Stocks were mixed yesterday as favorable earnings news clashed with higher interest rates. A strong retail sales report for September boosted yields as the U.S. economy continues to defy expectations that a slowdown is imminent. With net monthly job gains averaging near 175,000 and unemployment still well below 4.0%, Americans have little reason to defer spending as long as money keeps coming in.
There have been signs that most of the excess savings built up during the pandemic has been spent. But not all. Concerts are still sold out and airline bookings are solid. The corollary to economic strength is that inflation is receding at a slower pace than the Fed wants to see. Hence, its intention to keep rates elevated for a longer period of time. The strong retail sales numbers helped to lift bond yields back toward recent highs. So far, yields are contained within their recent range. It doesn’t help that government financing needs continue to be elevated. Thus, it is a close call whether the 10-year yield crosses the 5% barrier or not.
In the meantime, it’s earnings season. While the most concentrated part of the period is still about a week away, the pattern to date suggests that investors should be pretty happy with results. Clearly, the economy in the third quarter grew faster than expected. The only offset is the impact of a strong dollar translating foreign sales and earnings. But investors often ignore currency impact assessing the long-term value of a business. Wall Street eagerly awaits the reports from the big tech companies. Netflix and Tesla report this week. The bulk of the rest report next week. The results of Netflix and Tesla aren’t likely to give us hints of what the rest of the Magnificent Seven are likely to report. Netflix’s results will be impacted by the writer’s and actor’s strike. New content will soon be depleted, but on the other hand, production costs will be way down. The company will try and lay out a roadmap for the months ahead, but that will be difficult not knowing when the actor’s strike will end. We know that Tesla’s deliveries in the third quarter were a bit short of expectations. The focus will be on margins as it has been cutting prices to keep orders high. Investors will also look for details as to when it will begin making truck deliveries.
While business continues as usual, a lot of attention will be diverted to the conflict in the Middle East and Republican efforts to pick a new House Speaker. Events in the Middle East grab most of the headlines. So far, the war has not expanded but it is too early to reach any conclusions. So far, the economic impact is minimal. Thus, Wall Street’s focus remains on earnings, not geopolitics. As for the Speakership, Republicans will make another effort today to select a speaker. The only clear candidate at the moment, Jim Jordan, has been in office for 16 years and has never sponsored a single bill that became law. Quick to criticize, he is unlikely, if elected, to move much forward beyond the bare essentials. Even those might be a struggle. If he does not get the votes needed, it appears the most likely short-term path would be to expand the powers of the Interim Speaker, Patrick McHenry to allow government to finish approving appropriation bills and decide whether to fund aid to Israel and Ukraine. Mr. McHenry doesn’t appear to want to be anything more than an interim leader. What follows if Mr. Jordan doesn’t get the required votes soon is open to conjecture. What one can say is that beyond keeping government open, getting anything of substance passed is unlikely. This suggests funding close to fiscal 2023 levels without any significant new programs. To many on Wall Street, this may sound good. But left unchecked we face years of deficits of $1.5 trillion or higher. That hardly sounds like effective fiscal policy.
Normally, the fourth quarter is seasonally the best as investors look ahead to what more often than not is a brighter future. In 2022, stocks fell amid the outbreak of war in Ukraine and rising inflation. In the first half of 2023, stocks rallied, partly on a belief that the selling in 2022 had been overdone, and partly related to enthusiasm over the potential of generative artificial intelligence. Since mid-summer, however, the mood has changed. Stubborn inflation and rising deficits that need to get funded together have pushed interest rates higher, offsetting the continuation of moderate growth. As we come toward year end, the consensus says growth is going to slow. Student loan payments have resumed. Higher mortgage rates are slowing housing activity. High gasoline prices are impacting discretionary spending. Few expect a robust Christmas season. But the Fed is likely done, or nearly done, raising interest rates. Whether a soft landing or recession lies ahead, investors soon may focus on when the Fed will start to cut rates. That is likely in the second half of 2024. Wall Street will celebrate when that happens. But until then economic softness should mute any robust market recovery. Thus, we face the clash between a slower pace of economic growth and moderating inflation and interest rates. Given that economic softness must precede any change in Fed policy, it is likely that markets remain choppy for a while longer. While the NASDAQ is still up close to 30% year-to-date, the Dow is up less than 3% while the equal weighted S&P 500 is up only 1%. There are just as many stocks down year-to-date as up. Near term, the reaction to earnings for the big tech companies will be critical. But overall, I see no near-term change in the volatile sideways motion of the overall market.
It’s a sports day for birthdays. Lindsey Vonn is 39. Martina Navratilova is 67. Mike Ditka turns 84. Go Phillies!
James M. Meyer, CFA 610-260-2220