While there have been no shortages of macro headwinds weighing on equity markets, the major indices are still higher year to date. Jim Kelleher, Director of Research and Senior Technology Analyst at Argus Research, discusses three factors he says have been supporting stocks.
Greg Bonnell: While markets are off the highs that we saw in the summer, the S&P 500 is still close to 14% to the upside for the year. And our guest today says there are three key elements that are keeping stocks afloat. Joining us now to discuss, Jim Kelleher, Director of Research and Senior Technology Analyst at Argus Research.
Jim, great to see you again. Always great to have you on the show.
Jim Kelleher: Good day, Greg. Good to see you as well. Good to be here.
Greg Bonnell: Yeah, no shortage of things out there as investors for us, as global citizens, to be worried about. And yet, the markets, despite their ups and downs, still showing double-digit gains for the year. You talk about the three earnings — the three Es that are behind this. Let’s break down what those three Es are. I think I just gave one away.
Jim Kelleher: You gave away one of them. So what they’re battling are the two Is of Inflation and Interest rates, both of which, as you pointed out, were at multi-decade highs. Inflation has come down somewhat but remains frustratingly above the Fed’s target. And so the perception is the Fed could still be active in its rate hiking. And the three Es that I’m about to talk about are very positive for the market but conversely could cause the Fed to remain in restrictive mode, that is, in a rate-tightening mode.
So first you have the Economy. And the economy in the US is percolating along. According to the Atlanta Fed’s GDPNow tracker, it’s hard to believe, but US GDP is forecast to grow 5.4% in the third quarter. That’s like a Southeast Asia level of growth we haven’t seen here in a long, long time, except in those weird numbers coming out of the pandemic.
And note that the consensus of analysts and economists has gone from expecting almost no growth in the third quarter to about 3.5% to 4%. So it’s realistic to expect this will be the strongest quarter of the year but hardly consistent with the recession scenarios we’re hearing about.
And then the second E is Employment. US job growth did seem to be moderating, dipping down below $200,000 for a few months there as we got to the middle of 2023. And then we had the blowout September non-farm payrolls growth of $336,000, including prior month revisions of over $100,000.
And unemployment remains very healthy at 3.8%. And we’re seeing wages running at about above 4% annually, which is a little better or roughly in line with the annual change in inflation right now. So consumers are staying afloat because their wages are keeping up with rising costs now. That was not the case a year ago.
And then finally, there’s Earnings. And the S&P 500 earnings are the barometer that most analysts and investors look at. S&P earnings are forecast to grow a little bit in the third quarter, depending on who you ask. We think they’re going to grow a little bit, given the usual outperformance against expectations. It’s right around breakeven if you look at the tracking agencies.
But the point is, if we do get earnings growth in this third-quarter earnings season, that would be the first time since the third quarter of last year. So that would be a psychological lift to the market. And then we look for much better earnings in the fourth quarter.
So economy, employment, and earnings are all positive for the economy. Conversely, that might keep the Fed in restrictive mode. But on balance, it’s better to have a healthy economy than one that is crashing.
Greg Bonnell: Yeah, indeed. Because that’s the big concern after the aggressive rate hike cycle, the central banks, that you would have a hard landing. So that’s what we’re living through right now. What is the potential going forward that we’re continuing to see economic data that outperforms earnings growth?
And I want to throw the 10-year bond yield in there. Because I know, Jim, you’ve been watching markets for a long time. We are at like 4.93%. What’s the significance of this?
Jim Kelleher: Well, the significance, I would say, well, for one thing, we could be finally getting to a situation where the so-called yield curve balances out. And while that’s kind of wonky, whenever the shorter maturities, such as the three-month money or the two-year Treasury note, yield above the 10-year note, that’s considered an inverted yield curve and indicative of potential recession. So getting the long end of the curve up to the point where it’s level with and then eventually below the two-year would be a better indicator for the economy overall.
However, there’s no doubt — and people sometimes forget this — the rate hikes initiated by the Federal Reserve in the US have a lagged effect that might be 6, might be 12, might even be longer in terms of months. So we’re only now beginning to feel the impacts of those higher rates. And investors and consumers have been tired of inflation for a long time. But these high rates are sticky. And they will impact purchases of financeable items, houses, and cars going forward.
So while I just laid out a scenario for a pretty healthy economy, there’s certainly risks in the outlook. So far though, we see the consumer still chugging along, pretty solid. Retail sales growth the other day, up 7/10 of a percent in September, where it was outstanding. So the consumer’s still feeling pretty good.
Greg Bonnell: Consumers feeling good. We are entering earnings season. The banks in the United States lead the way. Been a bit mixed there. But the tech sector specifically, as we start getting some of the names coming through, what’s your outlook there?
Jim Kelleher: So once, consistent with overall earnings growth, it’s really hanging in the balance. It really does depend on how much outperformance against expectations we got. Companies always guide low because they have no incentive to guide accurately. So consensus is usually a little bit low.
S&P — I’m sorry — technology sector earnings were down for the last few quarters. But they were getting closer to breakeven on the second-quarter earnings season. We think they could be close to breakeven this time but might edge up to positive.
There are a couple of areas in the tech sector that are deeply negative, like the memory companies. That would be the Microns, the Western Digitals, and the Seagates. And they’re going to tend to weigh. And the PC-exposed companies, the CPU makers, such as Intel and AMD, they’re probably still looking at down earnings. But lots of companies are surprisingly sharply to the upside.
And software companies are doing a little better. So it’s a big, big universe of tech companies. But on balance, we think we can get to a little bit of growth this quarter and then better growth in the fourth quarter.
Greg Bonnell: Now, for some investors, Jim, and for some pundits, they are a bit surprised by the leadership of big tech this year in the market, considering what we lived through last year. Should they have been that surprised?
Jim Kelleher: Well, I would just say that growth leads a market when the market is rising. And growth leads on the downside when a market is falling. When we entered 2022, we were in a worsening supply chain crisis. We were seeing very high inflation headed to record levels by mid-2022. And the Fed had not even begun its interest-rate-hiking campaign, which everyone knew was coming.
As we entered 2023, there was an awareness that a lot of these things were on the downside of the mountain. The supply chain crisis was largely resolved. Inflation was running at half the levels it was a year earlier. And the Fed is largely done with its rate-hiking campaign. We knew there were one or two more left. There could be one more left this year. We don’t know. But our expectation is the Fed is done.
So there was optimism coming into the season. And so with the market rallying in 2023, the growth sectors led in 2023. And of course, the big kicker was the AI mania.
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