Stocks To Slog Up in Face of Mixed Corporate Earnings and Fed Uncertainty

The stock market will likely slog up over the next few weeks, dealing with mixed corporate earnings reports and uncertainty regarding the Fed rate decision at the November 6-7 FOMC Meeting.  A 25 BP cut is probably the best bet as of now, despite the stronger-than-expected September CPI and Employment Reports.  Expectations of modest prints for this week's US economic data -- Retail Sales, Phil Fed Mfg Index, Industrial Production -- should support this view and help stocks.  However, the most important data for the Fed will likely be the October Employment Report, due November 1.  It is too soon for evidence on Payrolls.

Fed Chair Powell has said that while the intention is to bring the Fed Funds Rate down to a neutral level over time, the pace will depend on the impact of economic data on the Fed's outlook.  The most recent data will not likely derail the Fed's expectation of slower economic growth and lower inflation.

Consensus among market observers is that the September Employment Report and CPI were stronger than the Fed liked.  My view, as discussed in last week's blog, is that the Employment Report was not as strong as appears at first glance.  It is consistent with slower economic activity at the end of Q324 and leaves open the possibility this could continue in Q4.24.  It's unlikely that Fed officials would mention the mitigating parts of the Report in their upcoming speeches, but they should be aware of them.  This week's key US economic data -- September Retail Sales and Industrial Producton --are expected to post slight gains, supporting the idea that growth is moderating.

Although the September CPI showed a wider distribution of speedier increases among components than in recent months, the Fed could discount the speedups as being part of the "bumpy" ride they expect in the decelerating trend in inflation.  Moreover, the one piece of good news in the Report was the sharp slowdown in Owners' Equivalent Rent (OER) to a below-trend 0.3% m/m.  If OER's slower pace persists, the Fed's 2% inflation target may very well be achieved.

Looking ahead to nest year, four possible scenarios are conceivable:  

1.  Aggressive fiscal policy could boost inflation expectations and longer-term Treasury yields -- raising the possibility of renewed Fed tightening.   This would be a negative for stocks.  Both presidential candidates' policies have this potential outcome.

2.  The Fed policy easing in H224 boosts economic growth and inflation in H125, raising longer-term Treasury yields and pulling in expectations of further Fed easing -- a negative for stocks.

3.  Economic growth and inflation continue to moderate, keeping Fed rate cuts on track, positive for stocks.

4.  The US economy somehow slips into recession.  This seems unlikely, unless Fed policy shifts away from easing.

A Strong September Employment Report?

The stock market should climb  this week, after Friday's ostensibly strong September Employment Report dispelled fears of recession.  However, there was less strength than met the eye in the Report.  So, along with benign inflation data expected this week, the Fed should still be on an easing path.  Although Q324 corporate earnings are expected to slow, the slowdown may be temporary.

A large increase in September Payrolls and lower Unemployment Rate were the risk, given the recent decline in Unemployment Claims.  Unless the October Report (to be released prior to the next FOMC Meeting) is as strong, the Fed will not likely stop cutting rates in Q424.  The Fed apparently is focused on its expectation of future weakness stemming from prior tight monetary policy, not current economic activity.  Moreover, although the September Report shows a strong labor market, some parts of the Report suggest the headline Payroll print may overstate strength.  Some of the jobs gain may reflect a shift toward part-time workers.

The Household Survey shows that the number of part-time workers in nonagricultural industries jumped 527k m/m in September, after a string of sub-100k increases in prior months.  To be sure, this should be viewed as only suggestive, given the relatively small sample size of the Household Survey (on which the Unemployment Rate is based) compared to the Establishment Survey (on which Payrolls are based).

A shift toward part-time workers, nonetheless, could explain the dip in the Nonfarm Workweek to 34.2 Hours from 34.3 Hours in August.  But, the dip could be just noise.  It was 34.2 Hours in July, as well, although the industry breakdown was different from that of September.  The dip in Workweek in September did not appear to be mainly among Production Workers.  Their workweek was flat.

Total Hours Worked slipped m/m because of the decline in the overall Workweek.  The Q324 average of THW is only  0.2% (annualized) above the Q224 average, versus +1.6% (q/q, saar) in Q224.   This raises doubt about 2+% Real GDP in Q324.  However, THW may overstate weakness.  This is because THW for Production Workers rose 1.0% (q/q, saar) in Q324, not much below the 1.5% in Q224.  So, Q324 Real GDP Growth still may be in the 2.0% range.  The Atlanta Fed model's latest estimate is 2.5%, but does not yet take account of Friday's data.  The next model update is on Tuesday.

The 0.4% m/m increase in Average Hourly Earnings (AHE) after an upward-revised 0.5% in August is somewhat troubling.  The Q324 average rose 4.0% (q/q, saar), compared to the 3.4% increase by the Q224 average.  The y/y rose to 4.0% from 3.9%.  Nevertheless, large wage gains were not widespread, as fewer than half of the major sectors had large increases.  AHE rose 0.4% m/m or more (on average) in only 6 of 13 sectors in Q324, versus 4 in Q224.

Consensus expects a benign print for the September CPI.  It sees +0.1% m/m for Total and +0.2% for Core.  The risk would be for a higher print if Owners' Equivalent does not fall back to 0.4% m/m after speeding up to 0.5% in August.  Consensus looks for +0.1% m/m Total and +0.2% Core for the September PPI, as well.

Consensus estimates +4.6% (y/y) for Q324 S&P 500 earnings, down from 11.2% in Q224.  The macroeconomic background appears to support a slowdown in earnings.  On a y/y basis, Real GDP Growth slowed, oil prices fell and the dollar strengthened further (thereby making foreign earnings appear lower in dollar terms).  In contrast income from abroad could help profits this quarter.  Based on the European PMI, foreign economic activity improved on a y/y basis, although it slowed q/q.  Profit margins look to have been little changed.  A soft quarter of corporate earnings could be temporary, as consensus, at this point, looks for double-digit y/y returning in Q424 and continuing through 2025.

                                                                                                                                       Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level) 

Q123            2.3                -19.5                +3.0                              4.5           5.5               47.9  

Q223            2.8                -32.0                 +0.5                              4.4           5.2               44.7

Q323            3.2                -12.0                 -2.5                               4.3           4.4               43.2

Q423            3.2                -12.0                 -2.5                               4.3           3.9               43.8

 

Q124            2.9                +14.0                  0.0                              4.3           3.8               46.4

 

Q224            3.0                  +2.5                +3.0                              3.9           3.4               46.3 

 

Q324            2.6                  -6.0                 +2.5                              3.8           3.3               45.3                                                      

                                                                           

* Based on the Atlanta Fed Model's latest projection of 2.5% (q/q, saar).