The Bull Thread

Guess What? The Bearish Narratives Look Even Worse Now


We just got a slew of economic data revisions from the Bureau of Economic Analysis (BEA) and my first response was, Wow! A lot of this is backward-looking data, but it’s important to (re) level-set where we are, and the momentum associated with that. As my colleague Barry Gilbert said to me after these revisions, it shifts the forward-looking perspective, because we’re standing in a different place than we thought.

Let’s start here: GDP growth over the last 5 years was revised up. From the end of 2019 through 2024 Q2, real GDP growth was revised up from 9.4% to 10.7%. Here’s some perspective on that upward revision of 1.3%-point:

• Germany grew just 0.3% over the entire period (hard to call it “growth”)
• The UK grew 2.3%
• Japan grew 3.0%

One of my favorite charts is the one below, which compares Congressional Budget Office (CBO) pre-pandemic projections for growth to actual growth. Actual real GDP growth is running 2.3% above what the CBO projected back in January 2020. Remember, this is after a worldwide pandemic, 40+ year highs in inflation, and an ultra-aggressive Fed. There’s a reason why the S&P 500 has risen over 90% over this same period, and that was because economic activity drove profit growth (I wrote about this earlier this week).



There’s more: Gross Domestic Income (GDI) was also revised higher, by a lot. GDP and GDI are both measure of output. GDP measures production/sales (household consumption, investment, government spending, net exports), whereas GDI measures incomes (labor income, interest, profits, etc.). In theory, they should be the same, but they differ because the data sources are entirely different. The divergence was huge, until the revisions. Real GDI growth was revised up significantly. For the end of 2019 through 2024 Q2, it was revised up from 7% to 11%. There was a bearish narrative that GDP would be revised down to GDI (there was never a basis for that), but now GDI growth is actually outpacing GDP in the post-Covid era.



By the way, with the revision there was no “technical recession” in 2022. A technical recession is colloquially described as two consecutive quarters of negative GDP growth. However, it’s typically used for countries other than the US. That’s because in the US, a recession is officially “dated” by the National Bureau of Economic Research (NBER). The NBER recession dating committee does not use GDP (or GDI), instead focusing on six other economic indicators measuring consumption, income, employment, sales and production. The prior data showed that GDP growth was negative in Q1 and Q2 of 2022, prompting a hue and cry from the bears who were apoplectic that a recession wasn’t “called.” Never mind that most economic indicators pointed away from a recession even in mid-2022. Ryan and I spent a lot of time pushing back against the recession narrative over the last two years, whether on the Facts vs Feelings podcast, blogs, and even our Outlooks. Well, Q2 2022 GDP growth was revised up, and now we don’t have two consecutive quarters of negative GDP growth (or GDI for that matter). Another narrative bites the dust.



Here’s something that is hardly being talked about, and ought to be celebrated: over the last two years, real GDP growth has clocked in at an annualized pace of 2.9%, and over the last year it’s up 3.0%. The economy grew at an annualized pace of 2.4% over the entire 2010-2019 era, and even over the relatively stronger 2017-2019 period, it grew 2.8%.

That’s obviously backward-looking data, but as of now, the Atlanta Fed is projecting Q3 GDP growth at 3.1%, on the back of strong consumption and investment spending. The momentum continues.



Consumers Are in Better Shape Than We Thought
GDI was revised up on the back of stronger income growth for households and corporations (i.e. profits). Disposable income for households was revised higher, even as durable goods consumption was revised down. (Turns out Americans didn’t spend as much on durable goods like cars and recreational goods as we first thought.) As a result, the savings rate was revised up from 3.3% to 5.2% in Q2 2024. That’s lower than the 2019 average of 7.3%, but not that much lower. And remember that 2019 came at the end of a massive deleveraging cycle, as households were repairing their balance sheets after the financial crisis (which crushed stock and home prices).



By The Way, There’s No Manufacturing Recession
Survey data from the manufacturing sector have told us that the manufacturing sector has been in contraction for the last two years. The ISM Manufacturing PMI (a survey of purchasing managers) averaged 48.8 in Q2 2024 (any reading below 50 indicates the sector is in contraction). But with the GDP/GDI data, we also got “industry value add” data, which is actually a third way to measure output, this time aggregating output across various private sector categories, and the public sector. Turns out, real GDP grew 3.0% annualized in Q2 2024, and of that, 0.79%-points came from the manufacturing sector. That’s a quarter of the growth rate contributed by a sector that makes up just about 10% of the economy, and supposedly is in a recession. Over the last year, through Q2 2024, real manufacturing output has increased by 3.9%.



