Three of the four major market indexes were down about one-half percent for the New Year’s week (ending January 3rd), with the small cap Russell 2000 the exception (up just over +1%).1 As shown in the table, 2024 was a good year for equities with the S&P 500 and the tech heavy Nasdaq showing well over 20% gains. The heavy industrial DJIA and small cap Russell 2000 also performed well, but their 13% and 10% respective gains seem to pale in comparison.2 That’s because neither contain the big tech names (Magnificent 7).
Truly, tech stocks were the drivers in 2024. In fact, on an equal weighted basis, the average Magnificent 7 stock rose more than 60% for the year.3
Some observations:
- All of the Magnificent 7 are currently below their peak prices.
- Five of the seven hit new record highs in mid/late December, with Nvidia peaking in early November and Microsoft in early July (see table).
- For the first two trading days of the new year, the prices of six of the Magnificent 7 stocks rose; the only laggard was Apple.
- The question on traders’ minds is: “Can 2025 replicate 2024, or come close?” Only time will tell!
Divergences
The divergences between what the macroeconomic data say and what we see via a deep dive into the microeconomic sphere are about as great as we have seen at least since the Great Recession. GDP reportedly grew at a +3.1% rate in Q3/’24.4 And forecasts for the just ended Q4 are as high as 2.6% according to the Atlanta Fed’s Nowcast model (recently revised down from 3.1%). (Note: The NY Fed and St. Louis Fed model forecasts are somewhat lower, +1.9% and +1.3% respectively. So, the latter two seem to have views similar to ours.)
According to a Mastercard report, on-line nominal spending was +6.7% higher for the holiday season than it was in 2023, while in-store sales grew +2.9%, making holiday spending +3.8% higher than it was a year ago.5 That’s on a nominal basis. Given the 2.7% rise in the year/year CPI, real spending only rose at a +1.1% rate.6 This simply doesn’t comport with an economy supposedly growing at a +3% clip (real GDP)!
Other Signs
There are other signs on the micro level that indicate economic sluggishness.
- Industrial Production is no higher today than it was in 2022!
- With recent revisions to the employment data, the monthly Household Survey shows that the number of jobs fell by -725,000 over the year ended in November. The “Employed” line in the table below shows 161.866 million people employed in November 2023, and 161.141 million employed a year later (November 2024). That’s a difference of -725,000.
- In addition, the average duration of unemployment for those looking for a job (either laid off or new labor force entrants) now stands at 24 weeks according to Rosenberg Research (Breakfast with Dave, 12/31/24). It was at that level in May, 2019. Back then, the Fed cut the Federal Funds Rate from 2.5% to 0.25% over the next ten months.7
- From BLS’ JOLTS (Job Openings and Labor Turnover Survey), the number of job openings is now back down to its pre-pandemic level (see chart). If the recent downtrend continues, and we believe it will, then we are likely to see both a higher unemployment rate and a continuation in the lengthening of the duration of unemployment (i.e., the number of weeks spent looking for a job).
- Of greater concern is the rise in credit card delinquencies and defaults. The left-hand side of the next chart shows the significant rise in delinquencies in 2023 and continuing in 2024. The right-hand side shows a spike in actual defaults (i.e., write-offs) from relatively low levels in 2022.
- As one would expect, auto loan delinquencies have also spiked and are now at a post-pandemic high.
The Fed & Inflation
Against the backdrop of diverging macro and micro economic data, the Fed has become increasingly hawkish, causing interest rates to spike. Per David Rosenberg’s New Year’s Eve blog, “The Fed has decided … to ease policy and tighten policy both at the same time – cut rates but offer up hawkish guidance, and it is the latter that has dominated the landscape for the treasury market over these past three months … Bond yields haven’t backed up because of inflation, they have surged because the Fed has …played the role of Lucy with the football, while investors played Charlie Brown.” (Rosenberg, Breakfast with Dave, December 31, 2024).
The Fed looks to us to have been spooked by the slight uptick in inflation shown on the far right-hand side of the CPI chart.
As we have written in our past blogs, the CPI is destined to fall below the magic 2% level simply due to rents. In the CPI, rents have a 35% weight.8 The Bureau of Labor Statistics (BLS) uses rental data that is lagged nearly a year. As seen in the National Rent Index chart, rents have now been falling for a year, and that is destined to push CPI lower – we think under the 2% year/year Fed target – sometime this quarter (Q1/25).
As a result, we see the recent spike in interest rates as an aberration. The current Fed Funds target rate is 4.25%-4.50%. The Fed’s hawkish rhetoric has the market believing that, over the next year, the Fed Funds rate will barely get below 4%. The right-hand side of the above chart shows the market’s view of where the Fed Funds Rate will be in one year. Note that in September, the market believed that the Fed Funds Rate would be below 3% a year hence. Contrast that with the 4% current view, indicating the market’s belief that there will only be one or two 25 basis point (0.25 pct. points) rate cuts in 2025.
Our view is much more sanguine. The lagged impact of falling rents will soon show up in the CPI and the year/year inflation rate will be 2% or lower by the end of Q1/’25. Furthermore, the Fed has told us that in their view a “neutral” (neither accommodative nor restrictive) Fed Funds rate is at or below 3%. Thus, as the economy slows, the Fed will want to move its target Fed Funds rate at least to the “neutral” zone (below if a Recession occurs).
Final Thoughts
2024 was a great year for equities with all the major indexes rising double digits. December was particularly kind to the Magnificent 7 with five of the seven hitting record highs.
We currently see divergences between the ebullient macroeconomic data, and the not-so-great micro indexes. Early indications are that holiday spending in real, inflation adjusted terms, only rose at a 1% rate.9 That won’t be enough to maintain the 3%+ GDP growth rate of Q3. In fact, the St. Louis Fed and NY Fed GDP models indicate Q4 economic growth was less than 2%. And even the always optimistic Atlanta Fed recently reduced their Q4 GDP growth estimate below 3% to 2.6%.
Industrial Production continues to be flat, and the jobs numbers have been revised down significantly. From the Household Survey, the economy lost -725,000 jobs in the year ended in November. Job openings, too, are falling. So, it isn’t any wonder that the duration of unemployment (how long it takes to find a job) has risen.
Further divergencies from the seemingly strong macroeconomic data are found in consumer loan delinquencies. Credit card and auto loan delinquencies have spiked upward, and along with those, so have consumer loan write-offs.
Given this backdrop, it is puzzling why the Fed has become hawkish, especially with its verbal guidance. As a result, bond yields, as indicated by the 10-Year Treasury, have backed up 100 basis points (1 percentage point) from the 3.6% area in September to 4.6% as of the close of business on January 3rd.
Because of the underlying weakness we see in the disaggregated data, it is still our view that, by the end of Q1, year/year inflation readings will be at or below the Fed’s 2% goal. As a result, we believe that the Fed Funds rate will be at or below “neutral” (3%) by year’s end. That’s a whole percentage point (100 basis points) lower that what the bond market has currently priced in.
(Joshua Barone and Eugene Hoover contributed to this blog.)