Consumer Sentiment Soured With Inflation and Layoffs
Market Outlook – Consumer Confidence
Consumer confidence slumps more than consensus in February, with the index coming in at 98.3 vs. 103.0 consensus and 105.3 in January (revised from 104.1), according to data released by The Conference Board this morning,
The drop was severe, and the most since August 2021 on concerns about the outlook for the broader economy – uncertainty over the Trump administration’s policies weighing on households.
I had posted on Friday, stating that a plethora of weaker economic indicators was likely to lead to a drop in the market and this one added to the market’s woes, which at writing was down about 1% to 5,940 – some 3% lower than its high of 6,147.
The Conference Board’s gauge of confidence decreased by 7 points in February to 98.3, the third straight decline.
The expectations index ( 6 months) sank 9.3 points to 72.9, the most in three-and-a-half years, while a gauge of present conditions declined more modestly 3.4 points to 136.5
Recession woes and worsening outlook: The drop in confidence was broad across age groups and incomes, with consumers more pessimistic about current and future labor-market conditions, as well as the outlook for incomes and business conditions. The DOGE cuts are not helping confidence for sure.
“In February, consumer confidence registered the largest monthly decline since August 2021,” said Stephanie Guichard, Senior Economist, Global Indicators at The Conference Board. “This is the third consecutive month on month decline, bringing the Index to the bottom of the range that has prevailed since 2022. Of the five components of the Index, only consumers’ assessment of present business conditions improved, albeit slightly. Views of current labor market conditions weakened. Consumers became pessimistic about future business conditions and less optimistic about future income. Pessimism about future employment prospects worsened and reached a ten-month high.”
The dreaded R-word, which had been buried under the AI boom resurfaced, – the share of respondents expecting a recession in the next year rose to a nine-month high.
Tuesday’s report reinforces other surveys that I had cited, showing a doubtful and hesitant populace, waning after an initial surge of animal spirits post-election. Tariffs and higher prices dominate the conversation, as they did in the Michigan sentiment survey, as inflation pressures pick up again and the labor market suddenly looks shaky. One would wonder if the DOGE leadership thought through their actions and the effects on the economy with all the government layoffs. Clearly, the mood seems to have soured.
I continue to be extremely cautious, and will only buy exceptional bargains, I believe the S&P 500 could correct to 5,780 – the pre-election level, after which I would re assess the market before entering again.
I sold 15-25% of several stocks on Friday, 02/21/2025 as a de-risking exercise in the wake of weakening economic indicators, which I wrote about in this article.
Here’s the list and you can see them in the Trade Alerts Section as well.
ARISTA NETWORKS (ANET) $101
ADVANTEST CORP SPON ADR (ATEYY) $63
AMAZON INC (AMZN) $218
APPLIED MATERIALS INC COM (AMAT) $174
APPLOVIN CORP COM CL A (APP) $430
ARM HOLDINGS PLC (ARM) $147
BROADCOM INC COM (AVGO) $222
DOORDASH (DASH) $201.65
DUOLINGO INC CL A COM (DUOL) $410
DUTCH BROS INC CL A (BROS) $80
GITLAB INC CLASS A-COM (GTLB) $65.75
KLAVIYO INC (KVYO) $42.75
MICRON TECHNOLOGY INC (MU) $101
NETFLIX (NFLX) $1,012
SAMSARA INC (IOT) $54.25
SPOTIFY TECHNOLOGY S.A. COM (SPOT) $626
Earnings alone won’t save this market from a correction
Earnings season for Q4-2024 is mostly over except for Nvidia (NVDA), which reports on 02/26. M-7, and overall earnings were mostly lackluster and while most beat sandbagged estimates as always, the beats were nothing to write home about.
Instead, there was a lot of pressure for Q4 earnings to outperform to trump bearish indicators such as stubborn inflation, high valuations, tariff uncertainty, the likelihood of no interest cuts in 2025, difficult housing markets with 7% mortgage rates, weakening consumer sentiment, and so on….
Analysts, according to FactSet are still forecasting an estimated $268-$275 in 2025 S&P 500 earnings (about 11.5% growth), but this number seems more and more likely to either come in at the lower end or be revised lower as the year progresses. Second – the two-year back-to-back gains of 23% are a historical anomaly so I have to keep that in mind of a likely down year or a flat to 7-8% gain from already high levels.
Against all that is the $320Bn in Capex from the hyperscalers (That’s real money, not an economic survey or estimate – therefore the strongest catalyst ), which is extremely good for the AI industry and a very strong and vocal belief in the fundamentals – longer term we are on solid footing, and the AI story is just beginning, there are a lot of benefits to reap.