Underrated but Hugely Important: The Investment and Productivity Story
A big driver of upward revisions to GDP was investment, which more than overcame the downward revision to goods consumption over the last few years. We’ve written extensively about productivity, and how tight labor markets and investment are key to its growth, including in our 2024 outlook. Productivity gains allow for strong wage growth without excessive inflation. Turns out that’s the story of the US economy over the last year and half.

Upward GDP growth revisions imply productivity growth is likely stronger than reported. It was already strong, running at a 2.9% annualized pace over the last five quarters (compared to a 1.5% annualized pace from 2005-2019). Income growth has been really strong as well, with employee compensation running up over 6% over the past year through August. Yet, inflation has continuously eased. The core personal consumption expenditures index (PCE), which is the Fed’s preferred inflation metric, has eased from 3.8% a year ago to 2.7% as of August 2024. Over the last 3 months, it’s running at a 2.1% annualized pace, barely above the Federal Reserve’s (Fed) 2% target.



Like we’ve been saying since the beginning of the year, inflation is no longer a problem. The good news is that the Fed is recognizing this and signaled real intentionality at their September meeting to protect the labor market (by cutting 0.5%-points). A strong labor market is also key to productivity growth, boosting investment and keeping inflation benign. That will allow the Fed to continue easing interest rates, which will be a tailwind for the economy and markets.

 

S&P 500 Up 9 of Last 12 on First Trading of October Day, But Erratic Longer-Term



Based upon data in the soon to be available 2025 Stock Trader’s Almanacon page 90, the big gain on 10/3/2022 pushed the first trading day of October into 5th place for DJIA of all monthly first trading days since September 1997 based upon total DJIA points gained.

S&P 500 has been up 16 of the last 27 years and 9 of the last 12 on the first trading day of October. DJIA’s record is slightly softer with 13 declines and NASDAQ’s performance has been the worst of the group, down 13 times with an average loss of 0.12%. Impressive gains occurred in 2002, 2003 and 2022 while sizable declines happened in 1998, 2000 (NASDAQ), 2009, 2011. 2014 and 2019 also stand out for across-the-board losses exceeding 1%.

 

The Bulls Take September, October Jitters, and a Fourth Quarter Preview


“October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.” -Mark Twain

September to Remember
Stocks had a rough start to September, but the bull market continued and it is looking like the S&P 500 will be higher this year in the usually weak month of September. (The S&P 500 was up 1.7% on a total return basis as of Friday, September 27, with one trading day left in the month.) Assuming September holds up, stocks would be up eight of the first nine months of the year (with only the usually bullish month of April in the red) and up 10 of 11 months going back to last November.

The S&P 500 has made 1,415 new all-time highs and no month has made less than September, making the new highs we’ve seen in 2024 all the more special.







Were new highs this month really a surprise? Maybe it shouldn’t have been as past months that started off with a big down day more often than not tended to have strong rallies.





The reason for the rally? The economy continues to surprise to the upside, with forward earnings hitting another new high. The Federal Reserve Bank (Fed) cutting rates is also a tailwind. But let’s not lose sight of the big picture. With earnings hitting new highs and the economy continuing to expand, it’s no wonder stocks have hit 42 new all-time highs in 2024.



Where do those 42 new all-time highs rank? As you can see here this is one of the most ever and it extrapolates out to nearly 57, which would put 2024 in the top five for the most new highs ever.



An October Surprise?
You may be hearing a lot about how October is a month known for high market volatility and large drawdowns. This is true, as 1929, 1987, and 2008 all saw spectacular meltdowns in this spooky month historically. But it is worth noting that overall October is really about an average month, up 0.9% on average, making it the 7th best month of the year. The past 10 years it has gained a very respectable 1.8%, making it the third best month of the year. It was down last year, but hasn’t declined two years in a row for 15 years. October is the worst month during an election year and after the incredible run stocks have seen so far this year, we wouldn’t be surprised at all if we saw some usual October volatility in 2024.



One potential worry for October is stocks have done so well in 2024. With one day to go in September, the S&P 500 was up more than 20% for the year and October has done quite poorly in years that were up nicely heading into the spooky month. In fact, seven of the nine times the S&P 500 was up more than 20% YTD heading into October saw stocks fall the 10th month of the year with an average decline of 3.0%.

