by Professor Jeremy J. Siegel, Senior Economist to WisdomTree and Emeritus Professor of Finance at The Wharton School of the University of Pennsylvania
Last week was the heart of earning season for a number of big technology stocks. We also received a number of economic reports showing continued economic strength supporting the earnings outlook.
First on the economic data. The third quarter real GDP came in very strong at 4.9%, well above Wall Street estimates, although a little bit below the Atlanta Fed forecast, which tends to be overly optimistic. But there’s no question the economy is strong, and economists are upgrading their forecasts for the fourth quarter.
The durable goods report looked good. New housing sales, although lagged, came in surprisingly strong. The manufacturing PMI data also came in strong. Weekly unemployment claims ticked up a bit but are still extremely low.
One cautionary indicator: money supply data shows signs of weakness again and the data decreased back towards April levels. We had three consecutive monthly increases from April, but the declines the last two months are not encouraging. Even before these two monthly declines, money supply was not growing enough in my opinion to support 2-3% real growth plus 2-3% inflation, which would be a 5% rate. Of course, there’s a big lag between money supply growth and the impact on the real economy. But this recent weakness is something the Fed should pay attention to.
Two clouds on the horizon might be parting. The auto workers union strikes look to be getting settled. And the Republicans finally have a Speaker of the House. While he is conservative and wants to restrict spending, I don’t think the new Speaker wants to debut by shutting the government down.
Reactions to earnings reports have been mixed, although the growth rates on earnings have come in strong. 60% of the S&P 500 Index weight has reported an aggregate earnings growth rate of 7.8% in the third quarter, which was a surprise as expectations for these companies were for earnings growth to be flat. The energy sector has been a big drag on earnings; excluding energy, earnings growth was 14.8% this quarter for those who reported. Overall, the S&P 500 Index earnings are expected to show 2% growth this quarter after the remaining 40% of the index reports, but we can say the reports thus far have been better than expected.
We had a big jump in one-year inflation expectations reported from the University of Michigan Consumer Sentiment Surveys last Friday. This might have been caused by the Hamas attack on Israel raising expectations of an oil surge and higher gasoline prices. Powell has alluded to these consumer inflation surveys so it bears watching. But none of the current events imply we’ll get a hike in rates this week.
Powell has been masterful in getting consensus, but Powell will leave the door open for a hike at the December meeting. There's a lot of data to come. But the rise in real rates should convince the Fed to wait and see how these higher rates impact the economy.
In addition to this week’s Fed meeting, we will get a number of additional key metrics that can gauge the outlook ahead. We get the Case-Shiller Home Prices Index. This report may not be so meaningful since it reports sales in August, and the real surge in mortgage rates above 8% happened in September and October. And of course, the employment report on Friday, which as of now forecasts a $190k increase in payrolls and a 0.3% increase in monthly wages.
The recent sell-off creates an opportunity for equity investors. The economy has shown strength and earnings are coming in well as a result—valuations are supportive for good long-term returns from these levels.
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