Waiting On The Fed

Major stock market averages opened modestly lower this morning (Dow -120 pts; SPX -.1%). Banks, biotechs, retailers and commodity stocks are rising, whereas utilities & transports are in the red. If there is any pattern in that move, it speaks to investors expecting higher interest rates down the road. The VIX fear gauge is unchanged and gold is down more than 1%. WTI crude oil, having recently surged above $84/barrel, backed down to $81 this morning. The bond market is little changed in early trading; traders are nervously awaiting the Fed’s monthly policy decision/announcement.

The S&P 500 Index has posted the best one-year return following a presidential election in modern history. Since the election the index has soared 37%, according to Bloomberg News. Of course, as Charles Schwab points out, much of that gain has to do with timing of the recovery from the Covid pandemic. But then again, stock markets around the world haven’t matched our domestic rally. China’s Shanghai Composite is up only 7% in the past year, Japan’s Nikkei 25 is up almost 25% and the MSCI Europe Index is up nearly 32%. Over that time, the price-to-earnings ratio on the S&P 500—a rough measure of how expensive US stocks have become—edged back to 21.5 from 22.5. While the lower P/E suggests stocks are getting slightly less expensive (good news), the current level is still considered elevated by historical standards (bad news). The market’s P/E ratio will likely continue to decline over the coming year. Stocks can continue to rally with a falling P/E ratio only if corporate earnings growth is sustained. And that is what we predict. Economist Ed Yardeni says, “An earnings-led bull market is much better than a P/E-led bull market. The former is less prone to selloffs and corrections because it is supported by fundamentally strong earnings.” And that’s my point: this rally is supported by improving sales & profits at real companies.

The Institute for Supply Management’s (ISM) monthly surveys confirm very strong demand for goods and services despite logistics issues. The ISM Manufacturing Index edged down to 60.5 and the ISM Services Index surged to its highest level since data began in 1997. Any reading above 50 indicates expanding business activity. Business leaders reported longer supplier lead times, acute parts & transportation shortages and a lack of sufficient labor. But they’re also successfully passing through price increases. The report suggests inflation will remain elevated next year.