That’s the bad news. The good news is things are skewed greatly by 1987 and more often than not the fourth quarter still manages to finish higher, with solid gains the remainder of the final quarter of the year.



The Fourth Quarter Is Here
Let’s say we have some usual October volatility, which wouldn’t be abnormal. Planning for this now would be a wise decision. The good news is November and December historically do quite well in election years, as the uncertainty of the election is removed. Take another look at the chart above to see what we mean.

Looking past possible October volatility, the fourth quarter overall is higher nearly 80% of the time and up 4.3% on average, making it far and away the best quarter of the year.



Breaking things down by the four-year Presidential cycle shows this quarter is up more than 83% of the time, making it one of the most likely quarters out of all 16 to be higher. Of course, a 22% drop in the fourth quarter of 2008 pulled back the average return by a good deal, but to say stocks will be lower three months from now is probably a low probability event.



No year has ever seen the S&P 500 higher the first nine months of the year, but we found eight times that eight of the first nine months were higher. And wouldn’t you know it, the future returns were even better than average. October alone was better than average, and the fourth quarter overall has never been lower and is up a very impressive 6.6% on average.



Lastly, stocks made a new high in September, which could be a signal all by itself the bulls will do well the rest of 2024. We found 21 other times stocks hit a new high this month and the fourth-quarter was higher 19 times and up nearly 5% on average.



The bottom line is this is the best start to any year as of the end of September since 1997. Investors have been rewarded by sticking with a glass half full mentality amid the incessant negativity. Could we see a negative October surprise? Absolutely, but we would use that as an opportunity to benefit from potentially higher prices before 2024 is done.

 

Dividend Stocks with Strong Q4 Seasonality
Tue, Oct 1, 2024

It's the best time of year, at least for seasonality. As shown in the snapshot of our Seasonality Tool below, entering October is the strongest period of the year for three-month returns, and shorter term returns are also some of the best.



Looking at dividend stocks specifically, below is a list of the 30 in the S&P 500 that have been the best Q4 performers over the last ten years. The 30 dividend stocks below have all averaged a Q4 gain of more than 11.5% over the last ten years. At the top of the list is Tapestry (TPR) with an average Q4 gain of 17.4% and positive returns 80% of the time. TPR is already having a banner year with a 30% total return, but if history is any guide, it could tack on even more through year end.

Schwab (SCHW) and Citizens Financial (CFG) rank as the second and third best dividend stocks in Q4 with average gains of more than 15% and positive returns 90% of the time. French-fry maker Lamb Weston (LW) ranks fourth followed by KeyCorp (KEY), which is the highest yielding stock on the list. Notably, Bank of America (BAC), JP Morgan (JPM), and BlackRock (BLK) rank 6th-8th, which means there are six Financials stocks in the top ten.

As you can see in the table, all but three of the dividend stocks shown are up year-to-date, with most of these names up double-digit percentage points entering Q4. It has been a strong year already for high-yielding stocks, and now they have Q4 seasonality as another tailwind.

As always, past performance is no guarantee of future results.

 

What’s Behind the Melt-Up in Chinese Stocks


Chinese stocks have melted up over the past week, with Mainland China’s main index, the CSI 300, surging a whopping 25% since September 23rd (through the 30th). Just on Monday (September 30th), the index surged 8.5%, taking it to the highest level since August 2023. China’s markets will be closed for the rest of the week due to the Golden Week Holiday.



But here’s some perspective. Despite the surge, Chinese stocks still lag the S&P 500 by a lot over various lookback periods. Since the end of 2022, the CSI 300 is up 9% while the S&P 500 is up 54% (including dividends). Extending the horizon back to the end of 2019 (a quarter shy of five years), the CSI 300 is up 10% while the S&P 500 is up 92%. Pull it back to the end of 2014, almost a decade, and the CSI 300 is up 41% versus a massive 234% return for the S&P 500.

Panic Stimulus to the Rescue … Maybe
China’s central bank (the Peoples Bank of China, PBOC) announced a slew of measures to boost the economy, and markets, on September 24th. This was clearly an acknowledgment that economic growth is faltering. Consumption is running well below trend. Youth unemployment (ages 18-24) hit 18.8% in August (despite the statistical agencies changing the methodology to exclude students). Real estate activity, which is a backbone of the Chinese economy, is crashing, including construction activity, home sales, and home prices. Real GDP growth was up just 4.7% year over year as of Q2 2024, and on track to fall below the Chinese government’s 5% growth target for 2024 (the latest announcements suggest Q3 growth is not looking good). GDP growth is running well below the 2016-2019 trend of 6.5% annualized growth. Even that was a slowdown from the 7.5% annualized pace of growth from 2012-2015.



