Dear Friends,
As we kick off the third quarter earnings season, expectations are for S&P 500 companies to generally report year-over-year earnings growth rather than a decline which has been the trend since Q3 2022. With core inflation continuing to decrease, the US market has recovered some of last month’s losses during the first two weeks of October. Find out more about how the markets have been affected in this week’s newsletter.
Economy, Geopolitics, and Commodities
1. U.S. Inflation Expected to Keep Slowing
The consumer-price index rose 3.7% from a year earlier, the Labor Department said Thursday, the same as in August but far below the 9.1% recorded in June 2022. Core prices rose 4.1% from a year earlier, down from 4.3% in August. On the month, they increased 0.3% in September for the second straight report after smaller gains in June and July. Recent progress bringing inflation down stalled in September, offering the latest sign that the path to fully extinguishing price pressures remains bumpy. The good news: Price gains have slowed markedly from the 40-year highs recorded last year, particularly when looking at a gauge of underlying, or “core,” inflation that excludes volatile food and energy prices.
Officials likely would feel more comfortable about the decision to hold rates steady with stronger evidence that price pressures and economic activity are cooling. The upshot is that they are unlikely to signal plans to pause rate increases indefinitely or to rule out a rate rise in December. Officials raised rates most recently in July to a 22-year high. Fed Chair Jerome Powell stressed after the September decision to hold rates steady that officials would base their monetary policy on new data. Even though the Fed uses a separate inflation gauge, the CPI report is more widely watched because it is released first. Officials will receive additional data on worker pay, along with their preferred inflation measure from the Commerce Department before their next meeting. Fed officials want to see continued cooling in core prices, especially in services, which tend to be more closely tied to labor costs than the price of goods.
2. IMF Raises U.S. Growth Forecast
The International Monetary Fund on Tuesday released its latest World Economic Outlook, which revised its forecast for U.S. growth higher while predicting slower expansion for the eurozone. The IMF raised its U.S. growth projection for this year by 0.3 percentage points, compared with its July update, to 2.1%. It hiked next year’s forecast by 0.5 percentage points, to 1.5%. Its euro area growth forecast for 2023 was revised down by 0.2 percentage points to 0.7%, meanwhile, and for 2024 was lowered by 0.3 percentage points to 1.2%.
It attributed the U.S. upgrade to stronger business investment in the second quarter, resilient consumption growth amid a tight labor market, and an expansionary government fiscal stance. Growth is nonetheless expected to slow in the second half of 2023 and into 2024, it added, due to slower wage growth, dwindling pandemic savings, tight monetary policy, and higher unemployment. In the eurozone, the IMF flagged divergence across its major economies this year — with the German economy expected to contract as trade slows and higher interest rates drag, as French external demand has outperformed, and industrial production has caught up. Its growth forecast for the United Kingdom was brought slightly higher to 0.5% for 2023 but lowered by 0.4 percentage points to 0.6% for 2024 as it expects “lingering impacts of the terms-of-trade shock from high energy prices.” The IMF reiterated a global growth forecast of 3% for the year and nudged its 2024 forecast lower by 0.1 percentage points to 2.9%.
3. Higher Bond Yields Likely to Extend Fed Rate Pause
A sustained rise in long-term Treasury yields could bring the Federal Reserve’s historic rate hiking cycle to an anticlimactic end. Top central bank officials have signaled in recent days that they could be done raising short-term interest rates if long-term rates remain near their recent highs and inflation continues to cool. The Fed in July raised its benchmark federal funds rate to a range between 5.25% and 5.5%, a 22-year high. Officials held rates steady at their meeting last month and indicated they were on track to lift rates at one of their last two meetings this year.
