US Fiscal Outlook Starting to Play a Role for Long-Term Interest Rates
The two charts below show that US long rates are disconnecting from Fed expectations and oil prices. Despite the market still expecting five Fed cuts over the coming 12 months, long rates are moving higher.
And despite oil prices falling, long rates are moving higher. This suggests that long rates are rising because of emerging worries about fiscal sustainability.
This next chart shows the relationship between 10Y yields and nominal GDP growth:
The differential has been negative since the late 1990s except in recessions. Since 2003, outside of recessions and Covid, 10Y yields have ranged between 0.5 and 2.6pp below nominal GDP growth.
Probably uncoincidentally, inflation expectations have stabilized in the 2-3% range since 2000.
Nominal GDP growth has stabilized around 5%. At the current 10Y yields of 4.3%, the differential is only 0.7%.
Real yields are at the high end of their range since 2000.
Can the U.S. economy accelerate much beyond 5% nominal? Unlikely unless inflation re-accelerates, something the Fed will not allow.
Inflation components:
- PCE-Goods inflation remains negative, actually accelerating to –1.2% YoY in September and –1.6% a.r. in the last 2 months.
- “Beautiful tariffs” could boost goods inflation in 2025 (one-off impact).
- PCE-Services inflation was 3.7% YoY in September, down from 4.2% last March. Last 2 months annualized: +3.3%.
- Oil prices are down with low probabilities of flaring up.
- ECI-Wages were up 3.8% in Q3, down from 4.3% in Q1 and 4.0% in Q2.
- Productivity is helping meaningfully.
- Rentflation is the sole sore point. CPI-Rent is still rising about 0.4% per month as is the BLS All-Tenant-Rent Index (+3.9% YoY in Q3 but +5.7% QoQ).
Goldman Sachs expects October Core CPI at +0.3% MoM, +3.3% YoY.
EARNINGS WATCH
From LSEG IBES:
449 companies in the S&P 500 Index have reported earnings for Q3 2024. Of these companies, 76.2% reported earnings above analyst expectations and 19.2% reported earnings below analyst expectations. In a typical quarter (since 1994), 67% of companies beat estimates and 20% miss estimates. Over the past four quarters, 79% of companies beat the estimates and 16% missed estimates.
In aggregate, companies are reporting earnings that are 7.8% above estimates, which compares to a long-term (since 1994) average surprise factor of 4.2% and the average surprise factor over the prior four quarters of 6.5%.
Of these companies, 60.3% reported revenue above analyst expectations and 39.7% reported revenue below analyst expectations. In a typical quarter (since 2002), 62% of companies beat estimates and 38% miss estimates. Over the past four quarters, 62% of companies beat the estimates and 39% missed estimates.
In aggregate, companies are reporting revenues that are 1.6% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.3% and the average surprise factor over the prior four quarters of 1.1%.
The estimated earnings growth rate for the S&P 500 for 24Q3 is 8.6%. If the energy sector is excluded, the growth rate improves to 11.3%.
The estimated revenue growth rate for the S&P 500 for 24Q3 is 5.3%. If the energy sector is excluded, the growth rate improves to 6.3%.
The estimated earnings growth rate for the S&P 500 for 24Q4 is 10.0%. If the energy sector is excluded, the growth rate improves to 12.6
Trailing EPS are now $236.68. 2024e: $243.59. Forward EPS: $263.38e. 2025e: $274.63.
Revisions are positive:
Pre-announcements are somewhat more negative:
Share-weighted earnings of the Tech and Communication Services Indices are seen up 22.0% in 2024 and 18.6% in 2025 when they will account for 34.6% of all S&P 500 earnings, up from 30.0% in 2023.
The remaining 9 sectors earnings are expected to rise 4.4% in 2024 but a strong 12.1% next year. How?
Non-tech/CS revenues, up only 3.2% in 2024, are forecast to explode 11.7% next year (+12.4% ex-Energy after +3.9%).