It was only a matter of time before stimulus was forthcoming, and there was much commentary over the past year as to when it would come. The only surprise was that it took as long as it did, and it was clearly panic. Amongst the stimulus measures announced:

• Cutting the benchmark policy rate
• Lowering the amount of cash that banks need to hold in reserve (to boost lending)
• Cutting interest rates on existing mortgages
• Lowering down payments for second homes

They also announced an offer of 500 billion yuan ($70 billion equivalent) in loans for funds, brokers, and insurers to buy Chinese stocks. No surprise that stocks melted up.

The PBOC has also said there’s more. Note that the PBOC is not really “independent” of the Chinese government (unlike the Federal Reserve here in the US). So, think of these measures as being pushed by the authorities in Beijing.

If you noticed, the measures were geared to boosting lending activity and the real estate sector. Regarding the latter, as I wrote earlier this year, real estate and related activities account for 25-30% of GDP, which is double the peak level we saw in Japan in the 1980s. Chinese authorities had already announced measures earlier this year to prop up real estate, but that’s not helped much. Real estate investment, which is key to watch, remains down 10% year over year as of August. This is partly because authorities themselves have tried to slow down the growth of bad debt in the sector, amid myriad issues with over-levered firms. Of course, that’s hit growth. Historically, property sector investment has come to the rescue of the Chinese economy when it was in trouble (2009-2011 and again in 2016). Hence the move to revive this growth engine.

The problem with these stimulus measures is that Chinea’s problem is not really a lack of borrowing. As Michael Pettis, a Professor at Peking University and an expert on China’s economy, points out, the problem for Chinese businesses is not that banks are capital constrained to make new loans. The Chinese non-financial sector is heavily levered already. Credit to the non-financial private sector is running at 205% of GDP, compared to 149% of GDP here in the US. In fact, as you can see in the chart below, debt growth in the US is falling whereas it continues to rise in China. In other words, output is falling in China even as debt growth is increasing – which means the use of that debt is becoming less productive. As I said above, China’s problem is not that it can’t borrow easily enough.



What China Needs: Fiscal Stimulus for Households
What China really needs is a fiscal stimulus package that ultimately redistributes income from the supply-side of the economy to households. Consumption was never the primary engine for growth in China, but it was still sizable. The problem is that consumption has seized up since the pandemic hit. Retail sales rose just 2% year over year as of August, versus a close to 9% annualized pace from 2017-2019.



Unlike the US, China never boosted households with stimulus measures once Covid hit. Chinese households also tend to save more than American households because there’s no social safety net (like Social Security and Medicare). A big part of those savings went into the real estate market (or in investment vehicles tied to real estate), but not anymore amid crashing home prices. That’s likely a reason why Chinese households have bought more gold over the past year.

Is This Time Different?
Chinese authorities have historically been against “handouts” to households. But that may be changing ever so slowly. The Chinese leadership seems to be acknowledging that stimulus needs to go further than the PBOC’s monetary easing. Details from the latest Politburo meeting, headed by President Xi Jinping, indicate a discussion of economic matters and boosting fiscal spending. This included the issuance of ultra-long government and special-purpose municipal bonds.

The City of Shanghai is piggybacking off of this already. They are planning to hand out 500 million yuan (about $71 million) in the form of consumption vouchers, including for dining, accommodation, cinema, and sports. But that amounts to about 0.0004% of GDP. They’re going to need to multiply that by a factor of 1,000 (if not more) to meaningfully move the consumption needle.

Perhaps this time will be different, with some acceptance that the economy needs more than easier borrowing and the prospect of fiscal spending coming into the picture. The Chinese government does have more than ample space to go this route — the central government will have debt of about 26% of GDP by the end of 2024 (versus over 100% for the US and over 200% for Japan). So, it’s just a matter of will, or rather, how much pain they’re willing to endure before throwing in the towel. There have been various points over the last decade when the rhetoric (or perhaps, investors’ understanding of the rhetoric) was way ahead of what actually happened on the ground. As the saying goes, fool me once, shame on you; fool me twice, shame on me. In other words, we’re going to need to see actual details of fiscal spending before coming to the conclusion that this time is indeed different.