The rise in long-term Treasury yields started after July’s Fed rate increase and gained steam after the September Fed meeting. The 10-year Treasury yield closed at 4.654% on Tuesday, down from 4.783% on Friday, as investors sought the safety of bonds following Saturday’s attack on Israel by Hamas. Still, yields are up from 4.346% on Sept. 20, the day of the Fed’s last meeting, and 3.850% on July 26, the day of the last Fed rate increase. The Fed raises rates to combat inflation by slowing economic activity, and the main transmission mechanism is through financial markets. Higher borrowing costs lead to weaker investment and spending, a dynamic that is reinforced when higher rates also weigh on stocks and other asset prices. But the rise in rates increasingly appears to be driven by factors that can’t be as easily explained by the economic or Fed policy outlook, with rising government deficits a prime suspect. This suggests the so-called term premium—or extra yield that investors demand for investment in longer-dated assets—is rising. “If long-term interest rates remain elevated because of higher term premiums, there may be less need to raise the fed-funds rate,” Dallas Fed President Lorie Logan, a voting member of the Fed’s rate-setting committee, said on Monday. Logan’s remarks were a notable shift from a Fed official who has been a leading advocate for higher rates this year.
4. China’s Economy Remains Shaky After Challenging Summer
Lackluster inflation and declining trade numbers in China have stoked concerns that the world’s second-largest economy is still on shaky footing, despite recent signs of stabilization. Consumer prices unexpectedly flatlined in September after rebounding in August, pointing to weak demand, and suggesting only a limited effect from Beijing’s recent efforts to put a floor under the economy. Outbound shipments also continued to contract last month, though at a less steep pace than in August, according to official data released Friday.
Despite signs in recent weeks that China’s economy might be perking up after a summer slowdown, the latest batch of data serves as a note of caution about the outlook for an economy that remains buffeted by a range of powerful headwinds. A drawn-out property crisis continues to ripple through the economy, with the rising prospect of default by a major Chinese developer triggering a fresh round of jitters among global investors. A long-hoped-for revival in consumer spending after the lifting of three years of COVID-19 restrictions has proven ephemeral. Exports, meanwhile, are expected to drag on growth through the remainder of the year, as overseas demand for Chinese-made goods cools. The fresh concerns around China’s near-term outlook in recent weeks have dimmed hopes for a turnaround of the global economy, particularly as higher interest rates pursued by central banks in the U.S. and Europe curb consumers’ and companies’ willingness to spend and invest. The International Monetary Fund this week lowered its forecast for Chinese growth this year and next to 5% and 4.2%, respectively, from earlier predictions in July of 5.2% and 4.4% growth. The cut in expectations for China also prompted the IMF to lower its global growth forecast to 2.9% for 2024, from 3%.
5. Oil Prices Rise Over 4% after U.S. Tightens Sanctions on Russian Crude Sales
Oil prices on Friday rose more than 4% after the U.S. tightened sanctions against Russian crude exports, exacerbating supply concerns in an already tightly balanced energy market. International benchmark Brent crude futures with December expiry traded 4% higher at $89.4 per barrel, while front-month November U.S. West Texas Intermediate crude futures rose 4.1% to trade at $86.3 per barrel.
The move back toward $90 a barrel comes after the U.S. on Thursday imposed sanctions on two shipping companies that it said violated the G7 oil price cap, a mechanism designed to retain a reliable supply of Russian flows in the market while curbing the Kremlin’s war chest. The G7, Australia, and the EU implemented a $60-per-barrel price cap on Russian oil on Dec. 5 last year. It came alongside a move by the EU and U.K. to impose a ban on the seaborne imports of Russian crude oil. Together, the measures were thought at that time to reflect by far the most significant step to curtail the fossil fuel export revenue that is funding Russia’s war in Ukraine. On Thursday, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) said it was imposing sanctions on two owners of tankers carrying Russian oil priced above the price cap: one in Turkey and one in the United Arab Emirates. The move to clamp down on Russian oil sales “demonstrates our continued commitment to reduce Russia’s resources for its war against Ukraine and to enforce the price cap,” said Deputy Secretary of the Treasury Wally Adeyemo.
6. U.S. to Hold Off on Disbursing $6 Billion In Iran Oil Revenue Unfrozen in Prisoner Deal
The U.S. and Qatar have agreed to deny Iran access to $6 billion in oil proceeds that Washington had previously freed up as part of a prisoner swap reached last month, according to people familiar with the matter. The decision with Qatar, whose government is overseeing Iran’s access to the funds, comes amid concern for Tehran’s long-running provision of money, arms, and intelligence to the group responsible for the terrorist attack on Israel last weekend, Hamas.
