Dear Valued Clients and Friends –
There is a lot on the Public Policy front today because you may have heard we are one week away from the inauguration of the new President. There is also a good amount of market talk as markets hiccupped Friday around the horror of a good jobs report. Ironically, the very “year ahead” paper I am going to discuss in the very next paragraph spent a lot of time talking about the relevance of bond yields in 2025 to (a) Economic strength (a good thing) and (b) Valuations (a potentially bad thing). Plenty to digest.
The Friday Dividend Cafe was my annual Year Behind, Year Ahead white paper. The link to the paper, charts and all, is here. The video can be found here and the podcast here. You will be shocked to hear that I am a rather big proponent of the written word on this one.
I was on set with Varney today with a highlight reel here.
Off we go …
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Market Action
- The market futures had the Dow down nearly -200 points and the Nasdaq down -300. By the time the market opened, the Dow was up being up a bit, and then it rallied steadily all day. Even the Nasdaq made back a lot of its huge drop.
- The Dow closed up +359 points (+0.86%), with the S&P 500 up +0.16% and the Nasdaq down -0.38%
*CNBC, DJIA, Jan. 13, 2025
- The market sell-off Friday was directly related to a spike in bond yields in the aftermath of strong economic data. The long end of the curve, measuring nominal GDP growth expectations, moved up. Shouldn’t this be a good thing? At normal equity valuations, yes. At stretched valuations, it provoked a re-pricing. It is a valuation story, not an economic one.
- Earnings season kicks off this week with a glut of financial companies reporting. Expectations are that full-year 2024 saw 4.1% revenue growth and 9.5% earnings growth and that earnings growth for 2025 will be around 13-15%. At $273 of S&P earnings for the year, if that very optimistic number happens, from where markets started this morning after last week’s sell-off, that forward multiple is still 21.3x.
- The ten-year bond yield closed today at 4.78%, flat on the day
- Top-performing sector for the day: Energy (+2.25%) – also best performer YTD
- Bottom-performing sector for the day: Utilities (-1.19%)
- Only 17% of S&P 500 companies are currently above their 50-day moving average right now, indicating the breadth of the recent sell-off. Combine that with a skyrocketing in the put-call ratio, and contrarians have a few things to like
- 41% of S&P 500 company revenue comes from countries outside the United States. American markets have outperformed Europe, China, and emerging markets for quite some time, but much of that is because a lot of “international” business is embedded in “American” companies.
- TIP spreads show inflation expectations are only up 0.21% since the Fed began raising rates, but the 10-year yield is up 100 basis points. In other words, the vast majority of the move is REAL economic growth expectations.
Top News Stories
- The gruesome and devastating fires in Southern California remain the major story of the news, with the footprint of the devastated areas now larger than many major cities around the country. The recovery is going to be among the largest and most expensive in our nation’s history.
- Nominee hearings for key cabinet positions begin tomorrow and will go throughout the week
Public Policy
- Sixteen Republican members of the House from New York, California, and New Jersey met with President Trump this weekend to discuss the future of the SALT deduction and their desire that its cap be substantially increased. Indexing the cap to inflation appears to be one solution being discussed, as well as “finding a number” to increase above the current $10,000 level that can work in the reconciliation process. One suggestion raised this weekend that I had not heard of before was maintaining a limit on the property tax portion of the deduction but lifting the cap on the state income tax deduction. It all appears to have the President-elect’s support if it can be made to find consensus with the GOP majority of Congress. In other words, I don’t think he cares much about the details – he wants something changed and wants the House GOP members of these states to figure out what it should be that can actually work in reconciliation and with the voting members of Congress.
- Another factor to keep in mind as some increase to the SALT deduction cap is considered: The 2017 tax bill’s AMT relief (alternative minimum tax) that was a big offset to many high earners in high tax states is currently part of the sunsetting provisions going scheduled to go away at the end of 2025
- At President Trump’s inauguration in 2017, he had filled 25 appointments (no typo) of the thousands of open spots required to be filled by the new administration. Going into next week’s inauguration, two thousand positions have been filled.