Active Risk Manangment
In short – a balancing act, which means there has to be active risk management. And especially when almost all the economic indicators came worse than expected, with sticky inflation and slower growth – stagflation. The Michigan survey of inflation expectations is followed closely by the Feds, and the weakening PMIs coincide with Walmart’s lower guidance. The reports have a lot of meat and don’t paint a pretty picture.
I’m not selling/trading the index or the stalwarts like Apple (AAPL), and Alphabet (GOOG) – there will be a flight to quality, thus not recommended. Even with a correction I don’t see the S&P 500 falling beyond 5,600-5,780. 5,780 was the Nov 5th election day level, that’s just 3.8% lower, not worth it.
My portfolio is tech-centric, and sometimes the drops in those are between 20% and 30% – AppLovin (APP), Palantir (PLTR), and Duolingo (DUOL) are examples, plus they’ve performed far better than expectations so taking some off is a great de-risking strategy for me.
There has been a spate of economic indicators in the past week or so, which are bearish for the market indicating a possible correction or at the very least a level of caution.
Let’s take a look.
The PMI – The Purchasing Manager’s Index – a 17 Month Low!
The index fell to a 17-month low at 50.4 in February, down from 52.7 in January, indicating that activity had slowed to a virtual standstill. Worse, cost inflation accelerated even with the lower activity, and was absorbed by suppliers who were unable to pass it on – indicating a possible stagflationary spiral.
Economists didn’t see it coming with expectations of 53.
It also marked the slowest pace of business expansion since September 2023, driven by a renewed contraction in services output that partially offset faster manufacturing growth. New order growth weakened significantly, while employment edged lower amid rising uncertainty and cost concerns.On the price front, input cost inflation accelerated to its highest level since last September, while selling prices saw their slowest increase in three months. Finally, business optimism about the coming year slumped to its lowest since December 2022, except for last September, amid concerns over federal government policies related to domestic spending cuts and tariffs, as well as worries over higher prices, and broader geopolitical developments.
The University of Michigan’s consumer sentiment index fell to 64.7 in February from 71.7 in January. Economists polled by FactSet were expecting a much better 67.5.
Year-ahead inflation expectations rose to 4.3% from 3.3% in January. This is a worrying sign, high inflation expectations hurt the mass consumer and spending.
Tariffs are scaring consumers as all five index components weakened this month, with durables lower by 19% mostly on ears that tariff-induced price increases were imminent.
Year-ahead inflation expectations jumped up from 3.3% last month to 4.3% this month, the highest reading since November 2023 and marking two consecutive months of unusually large increases.
Current Conditions Index: 65.7 vs. 68.7 expected and 75.1 January.
Consumer Expectations Index: 64.0 vs. 67.3 consensus and 69.5 prior.
Existing home sales of 4.08Mn also came in below expectations at 4.11Mn.. Economists surveyed by The Wall Street Journal had estimated a monthly decrease of 2.6%. In 2024, home sales fell to the lowest level since 1995 for the second straight year.
First-time home buyers seemed to be priced out by the double whammy of higher prices and high mortgage rates. I had reported earlier that the brave home buyers from 2022-2024 would feel the pinch of not getting to re-finance their 6-7% mortgage and clearly, few takers are willing to take that risk now.
Cash is at a record low:
According to the BOFA Global Fund Manager survey, cash is at 3.5% – the lowest level since 2010!
That begs the obvious question? With only 3.5% cash what’s left to buy the dip? With over-ownership of the M-7, these stocks aren’t just overbought, a) There’s previous little cash left to buy when the prices get attractive and b) You already own all of them, where’s the room to add more?
We could be in a fading, twilight of a bull run and headed for a correction according to Scott Rubner, managing director for global markets and tactical specialist at Goldman Sachs.
Rubner was categorical in stating the good times from corporate buybacks, retail investors jumping in on every dip, 401k inflows, and beginning of the year investing was waning, and once the corporate buyback period went into the quiet period for Q2, fund flows would move away from equities.
According to Rubner:
“My highest conviction is that this massive ability to buy dip alpha is starting to wane.” Rubner also said that hedge funds have allocated a lot of risk back into the market. Global equities saw the largest net buying in two months last week.
Rubner backed his findings with two key statistics; His assessment that computerized trading desks selling triggers, in the event of a market dip would unload $62Bn worth of equities compared to just $9.55Bn of buying on buying signals – pretty asymmetric towards the downside. Secondly, he also cited “A net retail buy imbalance for the last 22 days, including the top three largest days on record, he said. “This cohort is happy to buy any 2-3% dips for now.”
Q4-24 Earnings weren’t good enough:
The FactSet report on S&P 500 Earnings on 02/14 was just average and for this market to keep rising average won’t do – the valuations The M-7, bellwethers were also sluggish and will have a hard time taking the indices higher.
