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Market analysis
October 21, 2024
Number of the week:
0.4%
The growth in retail sales in September compared to August.
Term of the week:
Municipal bond
A bond issued by a state, city or local government to raise capital for day-to-day activities or projects. Interest on municipal bonds is generally exempt from federal taxes and, potentially, state and local taxes.
Quote of the week:
Economic growth in the United States and India remains exceptional while other major economies, including China, Europe, Japan and the United Kingdom, demonstrate modest but positive economic expansion despite elevated interest rates. Slowing growth and inflation trends are likely to persist well into 2025 due to lagged effects of high borrowing costs.
― Robert Haworth, CFA, Senior Vice President, Senior Investment Strategy Director, U.S. Bank
Global economy
Quick take: U.S. consumer spending continues to drive solid economic activity, though elevated interest rates remain a challenge for housing. China’s economic growth remains modest, with stimulus measures not yet driving new spending.
Our view: Economic growth in the United States and India remains exceptional while other major economies, including China, Europe, Japan and the United Kingdom, demonstrate modest but positive economic expansion despite elevated interest rates. Slowing growth and inflation trends are likely to persist well into 2025 due to lagged effects of high borrowing costs.
- U.S. retail sales remained robust in September, rising 0.4% relative to August. Control group sales, which exclude food services, automobile dealers, building materials stores and gasoline stations, rose 0.7%, exceeding August’s 0.3% gain. Control group sales feed into goods spending calculations in the quarterly gross domestic product (GDP) report. Based on the retail sales release, the Atlanta Fed’s GDPNow personal consumption forecast rose to 3.6% in the third quarter, which would represent the strongest growth in 2024.
- U.S. housing starts slowed in September, with declines in multi-family construction outweighing gains in single family residences. Overall, housing starts declined 0.5% to a 1.35 million annualized rate, in line with analysts’ forecasts but below the long-term median of 1.45 million. Single family home starts rose 2.7% to a five-month high, but overall starts declined due to a 9.4% drop in multi-family starts. Tepid home construction remains a drag on economic growth. However, the prospect for lower mortgage rates leading to improved affordability and future housing demand drove the National Association of Home Builders/Wells Fargo Housing Market Index to a four-month high in October.
- China released broad economic activity measures showing the economy slowed to a six-quarter low, but the third quarter ended with positive momentum, suggesting pro-growth central bank and fiscal spending measures will help the country achieve its 5% growth goal for 2024. Third quarter GDP slowed to 4.6% relative to a year ago, slightly exceeding forecasts for 4.5% growth but representing the slowest economic pace since 2023’s first quarter. However, September industrial production accelerated to 5.4% year-over-year growth while retail sales rose 3.2% relative to last year, the fastest pace in four months. “Cash for clunkers” government subsidies have spurred a 21% year-over-year increase on consumers’ spending in home appliances.
Equity markets
Quick take: The S&P 500 is at a record high, bolstered by economic stability and in line to better-than-expected third quarter earnings.
Our view: Inflation is falling, interest rate cuts are in motion and earnings are trending higher, which aid sentiment, provide valuation support and serve as the basis for stocks to trend higher. Near term, volatility is likely to be the norm due to elevated valuations, ongoing election-related nuances and geopolitical tensions.
- U.S. equities at record levels are an indicator of economic strength and favorable sentiment. The S&P 500 ended last week up 23.0% (excluding dividends) year-to-date, roughly twice its historical annual average dating back to 1926 of 12.1%. For the year, all 11 sectors are in positive territory, with 10 up 11% or more. Information Technology is the best-performing sector, up 33.3%, followed by Utilities at 29.3%. Information Technology is benefiting from spending associated with artificial intelligence (AI)-related products and services. Utilities are boosted by projections of increased electricity usage associated with the buildout of data centers to support AI-related applications and services.
- Third quarter corporate results are trending in line to modestly above expectations. Fourteen percent of S&P 500 companies have released results as of Friday’s close; sales and earnings are up 4.5% and 6.7%, respectively, over year-ago levels, according to Bloomberg. This compares to projections at the start of the release period for sales to advance 4.4% and earnings to increase 3.9%. The bulk of S&P 500 companies — 58% — will release results this week and next. Early results reflect economic stability and generally resilient consumer spending. We will glean more insight with additional reports from retailers, technology companies and industrials.