 

Good News Is Good News, for the Economy and Markets


There’s been valid concern that employment conditions are deteriorating, ever so slowly. The unemployment rate has increased from a low of 3.4% in April 2023 to 4.3% in July of this year. Hiring also seems to have pulled back a lot, with the Job Openings and Labor Turnover Survey (JOLTS) telling us that the hiring rate (hires as a percent of the labor force) has pulled back to 3.3% — a rate we last saw in 2013 (excluding the peak pandemic months in 2020). I wrote about rising risks a month ago.

The September payroll report went a long way to ease some of these concerns (which is not to say risks have disappeared). Payrolls grew by 254,000 in September, doubling expectations for a 125,000 increase. Monthly payrolls can be noisy and subject to revisions. The good news is that July and August payrolls were revised higher, taking the 3-month average to a solid 186,000. This report also takes on outsized significance because the next two payroll reports are likely to be impacted by Hurricane Helene, with job growth pulled lower in October and reversing in November. The good news is that the port strike has ended, and so that’ll be a non-factor. In any case, it’s going to be January (when we get December payroll data) before we get another “clean” report.





Also very good news was the unemployment rate easing to 4.1%. It was actually 4.051%, just a whisker (or two whiskers?) away from being rounded down to 4.0%. I’ve mentioned in previous blogs how I prefer looking at the “prime-age” (25-54 years) employment-population ratio, since it gets around definitional issues that crop up with the unemployment rate (someone is counted as being “unemployed” only if they’re “actively looking for a job”) or demographics (an aging population with more people retiring and leaving the labor force every day). The prime-age employment population ratio was unchanged at 80.9% in September. That’s higher than anything we saw between 2001 and 2019 (when it peaked at 80.4%).



The fact that the unemployment rate and the prime-age employment population ratio are pointing in the same direction is positive. In our business, it’s about combining a lot of different information, and our life gets easier if the data are mostly telling the same story (good or bad — but fortunately, a good one now).

Income Growth & Productivity Are Driving the Economy

Over the last three months, wage growth has run at an annualized pace of 4.3%, which is solid but shouldn’t raise anyone’s inflation hackles. If you combine wage growth with employment growth and hours worked, we get a sense of aggregate income growth across all workers in the economy. Right now, that’s running at a 3-month annualized pace of 4.4%. If you’re wondering why economic growth keeps exceeding a lot of people’s expectations, especially after recent upward revisions, here’s why: Income growth is powering the economy, as opposed to credit. That is perhaps why this cycle has confounded a lot of people, since we haven’t seen something like this in decades. In fact, consumer credit is up only 1.6% year over year as of the second quarter of 2024, versus 4.6% in 2019, 5.9% in 2006, and 7.8% in 1999. This is also why a lot of people who like to parrot on about M2 money supply have gotten this cycle wrong. M2 is a reflection of credit to the private sector, and that’s simply not growing as it has in prior cycles.



Keep in mind that inflation has likely normalized to around 2% (and would probably be running slightly lower, if not for lagged effects of shelter). Strong wage growth and output growth amid benign inflation implies productivity growth is strong — something we’ve been talking about for a year now, including in our 2024 Outlook. Crucially, that also means the Federal Reserve can continue easing interest rates, and that’s going to be a tailwind for the economy, and markets.

But Can We Believe the Data?

The same people who keep calling for a recession (no surprise, they have a large overlap with M2 watchers) also tend to call the economic data into question. Admittedly, we have seen significant revisions to the data. Employment between April 2023 and March 2024 was revised down by 818,000. The payroll growth chart at the top of this blog does account for this downward revision, and despite that, growth was solid during the revised period. But revisions can go the other way too, as we saw with recent GDP/GDI and savings rate revisions, all significantly positive.

But even if you want to take the economic data with buckets of salt, just look at the market. The S&P 500 was up 22% over the first nine months of the year, and over half of that return has been powered by corporate profit growth. Since the end of 2019, the S&P 500 is up 92%, of which

• Earnings growth has contributed 57%-points
• Dividends contributed 14%-points
• Valuation multiple growth contributed 21%-points

In other words, most of the returns have come from profits (and dividends). Profit expectations continue to move higher, driven by strong sales growth (which tells you that the economy is doing well) and profits margin growth (which tells you companies are in good shape and have operating leverage).



At the end of the day, profits come from the economy, and that’s what drives market returns. So, if you don’t want to believe economic data, hopefully you can believe what markets are telling us about the economy. That’s real money.