And while I’m positive about AI, semiconductors, and several fundamentally strong tech companies, valuations have been stretched for a while, thus it would be prudent to take advantage of some of the prices by booking profits, which I have started and posted in the trade alerts section.
While a set of economic indicators doesn’t necessarily doom the market, the downside surprise indicates that we’re not paying enough attention to economic weaknesses, against a backdrop of stretched valuations and interest rates that refuse to fall. The correct de-risking strategy would be to sell and keep cash available for better bargains.
The Software Multiplier Effect: An interesting note from Wedbush’s Dan Ives on Artificial Intelligence, who believes that software AI players will likely get 8 times the revenue of hardware sellers. I.e., a multiplier effect of 8:1 from software.
He is directionally right, and I do agree with him about the multiplier effect of software, services, and platforms on top of hardware sales. I had done a primary study several years ago with companies like Oracle, IBM, and Salesforce among others, and we saw similar feedback of about 6 to 1 for software spend to hardware spend, over time. People naturally cost more.
Nonetheless, regardless of whether it is 6 to 1 or 8 to 1, both numbers are huge and extremely likely in my opinion in the next 5 to 10 years and Palantir’s (PLTR) Dec quarter earnings hit it out of the park.
Dan Ives said:
Palantir Technologies (NASDAQ:PLTR) and Salesforce (NYSE:CRM) remain the two best software plays on the AI Revolution for 2025.
The firm also recommended other software vendors such as Oracle (ORCL) IBM (IBM), Innodata (INOD) Snowflake (SNOW), MongoDB (MDB), Elastic (ESTC), and Pegasystems (PEGA) enjoying the AI spoils.
Analysts led by Daniel Ives said:
Palantir has been a major focus during the AI Revolution with expanding use cases for its marquee products leading to a larger partner ecosystem with rapidly rising demand across the landscape for enterprise-scale and enterprise-ready generative AI.
Major Growth Expected: The analysts added that this will be a major growth driver for the U.S. Commercial business over the next 12 to 18 months as more enterprises take the AI path with Palantir. They believe “Palantir has a credible path to morph into the next Oracle over the coming decade” with Artificial Intelligence Platform, or AIP, leading the way.
Wedbush’s feedback about budget allocations is very helpful and even if one discounted Dan Ives’ perpetual optimism and bullishness by some, it’s a great indicator that this will be a favored sector in 2025-2028.
Ives and his team have been tracking several large companies that are or are planning to use AI path in 2025 to gauge enterprise AI spending, use cases, and which vendors are separating from the pack in the AI Revolution.
The numbers are gratifying:
Analysts expect that AI now consists of about 10% of many IT budgets for 2025 they are tracking and in some cases up to 15%, as many chief information officers, or CIOs, have accelerated their AI strategy over the next six to nine months as monetization of this key theme is starting to become a reality across many industries.
“While the first steps in AI deployments are around Nvidia (NVDA) chips and the cloud stalwarts, importantly we estimate that for every $1 spent on Nvidia, there is an $8-$10 multiplier across the rest of the tech ecosystem,” said Ives and his team.
What’s more important?
Analysts noted that about 70% of customers they have talked to have accelerated their AI budget dollars and initiatives over the last six months. The analysts added that herein is the huge spending that is now going on in the tech world, with $2T of AI capital expenditure over the next three years fueling this generational tech spending wave.
Hyperscalers indicated supreme confidence in their AI strategy committing in excess of $300Bn in Capex for 2025, which is historic. Amazon’s CEO Any Jassy was categorical in stating AWS doesn’t spend till they’re certain of demand.
Ives had this to add, underscoring Amazon’s confidence.
In addition, Ives and his team said that they are seeing many IT departments focused on foundational hyperscale deployments for AI around Microsoft (MSFT) Amazon (AMZN), and Google (GOOG) (GOOGL) with a focus on software-driven use cases currently underway.
“The AI Software era is now here in our view,” said Ives and his team. Wedbush’s team strongly believes that the broader software space will expand the AI revolution further, cementing what I saw at the CES last month. There is so much computing power available and so many possibilities of use cases exploding that this space could see a major inflection point in 2025-2026.
Large language models, or LLM, and the adoption of generative AI should be a major catalyst for the software sector.
Stubborn inflation and the fear of inflationary policies such as tariffs, budget deficits, and deportations had led to high 10-year treasury yields jumping to 4.8% before dropping to 4.66% today.
This, in turn, has spooked the S&P 500, which gave up its entire post-election bounce before bouncing back today.
