The Dow rose for the seventh straight session yesterday, and according to futures, is set to rise again this morning. This entire celebration goes back to last week’s favorable CPI report. The battle against inflation isn’t formally over, but equity markets see enough facts so far to declare victory inevitable.
It’s still relatively early in earnings season. So far, the reactions to results have been favorable. That could be tested tonight when IBM, Tesla and Netflix report. IBM’s results are always a combination of murky and confusing, never much of a guide for the overall market. Tesla already reported blowout sales, but at what margin? The company clearly had to lower prices to move cars. The focus tonight will be all about margins and future pricing. As for Netflix, its stock has soared over the past week and year-to-date. It is the only streaming company making money, has the most production in the can to protect against the pending evils of the writers and actors strikes, and has the greatest presence overseas. It seemingly can do no wrong. But if you have followed Netflix in the past, every so often it skips a beat, usually related to the growth rate for subscribers. Tesla and Netflix could well set a trend for the top ten S&P companies who report over the next two weeks. They will bear watching.
There was another big news item worth reporting. Ford lowered the price for its F-150 Lightning by up to 16%. Prices are now in line with its traditional F-150 gas-powered pickup truck. There is a big lesson here. To date, buyers of electric vehicles have been mostly higher income enthusiasts. Some bought them to be cool. Some wanted to help the environment (is there anyone left who still feels the planet isn’t getting hotter and wetter?). Some are simply enthusiasts of new ideas. But what has been missing are people who have bought electric cars because they are demonstrably the best value. When that tipping point is breached, sales of electric vehicles will soar. If I can buy a “better” car for less money, it will be a no-brainer. That hasn’t happened yet. Range is still too low. There aren’t enough charging stations. But mostly, the price is still too high. A Tesla Model 3 costs close to $50,000 while a Toyota Camry is still less than $35,000. What I am saying about cars applied to laptop computers and digital cameras. When they were better and cheaper than desktops or traditional film cameras, displacement took place rapidly. That tipping point will come. But until then, Ford and others, including Tesla, are going to have to cut price and eat profits. Auto manufacturing is a business of scale. Fixed costs are high. Factories have to be run to near capacity for any chance at a profit. Trends are moving in the right direction, but they aren’t there yet. When they get there, it will be obvious.
I noted Monday that today I would talk a bit about 2024. But before I do, let me address a few issues with 2023 still in front of us. We all know that actors and screenwriters are on strike. That promises to be a long one. The filmed entertainment business is moving to a new streaming model. After a relatively brief flurry when everyone spent like drunken soldiers to produce gobs and gobs of top flight content, the industry has figured that such a path would simply lead to huge economic losses. Movie theatres today are less crowded. Amateur entertainment on YouTube and TikTok is taking share. Studios are losing as are actors and screenwriters. The pie is getting smaller for everyone and all want a bigger piece of a shrinking pie. When everyone is hurting, it’s hard to be a winner. That’s why this is likely to be a long strike.
There are other potential strikes pending against United Parcel# and the auto industry among others. All can be economically disruptive. A UPS strike would mess up supply chains big time if it were to go on very long. Teamsters view UPS as a test case for future contracts and efforts to unionize companies like Amazon#. The President stepped in to try and bring railroads and unions together, but politically, he may have a tougher time here, at least until any strike becomes overly disruptive to the overall economy. Customers of UPS are trying to make alternative plans, shifting more business, even to the Post Office. The contract expires at the end of July.
In the fall student loan payments are set to resume. The President is again taking steps to forgive some, change terms on others, and defer defaults if he can. But that won’t change the fact that many with existing student debt are going to have to start paying at a time when excess savings are winding down and credit card balances are rising.
