Investors Remain Upbeat Despite Government Shutdown

Investors have stayed optimistic throughout September and into October as enthusiasm for the AI data center buildout has swamped whatever fears investors may have had about the federal government shutdown, which is now sixteen days old.   Stocks have been hovering near record highs as a string of deal announcements from tech companies has kept equity investors feeling good about future growth. Bond investors are also in good spirits, as U.S. Treasuries have been strong (with prices up and yields down) in recent weeks, with the 10-year Treasury closing today with a yield of 3.96%, the lowest yield in about a year.  High bond prices and lower yields can indicate that investors expect slower growth ahead, but also that they perceive inflation to be under control.

Stocks are Expensive, but Quality is High

Stocks are trading at near-record highs and commanding robust valuations. With stocks trading at around 24 times the next 12 months of expected profits, they are trading at about a 30% premium to the 10-year average forward price-to-earnings (P/E) multiple of 18.  However, the companies atop the S&P 500 leaderboard today (mainly the largest tech companies) not only have very strong profit margins, but also have posted exceptional growth and are expecting more of the same in the coming years.  Thus, some premium to the average P/E seems warranted to account for the higher quality and more assured long-term growth trajectory of our largest and most successful companies. Should it be 30%?  No one knows.

Earnings Season Off to a Good Start

The third quarter earnings season kicked off this week with reports from the country’s biggest banks, including JP Morgan Chase, Morgan Stanley, Goldman Sachs, Bank of America, Citigroup and Wells Fargo.  The reports and outlook from these huge banks are seen as good barometers for corporate activity (mergers, acquisitions and IPOs) as well as consumer spending and credit trends.  All these companies reported strong results and provided constructive outlooks for the coming quarters.

More Fed Support on the Way?

Investors are expecting the Federal Reserve to cut interest rates at least three times over the coming months.  Whether the Fed does this or not will depend primarily on the future trends of two data sets: the jobs numbers and the inflation numbers.  Recently the job market has been weakening, and the Fed seems to have turned its attention to supporting the labor market rather than fighting inflation. (It cannot do both at the same time, as raising interest rates fights inflation while lowering interest rates supports the economy and, by extension, the labor market.). A potentially nettlesome development for the Fed would be for inflation to start heading back up while the economy weakens.  This is the dreaded stagflation scenario, and it is very difficult for the Fed to combat this problem with the tools at its disposal.  So far, the flow-through of price pressures from tariffs has been muted, but ultimately the tariffs’ impact will probably become evident in slightly higher consumer prices, lower corporate margins and dampened consumer spending.  We expect these impacts to become clearer in the next six months now that companies are beginning to pass along their higher costs to consumers.

As always, we welcome your comments and feedback.  Please contact us if there is anything you would like to discuss about your investments or the markets.

Photo by Placidplace