The S&P 500’s current yield of 4.6% is less attractive compared to the 10-year treasury yield of 4.66%, questioning the risk-reward balance.
However, while the 4.66% yield will compete for investors’ funds, patient investors who can stomach a correction should do much better scooping up high-quality bargains.
There are enough positives to come from the new administration, such as lower taxes, less regulation, and business-friendly policies, which will trump the negative of high interest rates.
Will 10-year treasury yields of 4.66% drag down the market?
The equity risk premium
The current yield for the S&P 500 (NYSEARCA:SPY) is 4.6% or the 2025 Consensus Bottoms Up EPS of $274/S&P 500 of 5,953 = 4.6%. Comparatively, the 10-year treasury yield stands at 4.66% The commonsense argument is that if the US treasury gives me a risk-free return of 4.66% why should I make a risky equity index investment, yielding even less at 4.6%?
Risk-averse and conservative investors usually require a risk premium to invest in equities. During the great deflationary period from 2009, after the Great Financial Crisis, to Feb. 2020 (pre-pandemic), the equity premium was quite large as shown below. The average yield premium was 2.79%, and it rarely fell below 2%. The 10-year yield averaged 2.43%.
Source:Fountainhead, Yahoo Finance
In an inflationary environment, with the 10-year at 4.66%, we’re getting a discount of 6 basis points or 0.06%, which begs the question
a) Either I should get a premium return for that risk or
b) I should pay less to increase my yield.
Stubborn inflation
With stubborn inflation, a reduction in yields looks unlikely, and many would patiently wait for the reduction in the index to get in at a decent price. Not surprisingly, as of Jan. 14th, we’ve given back almost all the Trump bump, falling to 5,800, a mere 0.5% from the Nov 5th election date close of 5,782, which has now bounced back to 5,953 following the better-than-expected CPI report.
Last September, I was confident that the Fed’s reduction of 0.5% would lead to a 10-year closing between 3.25% and 3.5% in 2025. At an earnings yield of 4.6%, that would have been a fairly decent premium of around 1.25%. Initially, it did drop to 3.6%; however, given sticky inflation readings in the next 3 months and a stronger-than-expected job market and economy, 10-year yields have gone the opposite way climbing to 4.79%, before dropping to 4.66% — leading to the Feds anticipating just two cuts in 2025 in their dot plot from the December 18th FOMC meeting. Four weeks later, the markets have taken a step further, anticipating just a paltry 27 basis points reduction in 2025.
This morning, on Jan. 15th, the CPI report was much better than expected, with core CPI coming in only 0.2% higher from a month earlier, – a drop after increasing 0.3% in each of the previous four months. Its YoY increase was only 3.2%, lower than 3.3% in November and below the 3.3% consensus.
The 10-year yield dropped to 4.66% – a huge 13 basis point drop, leading to a 1.7% increase in the S&P 500 by mid-afternoon to 5,5953.
The Fed’s December meeting minutes also revealed a Fed that was worried about higher inflation from the incoming administration’s tax and tariff policies, which contributed to their forecast of only 2 cuts in 2025. From the FOMC minutes:
Almost all participants judged that upside risks to the inflation outlook had increased.
The S&P 500 (SP500) dropped 1% on January 7th, when PMI data revealed persistent price increases on the services front. It dropped another 1.5% with the massive 256,000 gain in net new jobs created, with the non-farm payrolls released on January 10th. Price action in the treasury clearly confirms this worry and, given how fast traders have sold bonds, suggests that this could well continue. Market headlines blaming the weakness in stocks on bond yields have only increased. Simply, the markets are sanguine until they’re not, and then the dam breaks.
The incoming administration’s volatility premium
I also believe that traders are assigning a “volatility” or even a “drama” premium if you will. Markets hate uncertainty. If you’re a bond manager already facing three years out of the last four of losses, witnessing the bizarre behavior of our elected officials towards the end of the year of getting a simple budget extension is going to weigh on your decisions. Why buy the treasury at 4.79% when the yield could shoot through 5.5% if there is more drama getting anything done in Washington with a razor-thin majority and an executive branch executing through Twitter?
An emboldened Trump, with a penchant for implausible actions such as annexing Greenland and the Panama Canal, will only increase bond market jitters.
High interest rates hurt Main Street, not just the market
The other factor that worries me about rising interest rates is the higher interest burden on other sectors such as commercial real estate lending, and residential mortgages. Residential mortgage rates are over 7% now, and while over 92% of residential mortgages are at much lower fixed rates, I would think that a significant amount of home purchases (some of which were chasing high-priced homes in short supply due to inventory shortages) have been made at higher mortgage rates in the last two-three years with the hope that they could refinance at cheaper rates – and clearly that hasn’t happened in 2023, and 2024 and from the looks of it, very unlikely to happen in 2025.