Finally, there is the heat. You can’t see heat. It doesn’t make the trees sway. It doesn’t create flooded roads or basements. Its impact is more insidious. Lines are shorter at Disney World in part because of higher prices. But temperatures and humidity both in the 90s are a factor as well. Excessive heat will keep others home. It will impact retail sales and baseball park attendance. It simply slows everything down. I don’t think this summer’s heat wave is going to have a dramatic or even noticeable impact on GDP. Its impact will be more insidious, but it bears watching. Congress only reacts to crisis. We aren’t there yet. But we are headed in that direction. My guess is that over the next few years more attention will be paid to the impact of changes in climate as the impacts are more noticeable. That isn’t a political statement on my part; it’s a pending economic reality unless the warming trend ends.
Now to 2024. Here are some highlights.
1. The Fed will have stopped raising rates. The question next year is when will it start to cut rates? If we end up with a soft landing (and kudos to Powell and the Fed if that happens), and growth is about 1% in the first half of the year, what incentive does the Fed have to lower rates unless inflation falls to the 2% target sooner than most expect?
2. Inflation is coming down. The June report suggests the pace might be quickening. That would be good news for markets. But we are in an economy still adding 200,000+ jobs every month and there are close to 10 million job postings. Wage inflation will moderate as overall inflation falls. But can it get below 3.5% with unemployment at 3.5%? The answer is subject to a lot of debate. The last thing the Fed wants to do is start lowering rates and see inflation start to creep higher again.
3. China is an emerging mess. It accounts for roughly a fifth of world GDP. It is still growing faster than the overall world economy but the gap is narrowing. Deflation is on its doorstep. Youth unemployment is over 21%. Foreign investment within China is down as much as 80%. There is no question the Chinese government will react to all this, but can it do what’s needed? A softer economy is lowering birth rates. Private debt, often backed by the government, has soared, limiting options. Simply said, the world economy needs a healthy China. At the moment, events are moving in the wrong direction.
4. Barring the use of nuclear weapons, the Ukraine war promises to be a stalemate. The so-called spring offensive has made little progress. Russia is unlikely to gain more territory and Ukraine is unlikely to push Russia out. An end probably requires exhaustion on both sides. No one knows when that will happen. Hopefully, it will be sooner rather than later.
5. Dare I notice but there will be a Presidential election next year. Barring surprises, at the moment, it appears to be a rematch between Biden and Trump. Voters know both all too well. With that said, it promises to be an ugly campaign. Economically, none of this matters. The best outcome is probably one where the winner’s party doesn’t control Congress. But it’s way too early to factor the election into stock prices. With that said, the Fed has a lot more impact on markets and the economy than the White House.
Pulling this all together, the outlook for 2024 is one of anemic growth with long bond rates not far from where they are today. Companies dependent on economic growth rates will probably deliver uninspiring results. Companies that are largely in control of their own destinies can still flourish. Obviously, if one looks at the top of the S&P 500, it’s clear that investors have already made big bets on big tech. That doesn’t mean markets are always right. All these big companies face headwinds. Digital advertising growth isn’t unlimited. The smartphone market is now a replacement market. Technology changes require companies to pivot. But overall, it appears stocks next year will depend less on economic direction and more on each one’s ability to navigate in a slow but changing environment. We won’t solve the streaming wars or high cost of electric cars over the next 12 months. We will learn more about the economic realities of artificial intelligence. We will react to steps China must take to stabilize growth. And companies will have to deal with an activist
FTC and Justice Department.
Valuation will be key. One can argue whether stocks today are fairly valued or expensive. Few will argue they are cheap. Many of the biggest names including the two largest within the S&P 500, Apple# and Microsoft#, are at all-time highs. For the market to move ahead substantially, breadth has to broaden. That process has begun. It needs to broaden. Normally, the third year of a Presidential term is the best. The fourth year is iffier. Recessions messed up 2008 and 2020. A recession in 2024 isn’t out of the question, nor is it a foregone conclusion. It’s too early to make a serious conclusion about 2024. But we know what to watch. As always, the Fed will get the most attention.
Today, actor Benedict Cumberbatch is 47. Brian May of Queen is 76. Still needs a haircut.
James M. Meyer, CFA 610-260-2220