one of the most likely causes would be wage increases (a possibility in 2025 if the labor market tightens and strikes pick up). The 2023 federal budget deficit exceeded 6% of GDP even as the economy was growing and unemployment was low. In the past, when we have run a budget deficit of that magnitude relative to GDP, we were either in a war (Civil War, WWI and WWII) or facing a disruptive shock such as the Global Financial Crisis or Covid-19. Neither presidential candidate seriously intends to bring the deficits down-to the contrary, it seems. Thanks to unprecedented stimulus, the current cycle is the eighth-longest going back to 1854 and counting. In 2025, whoever wins this election will face the largest fiscal cliff in US history.

Positives

• It remains dangerous to bet against the American consumer Retail sales increased by 0.4% in September versus expectations of 0.3%. The control group (ex-food, gas, autos and building materials) rose 0.7% m/m against expectations of 0.3%. Taken together, it was a strong reading without, importantly, being so strong as to prompt inflation.
• The soft landing needs a home The National Association of Home Builders' housing market index rose 2 points in October to 43, versus an expected 42, with all three components of the index rising. Housing starts fell 0.5% m/min September, but single-family permits (a leading indicator) rose 0.3%. Mortgage applications fell, however.
• A noisy production report Headline industrial production fell 0.3% m/min September, but Hurricane Helene and the Boeing strike together knocked 0.6% off the total per the Fed, which suggests underlying health. Prior months were revised lower, however. Separately, the Atlanta Fed's GDPNow tracker estimated Q3 growth at 3.4%, an increase from the prior 3.2%.

Negatives

• Regional Feds mixed The New York Fed's Empire State manufacturing survey fell by a more than expected 23.4, to -11.9, its lowest level in five months. Optimism for the six-month outlook rose, though. The Philadelphia Fed's manufacturing index rose in October. Like the Empire State, the six-month outlook was strong, suggesting respondents just want to get through the election.
• Whiff of inflation Import prices fell 0.4% m/min September, but this mostly reflected a drag from energy prices. On a core basis, import prices rose 0.5%. Prices on consumer goods ex-autos were 0.8% higher y/yand capital goods prices rose 0.4%.
• Playing it safe China's pivot appears to be aimed more at reducing risks of a downturn than at truly stimulating the economy. Thus, the fiscal package yields little stimulus spending but offers a refinancing of local government debt, to shore up social stability.

What Else

Consistent amid differences Economic policy uncertainty has not spiked this election year the way it usually would, even amid extreme events such as the replacement of Biden with Harris or the attempts on Trump's life. The reason for this may be simple: though the candidates' economic policies are at odds, each side's outlined policies have been consistent during the campaign.

Trump trade? Regional banks were strong outperformers in the last two months of 2016. They have been showing signs of life lately too. Perhaps the market is turning to them again in hopes of a repeat performance.

Most of us don't get tips No taxes on tips might be politically savvy for the candidates-both Trump and Harris have now offered some version. It's pricey though and imprecise. It would cost as much as $200 billion/yr in Trump's proposal (though a good bit less in Harris'), while helping a mere 2.5% of the workforce or, actually, less, since a third of tipped workers don't make enough to pay federal income tax.

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