According to Trepp estimates, roughly $1.7 trillion, or nearly 30% of outstanding debt, is expected to mature from 2024 to 2026. This is commonly referred to as the “maturity wall.” CRE debt relies heavily on refinancing; therefore, most of this debt is going to need to be repriced during this time.
The 4.5% yield threshold
Source: The 4.5% yield threshold (Bloomberg, FactSet, Morgan Stanley Research, The Heisenberg Report)
Last April the S&P 500 P/E fell in tandem with the 10-year rise, and it currently looks to be following the same path, not auguring well for the market in 2025.
Could we get “Trussed”?
UK 10-year bond yields surged by 30 basis points on January 8th, to 4.925%, bringing back bad memories of the harrowing 49 days of Elizabeth Truss’s short-lived premiership in 2022.
Back then, Truss had made the mistake of unveiling an unfunded budget of 45Bn GBP of tax cuts when inflation rates were about 11%! UK Equity, Bond, and Currency markets sank, with many even suggesting that the UK government’s treasury was no better than that of a Third World country. Almost destroying a weak Gilt market ultimately led to her resignation.
Fast-forward to 2025 – the 30 basis point drop to a level not seen since 2008 has 2 repercussions. 1) Bond markets are reacting very strongly to governments not having enough control over their country’s inflation. Punishment was swift and severe. It was the 4th day of drops in the UK bond market.
2) The second repercussion, and what worries me; is this going to happen in the US market as well as the incoming administration starts working on their planned tariff hikes, which will increase inflation; if so, where does the yield stop?
Tax cuts can be inflationary
Trump’s proposed tax cuts reduce tax revenues and increase deficits, which is inflationary.
The incoming administration plans to extend the 2017 tax reductions, reduce the corporate tax rate, and decrease or eliminate taxes on certain types of income. Here is the analysis from taxfoundation.org:
Using the Tax Foundation’s General Equilibrium Model, we estimate Trump’s tax proposals would increase long-run GDP by 0.8 percent, the capital stock by 1.7 percent, wages by 0.8 percent, and employment by 597,000 full-time equivalent jobs.”
“We estimate the proposals would increase the 10-year budget deficit by $3 trillion conventionally and $2.5 trillion dynamically. The debt-to-GDP ratio would increase from its long-run projected level of 201.2 percent to 223.1 percent on a conventional basis and 217 percent on a dynamic basis. Increased deficits and a higher debt load would require higher interest payments on the debt that would reduce American incomes as measured by GNP by almost 0.8 percent; the higher interest payments drive a wedge between the long-run effect on output of 0.8 percent and the long-run effect on GNP of -0.1 percent.
As you can see above, the repercussions can be good for the economy with higher GDP, but it will also be inflationary and expensive to service with higher interest rates. What’s also significant is that the administration believes that they can make up the shortfall by increasing tariffs, which in my opinion will worsen an already high inflation rate.
What the bulls say: There are a lot of positive factors as well
Juxtaposed with the negativity of high interest rates are the positive effects of excellent earnings growth from the S&P 500, lower taxes, and less regulation.
Source: S&P 500 Earnings (FactSet)
FactSet’s estimates call for a strong 14.64% growth in the S&P 500 for 2025 to 274.19, followed by 13.6% growth to 311.44 in 2025. In the years that I’ve been using FactSet, I’ve seen that the variation is not significant for the index. I strongly believe that the S&P 500 earnings would come in between 267 and 281, with an error margin of just 2.5%. But the problem is not in the performance – it’s the valuation, we’re priced to perfection as seen below, and disappointments could be the main catalyst for a drop.
Source: S&P 500 P/E Ratios (The Heisenberg Report, Datastream)
The last time the S&P 500 P/E was above 20, the 10-year was around 2%, currently, we’re at a P/E of over 21.73, but the 10-year is at 4.66%.
Good earnings and cash flow over the last few years have led to low debts on several investment grade and lower balance sheets. The level of fallen angels – or companies below investment grade, is at its lowest level in 25 years.
Risk premiums are not mandatory for equity investments
The lack of an equity risk premium is not the end of the world and as we can see from the chart below, in higher interest rate environments from 1985 to 2000, there never was one. The biggest premiums have been in the deflationary era, post the GFC from 2009 before the Fed started raising interest rates to quell inflation.
A high interest rate doesn’t kill the equity market just because of a lack of a risk premium, but it provides competing offerings at much lower risk, and we saw that hurt the equity market in 2022 when the Fed started raising interest rates aggressively to contain inflation. I, myself, put money in high-yield CDs and corporate bonds through 2023.