According to a preliminary unclassified assessment by U.S. intelligence agencies, Tehran likely knew Hamas was planning operations against Israel but didn’t know the precise timing or scope of the surprise attack. The funds are sitting in a restricted bank account in Qatar, and the U.S. has struck an informal agreement with Qatar to hold off disbursing them to Iran, the people familiar with the matter said. Deputy Treasury Secretary Wally Adeyemo described the arrangement in a meeting with senior House Democrats on Thursday. Biden administration officials have repeatedly said the money was already tightly restricted, adding that Iranians haven’t used any of it yet.
Financial Markets
1. S&P 500 Closes Lower on Friday, but Notches Second Straight Positive Week
Stocks fell Friday, pressured by a spike in oil prices and rising inflation expectations, as Wall Street wraps up a volatile week. The S&P 500 lost 0.6%, and the Dow Jones Industrial Average was 0.1% higher. The Nasdaq Composite shed 1.3%. The major indexes came off their session highs after consumer sentiment data was released earlier Friday.
According to the University of Michigan’s closely watched survey, consumer sentiment data slumped in October while inflation expectations spiked. The S&P 500 hit its low of Friday’s trading session as oil prices rose more than 6% on fears that the Israel-Hamas war could escalate geopolitical tensions in the Middle East. WTI crude gained more than 4% this week, posting its biggest weekly gain since Sept. 1. Investors also kept an eye on Treasury yields. The yield on the 10-year Treasury was down by 8 basis points at 4.631%. The 2-year Treasury yield was less than 1 basis point lower at 5.062%. Yields and prices have an inverted relationship. JPMorgan Chase, Wells Fargo, and Citi beat analysts’ expectations for both earnings and revenue. Shares of all three banks rose.
2. Profits Are Making a Comeback
The profit slump is over. Third-quarter earnings season is getting underway, and it will likely be much better than the second quarters for U.S. public companies. Industry estimates indicate that members of the S&P 500 will report earnings per share were 1.3% higher than a year earlier—a nice improvement from the second quarter’s decline of 2.8%. Moreover, current estimates almost certainly understate the third quarter’s strength given analysts’ tendency to lower their forecasts in the lead-up to earnings season. In early July, for example, they were looking for a second-quarter S&P 500 earnings decline of 6.4%.
The S&P third-quarter earnings estimate is also getting damped by an estimated 34.7% decline in energy-sector earnings—the consequence of fuel costs that were much lower than a year earlier. S&P 500 earnings excluding energy are expected to show a 6.2% gain after rising 3.6% in the second quarter. Finally, analysts reckon that profit growth in the fourth quarter will be substantially better, with estimates pointing to S&P 500 earnings up 10.8% from a year earlier. This figure needs to be taken with some skepticism—analysts might be unduly pessimistic about companies’ third-quarter earnings. But, if history is any guide, they are probably too optimistic about earnings in the fourth quarter and beyond. Even allowing for analysts’ sunny dispositions, though, earnings growth seems likely to pick up. And chief financial officers—who often play Eeyores to chief executives’ Tiggers—expect earnings to pick up next year, according to a recent survey conducted by Duke University and the Federal Reserve Banks of Atlanta and Richmond.
3. Big Banks’ Earnings Are Still Strong
Robust economic growth propelled earnings at the nation’s largest banks, but their executives warned the good times may be coming to an end. JPMorgan Chase, Wells Fargo, and Citigroup together reported more than $22 billion in profits in the third quarter, up by more than a third from the year-earlier period. Combined revenue of $81 billion rose 14%. After topping expectations set by analysts, their shares rose roughly 3% apiece in midday trading.
Higher interest rates are making their loans more profitable, and consumers and the economy remain surprisingly strong even in the face of the Federal Reserve’s rate hikes. But more loans are going bad after what had been record-low losses. American consumers are starting to deplete coffers of extra cash they built up during the pandemic. Fighting in the Middle East, the continuing war in Ukraine, and rising government deficits are adding to the uncertainty. “This may be the most dangerous time the world has seen in decades,” JPMorgan Chief Executive Officer Jamie Dimon said. Still, bankers have been warning of a looming economic slowdown for much of the year. They admit it hasn’t come yet. Third-quarter profit was driven primarily by a continued rise in interest income, with yields on long-term bonds recently pushing to the highest point since 2007. Wells Fargo and JPMorgan both said they expect net interest income to grow by more than previously expected in 2023. The banks have been able to raise the rates they charge on loans faster than they increase their payouts on deposits. But deposit costs are starting to catch up. JPMorgan is paying 2.53% on its interest-bearing deposits, versus 0.73% a year ago. Wells Fargo and Citi are also paying sharply higher deposit rates.