In fact, every sector but Energy (+5.6%) are currently seen boosting their revenues by more than 10.0% next year, never mind inflation at ~3.0%. Looks like a tall order for me.
Goldman Sachs reckons that
the Magnificent 7 will have grown aggregate earnings by 30% year/year during 3Q 2024. This reflects a combination of 16% sales growth and 265 bp of margin expansion.
In contrast, 3Q profits for the S&P 493 grew by 3%, driven by 4% sales growth and 33 bp of margin contraction.
However, analysts expect the growth differential will narrow next year as S&P 500 sales and earnings growth broaden.
Of course, the growth premium is reflected in share performance. The Mag 7 stocks have collectively returned 45% YTD and comprise 32% of the market cap of the S&P 500. The 7 stocks account for 1251 bp (47%) of the S&P 500 return YTD.
Tariffs represent potential downside risk to our estimates. Our economists expect the incoming administration to impose on average a 20 pp tariff increase on China imports. They assign a 40% chance of the 10%-20% blanket tariff proposed by Trump on the campaign trail.
During the 2018-2019 trade conflict, companies were generally able to pass the costs of tariffs through to customers. However, even if that dynamic were repeated, tariffs could potentially reduce earnings via weaker consumer spending, retaliatory tariffs on US exports, and increased uncertainty.
Based on our economists’ estimates of how tariffs would impact US GDP growth, each 5 pp increase in the effective US tariff rate would likely reduce S&P 500 EPS by about 1-2%.
But there’s also taxation:. A 6pp decline in tax rates would increase S&P 500 earnings by ~5%
Industry analysts are likely to up their earnings estimates. We are too. For the S&P 500, we are raising our 2025 and 2026 operating earnings per share from $275 to $290 and from $300 to $320. These estimates assume that Trump will quickly lower the corporate tax rate from 21% to 15%. As of the week of November 7, industry analysts were at $275 and $308 for the next two years. We expect that the S&P 500 profit margin will rise to new record highs of 13.9% and 14.9% over the next two years thanks to Trump’s corporate tax cut, deregulation, and faster productivity growth.
We are raising our S&P 500 year-end targets as follows: 6100 (2024), 7000 (2025), and 8000 (2026). We are now targeting 10,000 by the end of the decade. That’s a 66.6% increase from 6000 currently over the next five years.
We believe these forecasts are consistent with our Roaring 2020s scenario, which is receiving a boost from the animal spirits that should result from Trump 2.0’s economic policies. We also expect that the animal spirits will intensify as the wars between Russia and Ukraine and in the Middle East are resolved sooner rather than later.
Regarding the debt crisis: We expect that better economic growth will boost federal government revenues and that Elon Musk will succeed in slowing the growth in federal government spending. GDP growth might actually keep pace with mounting government debt.
So, we are changing the subjective probabilities of our three scenarios as follows: Roaring 2020s (55%, up from 50%), 1990s-style meltup (25%, up from 20%), and 1970s-style geopolitical and/or domestic debt crisis (20%, down from 30%).
Animal spirits can be associated with irrational exuberance causing a stock market meltup that could set the stage for a meltdown. Valuation multiples are historically high currently, especially for LargeCap growth stocks. However, we’ve recently observed that these multiples are likely to be elevated when investors believe that earnings can grow faster for longer because a recession is less likely in the foreseeable future.
We aren’t saying that a recession can’t occur over the rest of the decade. However, we note that despite the significant tightening of monetary policy during 2022 through 2024, there has been no recession. Why should there be one over the remainder of the Roaring 2020s?
Here’s the current snapshot:
China Price Growth Stays Near Zero as Deflation Persists
The consumer price index rose 0.3% from a year earlier, the National Bureau of Statistics said Saturday, compared with a 0.4% gain in the previous month. The median forecast of economists surveyed by Bloomberg was for the reading to stay unchanged from September.
Core CPI increased 0.2%. Producer inflation slid for a 25th straight month, with a 2.9% drop on year, more than the 2.5% decrease predicted by economists. (…)
