For two and a half years, a dwindling cadre of bearish forecasters has insisted that the sun will not rise tomorrow if the Leading Economic Indicators (LEI) continue their downward trajectory. Remarkably, this is the first instance in which such an extended LEI contraction has not presaged economic upheaval. The myopia of these analysts is evident in their failure to account for the manufacturing sector’s inherent bias within the LEI, as well as the substantial stimulus that has buoyed the far more significant service economy.
Since the brief, government-mandated economic lockdown in March 2020, current or coincident indicators have ascended unimpeded. Today, the economy maintains a steady growth rate of 2 to 3 percent, buoyed by robust individual and corporate balance sheets. Stellar profit margins and earnings are poised for even greater performance in the long term as the early stages of artificial intelligence adoption take root. Encouragingly, we are witnessing the first signs of a reversal in the LEI. While it may be premature to declare a definitive upturn, historical patterns suggest that when the LEI begins to ascend, it typically continues on an upward trajectory, signaling accelerating growth.
Time will reveal whether these economic proxies for future growth can sustain a new trajectory, but just as the LEI underestimated the resilience of the economy over the past two and a half years, any emerging uptrend is likely to coincide with GDP growth that exceeds expectations in the coming years. Notably, purchasing manager surveys indicate the possibility of an expansion cycle in the moribund manufacturing sector for the first time in over two years. This bodes well for turning the mis-leading indicators (LEI) back to a positive path.
This unexpectedly robust economy presents a modest headwind for stocks, as real, inflation-adjusted interest rates trend back toward multi-year highs. We anticipate a bullish downtrend in real rates before the year concludes; however, short-term risks loom in the first quarter, particularly if political machinations stall the Trump agenda.
While the U.S. economy remains strong and China continues to stimulate, U.S. equities must navigate a turbulent technical backdrop this quarter. The degree of leveraged equity exposure among money managers has historically served as a reliable barometer of a bull market nearing short to medium term exhaustion. When managers push for 100 percent or greater portfolio exposure to equities through leveraged contracts, it often coincides with impending corrections from significant peaks. This has been evident in recent weeks; as we noted on December 16, the day before the S&P 500 fell 5 percent.
It is premature to assert that weak hands have been purged, allowing for another leg of record-high stock market valuations. Caution is warranted in the near term, even as a longer-term bullish disposition remains intact. While it is impossible to determine how high stock ownership among households can rise, it is evident that the market is susceptible to a liquidation phase should unfavorable news emerge, particularly as individuals increase their stock allocations to record levels.
Capital exp[enditures for technology by US hyperscale’s increased from $110 billion in 2023 to $165 billion in 2024 and are expected to approach $200 billion in 2025. In this era of artificial intelligence, marked by rising profit margins and a potential wave of capital investment, corporate valuations may be justified, but they have reached unprecedented heights that are susceptible to some corrective digestion in pricing. This is especially true if the Trump agenda encounters unexpected obstacles. The last time the S&P 500 Index to book value ratio reached such heights was at the peak of the tech bubble in 2000. It may continue to rise, but a more rapid pace of sales and earnings growth will be necessary to justify such lofty valuations.
Our medium-term overbought-oversold indicator group recently triggered a sell signal, as we highlighted in our December 13th report, one day prior to the market peak. The benchmark S&P 500 subsequently fell about as predicted, down 5 percent. Nevertheless, it is too early to assume that the lows from this sell signal are in. Our Trump trade honeymoon bias has limited corrections in the S&P 500 to less than 10 percent until after Trump takes the oath of office on January 20. With earnings season reports commencing in mid-January, one should expect more choppy price action, accompanied by downside risk into February.
The price action in December was weaker than anticipated in broader averages yet stronger than expected in key indices, thanks entirely to the so-called Magnificent Seven stocks that dominate the benchmark indices. With Trump’s inauguration just ten trading days away, we anticipate some sideways to upward price movement, primarily driven by a “buy the rumor” effect. Once the markets digest all the speculation surrounding Trump’s actions post-inauguration, another round of selling is likely until we observe technical oversold conditions.
Looking further ahead, we foresee a gradual economic rebound in Europe, significant stimulus efforts in China and the anticipation of cuts to regulations and taxes in the US, all of which will underpin an already robust U.S. macroeconomic backdrop through 2025 and beyond.