A 5% Treasury yield should attract buyers
I believe there could be a lot of buying if the treasury breaches 5%. In October 2023, when the Middle East conflict was raging, bond yields briefly touched 5% from where they reversed very steeply, on buying and a subtle push from Treasury Secretary Janet Yellen, who reduced the size of government auctions by $76Bn. Will history be repeated? I think it’s likely that there will be substantial buying of 5% treasury bonds, as do several analysts, and money managers.
Inflation: The worst is likely behind us
The PPI came in a little lower than expected at 0.2% M/M in December 2024, versus a consensus of +0.4% and November’s reading of +0.4%. Even better, the core PPI was flat M/M, significantly lower than the expected rise of 0.3%. The benign numbers triggered a relief rally on Jan. 14th, and the CPI report which came in today (Jan 15th, 2025), did even better with the core CPI beating estimates, leading to a drop of 13 basis points in the 10-year and a huge 1.7% gain in the S&P 500. This could be the beginning of a trend reversal.
Positive effects of lower taxes
Even as we move towards a more inflationary environment with unfunded tax cuts, the Tax Foundation believes that lower taxes would increase long-run GDP by 0.8 percent, capital stock by 1.7 percent, wages by 0.8 percent, and employment by 597,000 full-time equivalent jobs.
Rekindled animal spirits are great for Main Street
Small businesses, which are major employers and contributors to US GDP, are very optimistic about the Trump administration’s policies, which should augur well for the economy. Small businesses are notably excited about higher sales, less regulation, increased chances of finding high-quality labor, stabilizing inflation or price increases, and importantly, better credit conditions due to less regulation. Not surprisingly, the groups’ uncertainty indicator has dropped as well.
What is the best way forward to invest in a difficult year?
Keep realistic expectations
There are enough bullish and bearish factors without either one having a clear edge. In 2023, the S&P had a reasonable P/E of around 18, allowing the big AI bang from Nvidia’s May earnings report, to propel the index to a 24% gain. In 2024, the S&P 500 gained 23% as the AI trend continued, but now inflation has persisted and the S&P trades at an expensive 21.7 times 2025 forward earnings. The chances of a third year of 20% gains are rare; it’s happened only 3 times in the past 100 years, but two of those were in 1935, and 1936 following the great depression, and then the third one in the nineties during the dot-com bubble. So, my expectations have to be very realistic.
Wait for bargains
The correction should continue, which allows us to scoop up bargains: In my opinion, we’re likely to see 5,500 before 6,500 in 2025. The S&P had wiped out the post-election bump, dropping to 5,800, past the 20 and 50 DMAs, before reversing this morning. Should it drop again, I expect strong support around its 200 DMA of 5,582.
Besides, I think this market will continue to correct until interest rates stabilize, which won’t happen until we see a drop in PCE readings (due at the end of January) wage growth, and a reduction in volatility, which is high with the VIX hovering between 17 and 19. There’s also precious little one can do about volatility; this is a Presidential stock-in-trade. The first few weeks of the Trump administration should be fairly volatile, as they roll out their tariff, deportation, and tax plans. The incoming President has stated that they intend to get off the ground very quickly with executive orders on day one, with immigration a big priority, which means we should get a fairly good view of deportations and their inflationary effects. The Trump administration also showed in their previous innings, firing unrealistic salvos as opening bids – and thus I assume a zero chance of 60% tariffs – the realistic number is likely to be much lower, but the drama will unsettle the market.
Focus on the big picture and stick to the fundamentals
To me, the biggest investment factor is always the fundamentals of great companies, which trumps macro, economic, or technical factors in the long run, unless they’ve historically deviated from the norm, and we’re not anywhere close to that. The stellar jobs report for December confirms how strong the economy is, in fact, higher wages are your biggest defense against inflation – good news is good news. It’s idiotic to hope that the labor market weakens, so the Fed can cut rates – very twisted logic, which hopes for weakness in the economy!
Earnings
Earnings will continue to do well, as we saw from FactSet’s estimates and especially across the M-7; No matter how much we complain about the lack of breadth, the M-7 will still carry the economy and the markets. The M-7 are not outliers, they are truly entrenched in the economy and are in the rare, sweet spot of being secular and sustainable growers and stalwarts with strong brands, pricing power, and huge moats.
Stocks to buy on declines
Taiwan Semiconductor Manufacturing Company Limited (TSM) – I first recommended TSMC in August 2023, and continue to add on declines. Its December monthly revenue grew 58% YoY and fourth quarter revenue grew 39% YoY, suggesting a strong beat of its mid-point guidance, and confirming its strength as one of the strongest pillars of the semiconductor industry.
