Strong Corporate Earnings Should Sustain Stock Market Rally

A strong Q421 corporate earnings season should sustain the stock market rally in January.  It should help the market overcome selling typically seen early in the month after a "Santa Claus" rally.  In addition, Fed policy should not change, even if some of the upcoming key US economic data are above target.  The Fed should want to give its latest two sped-up taperings time to work.  And, it will probably want to keep policy steady soon after Powell's renomination hearing this month, trying to avoid undermining his credibility.  While there are reasons to expect above-target prints for December Payrolls and CPI, there are other reasons to believe they will be followed by more moderate prints in the following month or so (see last week's blog).  So, the Fed should be patient if high December prints turn out to be the case.

Consensus looks for about a 20% (y/y) increase in Q421 corporate earnings, versus 39% in Q321.  Although this would be the lowest quarterly increase for the year, it still would be historically high.  Most of the macroeconomic evidence, indeed, point to a larger y/y increase in Q421 than in Q321.  A pickup in Real GDP Growth and an improvement in profit margins, as prices sped up relative to wages, would appear to have lifted domestic profits.  Similarly, higher oil prices should boost profits in this industry.  But, a stronger dollar (thanks to easier year-ago comparison) and softer economic activity abroad should hurt earnings outside of the US.

                                                                                                                                          Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)
Q119            3.2                -12.8                 +7.9                             3.2           2.1               51.9 
Q219            2.7                -12.2                 +5.9                             3.1           2.1               47.8    
Q319            2.1                -19.2                 +3.6                             3.2           2.3               46.4
Q419            2.4                  -3.6                 +1.7                             3.2           2.3               46.2

Q120           -5.0                -16.5                 +2.9                             3.1           2.3               47.2

Q220         -10.6                -53.5                 +5.9                             6.5           1.4               40.1

Q320           -2.8                -27.8                 +1.0                             4.8           1.7               52.4

Q420           -2.4                -25.5                  -1.9                             4.8           1.6               54.6

 

Q121            0.4                  26.3                 -4.4                              4.9           1.4               58.3   

Q221          12.2                  32.1                 -8.3                              1.2           3.4               63.1 

Q321            4.9                  72.7                 -3.4                              4.2           4.1               60.9

Q421            5.7 *               80.3                +1.0                              4.6           5.0               58.2                                                                                                    

* Based on the Atlanta Fed Model's latest projection of +7.6% (q/q, saar). 

The latest Unemployment Claims data point to a speedup in December Payrolls, but hint at a slowing in labor market improvement over the month.  Both Initial and Continuing Claims are below their levels in the November Payroll Survey Week.  But, Initial Claims have flattened out over the past several weeks. 

 

 

Fear of the Fed

Besides fear of the Omicron variation of the virus, stocks may continue to grapple with the implications of the Fed's (and other central banks') increased emphasis on targeting inflation.  While there are some reasons to expect the currently high inflation to abate at some point, a sustained ratcheting down requires a slowdown in economic growth to the near-2% long-run trend -- given the already low unemployment rate.  The larger the extent of slowdown in H122, the less there will be to fear aggressive Fed tightening.

At this point, a GDP slowdown in Q122 is highly likely after its rebound in Q421.  The Atlanta Fed model estimates the latter to be 7.0% (q/q, saar), similar to the 6.9% implied by the Fed's Central Tendency forecast.  Part of the Q421 strength is just a bounce-back from the virus-impacted 2.1% Q321 pace.  This should not carry  into Q122.   Moreover, the boost to consumption from fiscal transfer payments already has begun to abate.  But, the issue is how much of a slowdown will occur.  Early evidence suggests a speedup in December Payrolls -- in the wrong direction if looking for a slowdown.  But, what will be more important is whether Initial and Continuing Claims stop falling.  Their flattening would signal a steadiness in the unemployment rate, which, in turn, would signal near-trend GDP growth.

Inflation may stay high in the next couple of months, but then could turn lower -- independently of economic growth.  /1/ Seasonals look to offset holiday discounting in December and post-holiday promotions in January.  This price cutting likely happened to a smaller extent than seasonals expect because of the supply problems.  So, seasonals risk boosting components like apparel in the next two CPI reports.  But, then seasonals look to offset the ending of this discounting by pulling down prices.  And, since this discounting was likely small, so should the rebound -- so seasonals should depress these prices in the CPI.  /2/ Start-of year price hikes could boost the January CPI -- one-off price increases.  /3/ The stabilization of oil prices may soon help to hold down transportation costs, which could be reflected in the prices of many products (and airfares).  /4/ Motor vehicle prices -- both for new and used vehicles -- could come down once the chip shortage abates.  But, this development seems well ahead in the future.  The November Industrial Production Report showed only a slight increase in motor vehicle production, so the chip shortage is still significant.  Used Car Prices continued to rise in first half of December, according to the Manheim Survey.

Some of these factors may help explain the combination of above-trend growth and slower inflation seen in the Fed's Central Tendency forecasts for 2022.  The Fed looks for 3.6-4.5% Real GDP Growth and 2.2-3.0% PCE Deflator Inflation.  Its forecast of a decline in the Unemployment Rate to 3.4-3.7% (consistent with the above-trend GDP forecast) should be accompanied by faster inflation unless there are non-economic factors holding it down.  Whether the non-economic factors will hold down inflation prints will be clearer by early Spring.  This will be after the Fed's asset purchases end and the markets become even more focused on whether the Fed has to hike by more than 3 times in 2022.  If inflation does not come down by then of if economic growth does not slow sharply, the Fed may have to aim for slower growth than what was behind its 3-hike projection.