- Consensus earnings for 2024 and 2025 reflect year-over-year growth albeit at a moderating pace. Analysts forecast earnings of approximately $240 per share for full-year 2024 and $274 in 2025, according to Bloomberg, FactSet and S&P Cap IQ, indicating robust 8.5% year-over-year growth in 2024 and 14.4% in 2025. At present, the S&P 500 trades at roughly 24.8 times last 12-month estimates and 21.8 times next 12-month estimates, both at the high side of historical averages. Elevated valuations are among reasons to expect increased future volatility.
Bond markets
Quick take: Bond prices held relatively steady last week, with Treasury yields settling at levels that reasonably compensate for Federal Reserve (Fed) rate cut expectations and inflation risk. Strong investor sentiment continues to support above-average valuations on corporate and municipal bonds.
Our view: Opportunities are fairly balanced across the fixed income market, with higher-than-normal valuations in corporate and municipal credit justified by strong fundamentals, and relatively cheaper valuations in structured credit such as mortgage bonds. Primarily allocating to high-quality bonds provides steady income for portfolios while modest allocations to riskier high yield bonds can improve return potential over time. Unique bond types such as non-agency mortgages and reinsurance also provide meaningful income generation opportunities.
- Bond yields reflecting 1.5% in additional interest rate cuts through 2025 align with the Fed’s patient trajectory toward neutral policy settings. Economists’ forecasts for modest economic growth, a balanced labor market and around 2% inflation in 2025 suggest the Fed can gradually reduce rates to levels that neither restrict nor constrain economic activity. Treasury yields fairly price in these consensus expectations, creating opportunities in high-quality bonds to generate meaningful income with balanced risks to bond prices.
- The European Central Bank (ECB) delivered its third 0.25% rate cut last week. The ECB cut rates for its second consecutive meeting, citing growth risks evident in recent weakness in economic data. The ECB is taking a similar approach as the Fed to determine policy going forward, making rate decisions on a meeting-by-meeting basis to flexibly respond to evolving labor market conditions and inflation risks.
- Strong demand continues to support corporate and municipal bond prices. The extra yields on corporate and municipal bonds over Treasuries are below historical averages, implying valuations are high. This limits opportunity for bond price gains to outpace Treasuries; however, fundamental tailwinds can support expensive valuations for some time. Corporate bond defaults have slowed in recent months and strong investor demand remains a tailwind for corporate and municipal bond issuers, allowing for easier debt issuance. Normal, modest allocations to riskier corporate and municipal bonds appropriately recognize the trade-off between currently expensive valuations and attractive long-run return potential on higher yielding bonds.
Real assets
Quick take: Publicly traded real estate and global infrastructure rose last week amid a constructive start to third quarter earnings releases and strong investor risk appetite across risk assets. Broad commodity indices fell, resulting primarily from lower energy prices.
Our view: Real asset categories such as publicly traded real estate present opportunities to generate meaningful current income with potential price support from Fed interest rate cuts ahead. Commodity index prices remain stagnant year-to-date but can serve as a hedge against rising inflation.
- Publicly traded real estate prices rose last week despite Treasury yields remaining elevated. The approximate 2.8% return last week bolstered solid year-to-date returns of around 14%, despite languishing the first four months of the year. Strong sentiment driven by rising prospects for an economic soft landing bolstered investor confidence and contributed to strong returns across many equity-related categories.
- Elevated residential real estate prices reflect low supply keeping a floor under prices despite high mortgage rates. New housing supply remains tepid, with new starts and new permits falling in September. Apartment occupancy remained near historical averages in September, while flat apartment rent growth persists after significant increases in 2021-2023 during the period of elevated inflation.
- Energy prices, particularly oil, dropped last week after the International Energy Agency cut its 2024 oil demand forecast, suggesting a sizeable surplus of oil going into 2025. Precious metals continued their recent rally, with gold and silver up more than 2% and 6%, respectively, while industrial metals fell modestly.
Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.
Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The NAHB/Wells Fargo Housing Market Index is based on a monthly survey of members belonging to the National Association of Home Builders (NAHB). The index is designed to measure sentiment for the U.S. single-family housing market and is a widely watched gauge of the outlook for the U.S. housing sector.
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