NVIDIA Corporation (NVDA) – The CES showcased a strong Nvidia with its foray into the PC market, its new gaming chips, and the introduction of Cosmos, which takes its Ominverse segment to much higher levels with the addition of Blackwell architecture. Any short-term thinking about Blackwell delivery delays is just noise and a great opportunity. I’ve started buying around $132 and will continue to add on declines. I’ve owned Nvidia for a long time and have recommended it in March 2023, and July 2023.
Alphabet Inc. (GOOG) (GOOGL) does not get enough recognition for its market leadership and moats in Search, YouTube, Google Cloud, and Waymo, with far too much focus on the antitrust ruling. Given the new administration’s anti-regulatory stance, I don’t believe Alphabet will be hurt as badly, and even in the worst case, here’s a sum of the parts valuation, which at $2.6Tr is higher than its current market value of $2.35Tr.
I would also add the following on declines: Duolingo, Inc. (DUOL), the market leader in language learning and a huge beneficiary of AI, Marvell Technology, Inc. (MRVL), which has a strong position in ASICs and is very attractive at 12 times sales growing at 40%, and 41 times earnings growing at 33%,
Corrections are healthy for the market, and I look forward to buying on declines.
Bonds Rally: The US 10-year treasury yield drops 14 basis points from 4.8% to 4.66%
The S&P 500 rallies 1.83% to 5,950, and the Nasdaq Composite zooms 2.45% to 19,511
CPI Data Signals Cooling Inflation in Good News for Fed
US Dec. consumer prices rise 0.4% M/M; Est. +0.4% The broader Consumer Price Index (CPI) matched expectations and rose 2.9% in December from a year earlier.
The benign numbers were in the Core CPI, led by shelter inflation, which was sorely needed.
Core prices rose 0.2% in December, less than the 0.4% estimated and 3.2% from a year earlier, down from 3.3% in November – an unexpected decline, which sparked the bond and stock rally.
Prices for shelter, airfares, used cars and trucks posted gains. Airfares were the outlier rising by 7% and gas prices also rose 4% MoM
Shelter inflation remained moderate, coming in at 0.3% on the month, a big sigh of relief for the Feds – shelter inflation is the stickiest and the hardest to reduce. The shelter index rose 4.6% YoY, the smallest annual increase since January 2022.
US government bonds rallied strongly, reviving hopes of additional Federal Reserve interest-rate cuts, which were down to a total 29 basis points cut for the whole year.
As the rally progressed Treasury yields across maturities fell by at least 10 basis points and closed with 10-year yields falling as much as 15 basis points to 4.65% for its biggest daily decline since August.
What a turbulent month so far – and all this before Trump is sworn in. The drop in yields reversed the sharp rise from a strong December employment data released Friday, which sparked a surge toward the highest levels in months to 4.81%, all but confirming that the Feds may not cut rates at all this year. At 4.81%, the 10-Year was a 100 basis points higher than when the Fed began easing in September.
Sometimes, you get the feeling that the inmates are running the asylum after the two-day fiasco in Washington sent the government into a temporary shutdown without passage of any stop-gap funding. Not that it hasn’t happened before; we’re all too familiar with and cynical of the antics of our esteemed elected officials, but the drama is causing serious damage to an already rattled market.
The S&P dropped 2% overnight after a smaller stop-gap funding bill rushed through by the GOP in the house failed to secure enough votes with a large number of Republicans opposing the bill as well. Briefly, Musk had torpedoed an already agreed bipartisan stop-gap bill, which would have kept the government funded through March 2025, because it did not include a debt ceiling increase and far too much pork. Republicans scrambled to put together a much smaller bill including a debt ceiling increase, but couldn’t get enough representatives on board, and this time a betrayed democratic side didn’t lend a hand.
As we barrel through the uncertainty, already exacerbated by a rising 10-year yield and the likelihood of only two cuts next year, the huge drop in overnight futures suggested that the S&P could break 5,872 and completely erase the post-election rally. Everybody appreciates the animal spirits, lower taxes, lesser regulation, and so on, but it comes with the price of high drama! No free lunches…
Slightly better than expected inflationary numbers with the core PCE rising 2.8% YoY against the 2.9% has stemmed the fall a bit. I had planned to buy the dip – may get some of my limit buys today, or even lower them.
Though this is a far less onerous shutdown. In a shutdown, government offices continue essential work, but tasks deemed nonessential are put on ice, paychecks stop and many workers are furloughed until Congress passes new funding. The impact of a shutdown varies, critical services continue, as would military and border-control functions. But, most federal workers, whether essential or not, won’t receive a paycheck. Under a 2019 law, workers will automatically get back pay when the shutdown ends. Private contractors who work with federal agencies and are furloughed during a shutdown aren’t guaranteed back pay.