 

Five Reasons for Stocks To Rally Into January

The stock market should rally to new highs into January for a number of reasons.  /1/ Economic growth is strong.  /2/ The Fed's shift to fighting inflation, although not yet through higher rates, reduces the significance of currently high inflation,  The markets can treat it as temporary.   /3/ The risk of Russian armed aggression against the Ukraine and of China against Taiwan may be more significant in the Spring. /4/ The Senate vote on the tax/spending bill may be pushed back further.  /5/ Strong Q421 corporate earnings are expected. 

The economy's strength is seen in the downtrend in the Unemployment Claims data.  While still early, there's reason to think they will point to a speedup in December Payrolls. The 4-week average of Initial is 219k, well below the 273k going into the November Payroll Survey Week.  This week's US economic data should flesh out the picture of solid growth.  In particular, consensus looks for +0.8% m/m Total November Retail Sales and +1.0% Ex Auto Sales.  This would be impressive after the 1.7% jump in October.  And, it could argue that monthly sales were, indeed, better than suggested by the Black Friday experience.  But, they may have to print even stronger to match the expectation for consumer spending built into the Atlanta Fed model's 8.6% Q421 Real GDP forecast.

The Fed is likely to increase the speed of tapering at this week's FOMC meeting.  There's no reason to think officials will not match market expectations of doubling the monthly tapering to $30 Bn from the current $15 Bn.  This will eliminate the expansion of the Fed's holdings of Treasuries and Mortgage-Backed Securities by February-March.  It will not mean the Fed will begin hiking rates at that point.  But, even if it does, the market rule of thumb is that 3 hikes are needed to turn down the stock market.  To be sure, the rule might not work this time, given the rate hikes will have been preceded by the tapering -- which, in effect, is like a tightening.  Meanwhile, the markets will likely view potential rate hikes as undercutting the likelihood that currently high inflation prints will last for long.

There are a couple of reasons to think a Russian/Ukraine or China/Taiwan conflict is not imminent.  /1/ Winter weather was a problem in the Napoleonic and German invasions of Russia.  Knowing this, Putin may want to wait to Spring.  /2/ China will probably not initiate an attack ahead of the February Olympics.  One curious thought is that Russia and China could act at the same time, making a US/European response even more difficult.

News reports are raising the possibility that Senator Manchin may be even less enamored with the Building Back Better bill after the November CPI underscored his concerns about its inflationary implications and the CBO estimated  a $10 Tn cost (over 10 years) if the short-term measures in the bill are subsequently made permanent (and not offset by even higher taxes).   Biden will speak with him on Monday.   So, headlines regarding this meeting could hit the markets.

Consensus looks for about +20% (y/y) in Q421 corporate earnings.  This would be the 2nd quarter in a row that y/y growth slowed, as the boost from pandemic-related easy year-ago comparisons unwinds.  But, it is still historically strong.

 

 

A Potential Speedup in Fed Tapering Now Takes Top Billing (Along With the Virus)

Besides fear of the virus, the stock market will have to contend in the next week and a half with the need for Congress to hike the debt ceiling and the likelihood of a Fed decision to speed up the pace of tapering.  The former will probably be a nail-biter as the December 15 deadline approaches, but should be resolved in time.  The latter, also due on December 15, could have significant implications for the timing of Fed rate hikes, but this issue is more for next year than now.

Friday's November Employment Report should not derail a speedup in Fed tapering, although it could argue for a smaller-than-otherwise degree of faster tapering.  While November Payrolls were weaker than expected (which was the risk), a rebound in the Nonfarm Workweek helped boost Total Hours Worked.  The latter suggests strong Real GDP Growth in Q421, as the October-November average is  up 4.7% (q/q, saar) from Q321.  Moreover, the drop in the Unemployment Rate to 4.2% indicates above-trend economic growth.  And, the Rate's level and the politically sensitive Black and Hispanic Rates are less than 1% pt from their prepandemic lows.  So, there is ample reason for the Fed to speed up tapering.  But, there is also reason to temper the speedup, found in the deceleration in Average Hourly Earnings.  The 0.3% m/m increase in AHE is below the recent 0.4% trend and suggests that wage inflation is contained.  

The Fed began tapering by cutting the $120 Bn/month purchases of long-term Treasuries and Mortgage-Backed Securities by $15 Bn last month.  With $105 Bn left, an increase in tapering to $20 Bn would end these long-term purchases in 5 months (April-May).  An increase to $25 Bn would end it in 4 months (March-April), while $30 Bn would end it in 3.5 months (February-March).  An ending of these purchases will not automatically mean the Fed will begin hiking rates, but it will open the door for it, based on officials' comments.

Even with wage inflation apparently in check, this week's print for the November CPI risks being high.  Consensus looks for +0.7% m/m Total and +0.5% Core.  The risks of higher or lower prints appear balanced.  Used Car Prices are likely to play a noticeable role in boosting the CPI again.  These will eventually reverse, but now signal the production constraints that limit the supply of new vehicles.  When Fed Chair Powell says that "temporary" is no longer a useful characterization of the observed higher inflation, he essentially means the Fed must lower its estimate of non-inflationary growth to account for these on-going constraints.  So, the Fed has boosted the significance of the outsized moves in Used Car Prices.