4. Microsoft-Activision Blizzard Takeover Approved by UK Regulators
Microsoft closed its $75 billion acquisition of Activision Blizzard, the largest in a decade of deals under Chief Executive Satya Nadella that have positioned the software giant at the center of sectors from video games to artificial intelligence. The purchase, which closed Friday, is the biggest deal in its nearly 50-year history and took 21 months to get through a global gantlet of regulators. The latest approval came Friday after the U.K.’s Competition and Markets Authority said the proposed acquisition no longer poses a major threat to competition in cloud gaming. To secure approval, Microsoft offered to restructure the deal by forfeiting cloud-streaming rights for Call of Duty and other popular Activision franchises in much of the world.
Activision’s stable of bestselling franchises, including Call of Duty and Candy Crush, will strengthen Microsoft’s videogame business by more than half to above $24 billion. The additions also will move the business further away from Xbox consoles and toward gaming content that lives across platforms and devices. Despite the large investment, Microsoft’s videogaming business remains a small part of the overall company. Adding Activision would have made gaming overall about 10% of Microsoft’s revenue in its latest fiscal year, up from the 7% the company reported. The bolstered video gaming operations would put it on par with the Windows business that Microsoft was first built on and significantly larger than its LinkedIn and advertising units, though still half of the Office products and cloud services category. The Activision deal, which Microsoft valued at $69 billion after adjusting for the videogame maker’s net cash, gives it access to a large library of titles for people who play games on their phones. It will also help the company entice subscribers to its Game Pass service, which includes cloud gaming, and the streaming of video games.
5. ‘Revenge Travel’ Fizzles for Budget Airlines
Americans’ appetite for travel is in question after nearly two years of bingeing on flights. Consumers’ pent-up desire to take trips has driven a post-pandemic resurgence—known as “revenge travel”—that propelled some airlines to sales and profit records. Now some budget airlines say they are having to slash fares to keep seats full. “You’ve got fuel, capacity, and demand all headed in the wrong direction,” Frontier Airlines Chief Executive Barry Biffle said during an industry conference last month. “We’re kind of the canary in the coal mine.” Other airlines see the good times continuing. United and Delta, which cater to premium and international travelers, say higher costs will dent profits, but demand isn’t slowing.
Delta President Glen Hauenstein said in September that demand for seats on the airline’s planes has remained solid through the fall, led by its high-end seats, for which customers are increasingly willing to pay up. The airline is planning its biggest-ever trans-Atlantic expansion next summer, betting that travel abroad will remain strong, and it has said it is encouraged by returning business travel. Still, Delta last month cut its quarterly profit projections to $1.85 to $2.05 per share from $2.20 to $2.50 per share because of a run-up in fuel prices and other rising costs. Rising inflation and interest rates have economists concerned about consumers’ spending capacity. Airline shares have been battered as investors fret over the combined threat of waning demand and rising costs—the NYSE index of airline stocks has fallen over 33% in the past three months. Consumers’ wallets have remained open, according to the most recent government data. Spending continued to grow in August, albeit at a slower pace than the previous month, with gains in spending on air travel. Passenger volumes at U.S. airports remain higher than they were in 2019, according to Transportation Security Administration data. But travelers spurned domestic destinations in favor of international trips this summer, a shift that caught some domestic-focused budget airlines off guard. The result has been an oversupply of airline seats within the U.S., analysts said.
Sources:
(1) www.bloomberg.com
(2) www.factset.com
(3) www.wsj.com
(4) www.barrons.com
(5) www.reuters.com
(6) www.cnbc.com
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. Economic forecasts set forth may not develop as predicted.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.
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Investment advice offered through Private Advisor Group, a registered investment advisor and separate entity from The Legacy Foundation.
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