- The so-called Department of Government Efficiency (DOGE), which begins formal interaction with government agencies next week, remains an advisory body serving at the pleasure of the President with no authority to cut spending. That said, the recommendations it makes for cuts to programs in which it finds waste and inefficiency are likely to receive serious political traction. The team who has been assembled to work for DOGE are unpaid “special government employees” who cannot work more than half a year by law (and that work is volunteer). The expectation out of this structure is that DOGE will have its first six months to launch substantial recommendations. It appears that DOGE will be housed inside the OMB (Office of Management and Budget). Right now, it is working out of the Space X offices in Washington, D.C. It is an element of activity I will be watching very closely in the first weeks and months after the inauguration.
- Three states, the lowest in Senate history, have two members of different parties (Maine, Wisconsin, and Pennsylvania). 47 states have two Senators aligned with the same party
Economic Front
- The jobs report came in better than expected Friday, which naturally led to a market sell-off (the horror of people having jobs!). The increase was 256,000 vs. expectations of just 165,000. The vast majority of the new jobs were private sector jobs, and education, health care, hospitality, retail, and professional services all meaningfully shared in the positive increase.
- Retail Sales had a strong report last week, as well, as did the Prices Paid for ISM Services. Restaurant bookings are the highest since COVID,
- Bankruptcy filings are extremely low and new business formation is very high.
- American economic optimism (TIPP Economic Optimism Index) reached its highest level in 3.5 years
Housing & Mortgage
- If the point of the Fed cutting short-term rates is to bring mortgage rates down, it has, ummmm, not worked. The 30-year essentially went from 7% before rate-cutting began down to 6% and now sits back around 7%. Housing prices have not dropped from the higher mortgage rates as the majority of American homeowners still have homes with mortgages below 4%. Instead, that dynamic has frozen many sellers and prevented a lot of activity from happening.
Federal Reserve
- The futures market assures us of what is essentially a 0% chance of a rate change in the January 29 FOMC meeting. Right now, there is a 34% chance that the futures market will not have further rate changes all year. The probability is 40% of only one additional rate cut by the end of the year and 25% of two or more rate cuts. I expect the futures curve of expectations to change a bit in the months ahead.
Oil and Energy
- WTI Crude closed at $78.74, up +2.82% on the day
- With the S&P down nearly 2% last week, MLPs and midstream were up about half a percent on the week and have remained up over 2.5% since the new year began.
- As midstream analyst Howard Hinds said in a recent report, “At various points in its 4-year run, midstream has been the growth trade, the value trade, the scarcity trade, and the safety trade.”
- Oil prices are up +12% in the last few weeks, and a big part of the reason is new sanctions imposed on Russia that are keeping ships from transporting Russian oil, forcing China and India to buy elsewhere.
Ask TBG
| “I’ve noticed that CAPEX to price of the S&P 500 has been declining since at least the mortgage crisis (about half of what it was then). With the exception of COVID, earnings growth for the same period has remained close to the mean. How can we expect higher economic and earnings growth without increasing capital investment?” ~ Mike M. |
| Capital expenditures are one of many important components in driving productivity. In theory, I have no problem believing that we can generate more profits with less capital expenditures when a greater share of the economy and market becomes less capital intensive. However, those areas that have less capital intensity only get cultivated after some investment, and as we see now, even light capital intensity businesses like technology have become in desperate need of capital expenditures (i.e. AI). It is a mistake to view capex on an island – there are other forms of business investment besides capital goods. Research & Development is outside the technical definition of capex much of the time but can drive success in health care, pharmaceuticals, some elements of technology, consumer products, etc. So at the end of the day, capex is vital, but I do not believe a historical ratio applies. We need more business confidence, we need more capital investment, we need more capital formation, we need more risk-taking, we need more productivity, and we need more economic growth. I would suggest the biggest reason for a decline in post-GFC capex was monetary policy. Rates below the natural rate incentivize leverage of incumbent assets, not production of new ones. |
On Deck
- Earnings season launches this Wednesday. Clients will receive their Weekly Portfolio Holdings Report this Wednesday.
Do not miss the Year Ahead paper, and have a great Monday night.
With regards,
David L. Bahnsen
Chief Investment Officer, Managing Partner
dbahnsen@thebahnsengroup.com
The Bahnsen Group
www.thebahnsengroup.com
The Dividend Cafe features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet.