How would this shutdown compare to previous ones?
From the Wall Street Journal “Congress has missed its deadline to pass 12 federal funding bills and failed to extend itself more time in about two dozen instances since 1976, but those lapses have often been short, with minimal impact.”
Quite the dysfunctional record but thankfully the impact has never been severe.
The Fed’s favored inflation gauge – core PCE – cools slightly in November
The core PCE Price Index, the Federal Reserve’s preferred inflation measure, edged up 0.1% M/M in November, less than the +0.2% consensus and cooling from the +0.3% pace in October. Personal income and spending also came in slightly lower than expected in the month.
On a year-over-year basis, core PCE increased 2.8%, just under the 2.9% consensus, and running at the same pace as in October.
PCE Price Index, which includes food and energy, also ticked up 0.1% M/M vs. +0.2% consensus and +0.2% prior.
That measure translated to a 2.4% Y/Y increase, less than the +2.5% consensus, but slightly hotter than the 2.3% rise in October.
Personal income: +0.3% M/M vs. +0.4% expected and +0.6% prior.
Personal outlays: +0.4% M/M vs. +0.5% consensus and +0.4% prior.
At the time of writing, premarket S&P 500 Futures are down 0.6% after being down 1.5% overnight after the second stop-gap funding bill failed miserably to get through the House of Representatives.
The likelihood of only two Fed rate cuts in 2025 sent the markets tumbling yesterday, even as Chair Powell was still answering pointed questions about the resilience of the economy and where inflation was headed in 2025. The S&P 500 eventually closed 2.96% lower. shattering the post-election rally.
The markets had been ignoring the 10-year yield for far too long. The 10-year went from 3.6% in September when the Fed started cutting to 4.40% before the FOMC meeting, signaling that inflation wasn’t completely done and that stock valuations were getting frothy. It unraveled yesterday. Analysts are talking about the 10-year possibly reaching 5%, which will remain bad for stock multiples. The S&P 500 and the Nasdaq Comp are down 4.5% from their highs. Let’s see how the PCE report is on Friday.
The last time the S&P 500’s P/E ratio was 22, it was 2021, and the 10-year treasury yield was 1%! We are at 4.5% and climbing! The expectations of 4 cuts in 2025 had kept the markets hopeful that the 10-year would follow suit and head back below 4%. Clearly, that’s not happening. Either the index has to come down or the 10-year has to drop to justify these valuations….
Also don’t forget the Fed’s reluctance to cut big for forecast more cuts in 2025 was based on the Sep, Oct and Nov inflation readings, they’ve not even talked about the possible inflationary impact of tariffs and larger fiscal deficits – somebody has to fund the government when they’re not collecting enough taxes, and the weaknesses in the past two treasury auctions suggest that lenders are demanding better rates to lend to the government.
As expected the Fed cut interest rates by 0.25% bringing the Fed Funds rate to 4.25% to 4.5% To be sure, this is a hawkish cut. The S&P 500 gave up its gains of 0.5% and has dropped 1.5% in a reversal as has the Nasdaq Composite, down a full 2% to 19,703.
The 10-year treasury yield has shot to 4.5%, a harbinger of how the markets believe that the Feds will have to pay more to finance the deficit, with analysts even talking of 5% – a rate seen last October.
The hawkishness stems from the FOMC Median 2025 PCE Inflation Forecast, which rises to 2.5% vs 2.1%
The median forecast of Fed policymakers for the benchmark rate for the end of next year is now 3.9%. That compares with 3.4% back in September. That suggests 50 basis points of easing compared with 100 basis points in September (including the impact of today’s rate cut).
Today’s cut means policymakers have now lowered their benchmark lending rate by a full percentage point since mid-September. The median estimate of Fed officials now sees just two cuts next year. Most folks were expecting three in the forecast.
Fed officials are tipping an unemployment rate of 4.3% next year a shade higher than the current 4.2%. Chair Powell in the conference that followed stressed that he wanted to ensure that labor markets didn’t get derailed when asked about the need to cut.
The Fed’s policy statement also alluded to a slower pace of cuts by saying “the extent and timing” of additional adjustments would depend on the outlook. This too was stressed in the conference that it would always be new data that would matter.
The neutral rate discussed (the rate at which the economy is neither inflationary nor disinflationary) is now 3%, higher than the original 2%, which the Feds were hoping to achieve by 2024, now highly unlikely before 2027.
Given the strength in the economy, with the GDP at 2.8% and projected to grow above 2% next year, a strong labor market with an unemployment rate of only 4.2%, this is not a bad call and regardless of how the market reacted, the caution to cut slower in 2025 is warranted in my opinion.
