Earnings season
Approximately 85% of S&P 500 companies have reported their quarterly earnings. On average, earnings are up 15% while revenue has increased roughly 4% Y/Y. Net profit margins have averaged 13%, up from 12% in the year-ago period. In aggregate, investors have reacted favorably to the published results, driving the S&P 500 index higher by 4% in the YTD period. However, it is notable that some of the mega cap stocks that have been the leaders during the past five years are not the primary contributors to the market’s performance so far this year. In fact, companies such as Apple, Microsoft, Amazon, Alphabet, Nvidia, and Tesla have all underperformed the S&P index average YTD with several delivering negative returns.
There are various reasons that caused the divergence in returns among these mega-cap stocks. Concerns about valuations and risks related to the monetization of ongoing AI infrastructure investments are certainly factors. But, in general, a broadening of the market leadership to include many of the non-Magnificent 7 stocks is seen as healthy by many market observers, but an interesting observation, nonetheless.
The housing market
One notable group of stocks that has struggled this earnings season is the homebuilders. On average, homebuilder stocks are down 8-10% YTD. Higher mortgage rates, slowing buyer demand, and rising costs are all contributing to shrinking profit margins. Moreover, rising inventories of unsold homes will limit price increases and the number of new housing starts as homebuilders work through the selling season and begin their capital budgeting for next year. This means earnings estimates are likely to decline.
The housing market is a leading indicator for the economy as a whole. Construction costs are affected by many of the issues that we see in national headlines every day including immigration policy and tariffs. It is hard to know what labor and material costs will be when many of the workers and goods needed to build a home are in a state of flux. For instance, it is estimated that nearly 40% of all wallboard installers who work in the homebuilding industry may be undocumented. And a significant portion of the lumber, appliances, and other building materials are imported and therefore potentially subject to tariffs. Thus, the stock prices of homebuilders have been hit sharply in recent months.
The challenges facing homebuilders illustrate the broader issues facing the economy. The Trump administration plan is to improve economic growth, but near-term impacts to some sectors, particularly those that are cyclical such as construction, may encounter short-term pain. The ultimate success of DOGE—reduced regulatory burden, increased domestic manufacturing, etc.—should boost the intermediate and long-term outlook for companies, but results won’t be known for some time. Until then, investors will be forced to speculate and monitor incoming data alongside the Fed.
Fed meeting notes
Yesterday, the Federal Reserve released its January meeting minutes in which it decided to maintain current interest rates, prioritizing further progress on inflation before considering any cuts, due to persistent economic uncertainties. Fed officials also expressed concerns regarding the potential impacts from a debt-ceiling standoff and the unfolding economic policies of the Trump administration, particularly in relation to trade and immigration. Despite these uncertainties, the Fed remains optimistic that inflation will eventually return to its 2% target with appropriate monetary policy.
DOGE, the economy, and interest rates
Investors are rightly focused on how the change in political and economic policies plays out. A significant reduction in the deficit that translates into lower inflation expectations and a more sustainable fiscal spending outlook could materially lower interest rates, especially the all-important 10-year U.S. Treasury yield. Rising interest payments on U.S. debt are becoming a bigger budgetary problem as more government bonds mature and must be refinanced at today’s higher interest rates.
Mortgage rates are tied to 10-year U.S. Treasury yields which affect homebuyers. Right now, home price affordability is the worst since at least 1980. Record-high home prices, combined with a 7% mortgage, have resulted in a 10-year low in home purchase transactions. Historically, homebuyers have paid 2-4x their income for a home. Now, the median home price in the U.S. is more than 5x the median income based on recent estimates. For many, the ability to purchase a home is simply out of reach. Thus, a lower 10-year U.S. Treasury yield and related mortgage rates could bring relief to the current affordability problem in the housing market.
For now, animal spirits, solid earnings reports from companies, and investor confidence in the Trump administration’s economic policies have supported stock market valuations which are near all-time highs. The record amount of cash (near $4 trillion) parked in money-market accounts has also helped prop up asset prices. However, we are beginning to see the effects of higher interest rates on the most cyclical industries, like homebuilding. Going forward, the direction of interest rates will matter more to the broader economy.
Senator Mitch McConnell and hockey great Phil Esposito both turn 83 today, basketball star Charles Barkley turns 63 and singer Rihanna turns 37.
Christopher Gildea 610-260-2235