The Bull Market Continues
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 reason for the rally? The economy continues to surprise to the upside, as we will discuss more below. 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.
You will 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. 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 worse 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.
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.
Lastly, 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.
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.
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 our 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. Even though it’s a revision of old data, 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%-points:
- 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.
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. We spent a lot of time pushing back against the recession narrative over the last two years, whether on the Facts vs Feelings podcast, in our blogs, and even in our Outlooks. Well, Q2 2022 GDP growth was revised up, and now we don’t have two consecutive quarters of negative GDP growth. 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 only 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
Gross domestic income (GDI), a different way of measuring total economic activity, was also 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 had 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 overall economic activity, 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 three 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.
The new point of view the revised data gives us reinforces the fundamental basis for continued profit growth and stock market gains. This hasn’t just been a sentiment-driven market. It hasn’t even primarily been a sentiment-driven market. There have been strong fundamentals in place that raise the odds of continued economic momentum. The main place we have seen some weakening of late has been slowing job market trends, but with the Fed now starting to lower very restrictive policy rates, the likelihood that economic momentum will continue to support markets looks even better.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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