Corporate Earnings and Fed Policy -- Near-Term Positives

The stock market may be buoyed in the next few weeks by two expectations -- strong Q326 corporate earnings and steady Fed policy at the October 27-28 FOMC Meeting.  These positive expectations could be tempered by a rise in longer-term Treasury yields.

 Corporate Earnings

Consensus looks for another quarter of huge earnings growth.  S&P 500 corporate earnings are expected to climb 23-29% (y/y) in Q326, lifted by strength in Information Technology and Energy.   This follows earnings growth of about 50% in Q226 and 28% in Q126.  The macroeconomic data support the idea of still strong earnings but not as strong as in Q226.  Real GDP Growth is seen slightly slower in Q326 than Q226 on a y/y basis.  Oil prices are still up sharply but not as much as in Q226.  The FX value of the dollar is a bit softer, making earnings abroad worth more in dollars, but not as much as in Q226 -- although this could be offset by an improvement in economic activity abroad in Q326.  Profit margins don't look to have improved, as the spread between the Core CPI and Average Hourly Earnings was steady after expanding in Q226.  

                                                                                                                                        Euro  Area   

                  Real GDP     Oil Prices      Trade-Weighted Dollar    AHE     Core CPI    Mfg PMI  

                     [                y/y percent change                                                            ]          (level)

Q126            2.6               40.0                       -8.0                               3.6           2.5                50.6     

 

Q226            2.2 *            75.0                       -4.0                               3.3           2.7                51.7      

 

Q326            2.1 *            40.0                       -1.0                               3.1           2.5                52.4          

                                                                           

* Based on the Atlanta Fed Model's latest projection of 3.7% for Q226 (q/q, saar). 

 

Fed Policy and Latest Key Economic Data

 

Last week's softer-than-expected inflation and employment data lifted expectations of steady Fed policy at the October 27-28 FOMC Meeting, although these Reports should not have changed Fed views by much if at all.  The Reports still showed higher-than-desired inflation and a solid labor market.  Nonetheless, they provide reasons for the Fed to fall back on if it wants to avoid hiking rates just before the mid-term elections.  Indeed, recent comments by two top Fed officials -- the Fed Vice Chair and the NY Fed President -- suggest they are open to skipping a tightening in October, citing a need to wait and see more data.

 

Although the headline m/m prints for the August PCE Deflator were lower than expected, the underlying pace is still higher than the Fed's 2% target.  Along with the benchmark revisions to prior months, the 0.2% m/m increase in the Core PCE Deflator resulted in 3.0% y/y.  Moreover, the Core PCE Deflator was rounded down from 0.245%.  On an annualized basis, it was up 3.0%.  The annualized increase since December is 3.2%.  Note that the Core PCE Deflator has to average less than 0.22% m/m for the rest of the year to lower the y/y by December.  All these ways of evaluating underlying inflation should not dissuade the Fed from sticking with its hawkish tilt.  

 

Similarly, although September Nonfarm Payrolls rose only slightly, the weakness was probably not enough to convince the Fed to change its view of a solid labor market.  The Unemployment Rate remained within its recent tight range that is typically viewed as full employment.  The broadest unemployment measure of the labor market -- U-6- which takes account of part-time workers for economic reasons and people marginally attached to the labor force -- dipped.  And, Total Hours Worked are up 1.2% (q/q, saar) in Q326 -- a bit more than the 1.1% in Q226.  So, they are consistent with 2.0+% Real GDP Growth in Q326, taking account of productivity growth -- better than the Fed's longer-run growth estimate of 1.8-2.0%.  

The lower-than-consensus increase in September Payrolls ran counter to the speedup suggested by Unemployment Insurance Claims data.  The contradiction suggests that the slow job growth results from  weak hiring rather than increased firings.  This result appears to have been the case over July and August.  The JOLTS Data show that a 241k decline in Separations in the Private Sector over the 2 months (that is fewer layoffs) was partly offset by a 170k decline in Hiring.  This combination is unusual.  Typically, cyclical forces lead to increased hiring accompanying reduced firings.  AI may be holding back hiring?

The difficulty of finding a job (along with high gasoline prices) may be behind the recent decline in consumer confidence.  The Conference Board's measures of Jobs Hard To Get and Jobs Plentiful could provide clues whether job finding remains a problem or is beginning to improve.  

Higher Long-Term Treasury Yields

A possible Fed reluctance to tighten ahead of the mid-term elections in the face of still problematic inflation may be behind the latest run-up in longer-term Treasury yields.  The latter may be making up for Fed inaction to fight inflation.  Although a more aggressive Fed could bring longer-term yields down, it would hurt the economy and stocks.  The best development for both the Treasury and stock market (and economy) would be an ending of the Iran war than results in a drop in oil prices.