3 Outcomes the Equity Markets Want for Christmas This Year
Long-time readers of my Mitch on the Markets columns know my view that equity markets don’t adhere to calendars. It’s true stocks tend to do well in the final two or so months of the year with the “Santa Claus rally” being a favorite adage for many. But it’s all for naught if economic, inflation, interest rate, and earnings fundamentals aren’t supporting prices.
This year, there are three outcomes/data points that could indeed give stocks a boost in the final weeks of the year, and investors should be watching closely. Here they are:
1. Look for More Signs Moderating Inflation on November 30th
Markets received some good news on the inflation front last week, with the Labor Department reporting that core CPI was flat from September to October and rose 3.2% year-over-year. Importantly, core inflation (which excludes food and gas) from June – October rose at a 2.8% annual rate, which is a major improvement from the 5.1% pace in the first five months of 2023.1
The data makes it abundantly clear: inflation has improved greatly since last year, and has continued to get a bit better with each print.
Consumer Price Index (CPI, blue line) and Core CPI (red line)
There was plenty of good news in the Labor Department’s report. Prices for cars, airfares, and housing all softened, which followed a summer when furniture and other goods prices started to come down. In housing in particular, rents for new tenants fell -2.2% from a year ago, compared to the +13.7% jump experienced last year.
In a sense, the equity markets have already received their ‘Christmas wish’ with this data, as it almost certainly implies the Federal Reserve is done hiking interest rates in 2023. But I would encourage investors to mark their calendars for November 30, when the Fed’s preferred inflation gauge – the headline personal consumption expenditures (PCE) price index – gets released. An encouraging inflation print there would all but ensure no rate hike at the December 12-13 monetary policy meeting. Instead, what investors might be better suited looking for in that Fed meeting is how their guidance shifts.
2. The U.S. Consumer Finishing the Year Strong
Economic growth in 2023 has been largely powered by the U.S. consumer, benefiting from a strong labor market. I’ve written before that the Wall Street Journal ran a headline in October that read: “Americans Are Still Spending Like There’s No Tomorrow.” That pretty much sums it up.3
Personal Consumption Expenditures are Softening But Remain Elevated
There has been some data recently, however, suggesting the U.S. consumer is losing a bit of steam just at the time it matters the most—the holiday shopping season. Let’s start with some data on goods. In the first nine months of 2023, U.S. imports of TVs, computer monitors, footwear, and games and toys fell 20% compared to a year earlier. Smartphone imports fell 16%. Retailers have been wary of building up inventories, partly because they wonder how much the consumer has left, but also because Americans have been shifting spending to services and other areas like travel and entertainment.
According to the National Retail Federation’s projections, overall sales this holiday season could rise 3% to 4%, which is quite modest compared to 5.4% in 2022, 12.7% in 2021, and 9.1% in 2020. When factoring in inflation, some analysts expect flat growth from 2022, which would register as disappointing.
The big question for equity markets in the next couple of months is, will consumers continue to defy expectations and spend more and bigger than many are anticipating? The U.S. consumer has been underestimated virtually all year. Will they exceed expectations again?
3. Corporations Show Signs of Exceeding Their Falling Earnings Estimates
With the Q3 earnings season pretty much wrapped up, we can say that the earnings picture turned a corner in the quarter. Earnings growth for the S&P 500 index, which was negative for each of the preceding three quarters, looks like it turned positive in Q3. Energy has been a drag for the past two quarters, and stripping it out, S&P earnings growth would have been positive. But now it looks like we’ll get aggregate earnings increase of +1% from the same period last year on +2.5% higher revenues.5
One factor to call out, however, is that companies have been scaling down estimates for earnings growth in Q4—substantially. The chart below shows how estimates for 2023 Q4 have evolved since the quarter got underway.
This is a bigger decline in quarterly estimates compared to the preceding two quarters, and it marks a departure from the favorable revisions trend that’s been occurring since April 2023. In the chart below, readers can see the recent pressure on full-year 2024 earnings estimates, which shows the aggregate earnings estimates for the S&P 500 index since May.
It’s common to see companies revise earnings expectations lower, especially given the recent softening in the labor market and a lot of headline warnings about the durability of the U.S. consumer. The question is, can S&P 500 companies surprise to the upside?
Bottom Line for Investors
As ever, the equity markets will often respond positively when reality exceeds expectations. For the final weeks of the year, investors should be looking for more positive momentum on inflation, a durable U.S. consumer that surprises the street with strong holiday shopping spending, and S&P 500 companies giving early indications that they revised earnings too far to the downside given ongoing economic strength. If that’s what we get, I anticipate a celebratory New Year for equity markets to follow.
Disclosure
2 Fred Economic Data. November 14, 2023. https://fred.stlouisfed.org/series/CPIAUCSL
3 Wall Street Journal. November 10, 2023. https://www.wsj.com/business/retail/five-economic-signs-youre-smart-to-procrastinate-on-holiday-shopping-this-year-2de9ed0f?mod=djemRTE_h
4 Fred Economic Data. October 27, 2023. https://fred.stlouisfed.org/series/PCE#
5 Zacks.com. November 8, 2023. https://zacks.com/commentary/2181217/earnings-estimates-come-under-pressure
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