A version of this post first appeared on TKer.co
After hitting a few bumps over the past month, the bull market resumed and stocks hit record highs last week.
This happened despite some notable headwinds intensifying in recent months.
Long-term interest rates, while off their highs, remain above levels we’ve experienced in recent years. This is a headwind for anyone needing to borrow money or refinance debt.
On the short end of the yield curve, expectations for rate cuts from the Federal Reserve have been coming down, a hawkish development that has market bears salivating.
The U.S. dollar, meanwhile, has appreciated significantly against many major foreign currencies. This is a headwind for multinational U.S.-based corporations doing a lot of business in non-U.S. markets.
All of this has been occurring as valuation metrics like the price-to-earnings (P/E) ratio suggest the stock market is expensive relative to history.
Higher interest rates, fewer Fed rate cuts, a strengthening dollar, and elevated valuation ratios are all things that many market pundits will cite as reasons to be cautious on the stock market.
While it’s fair to argue these developments are indeed challenges, none of it means prices must fall.
The bottom line
There are plenty of reasons to explain why the stock market would trend higher despite the challenges. Maybe the market expects the headwinds to be short-lived. Maybe the market expects these headwinds to be offset by other tailwinds. Maybe the market is just being irrational right now and will correct in the near future.
Something I’ve been stressing in recent pieces about interest rates, Fed rate cuts, and the dollar is that none of them will reliably signal where the stock market is headed in the next year.
And importantly, each one is just one of many forces that can affect the outlook for earnings growth — which is the most important driver of stock prices. As I laid out in TKer Stock Market Truth No. 5: News about the economy or policy moves markets to the degree they are expected to impact earnings. Earnings (a.k.a. profits) are why you invest in companies.
Two weeks into Q4 earnings season, most companies are reporting results that are beating expectations. And the outlook for earnings growth continues to be very positive.
Critically, this has been supported by robust profit margins. Companies have been reporting improving profit margins in Q4, and analysts continue to forecast fatter profit margins in the quarters to come.
Corporate executives and industry analysts all seem to agree that business prospects continue to look up.
For investors, the question is not whether some development will be a headwind for the stock market. Rather, investors should be asking if the companies underlying the market can overcome the headwind and deliver on earnings.
Review of the macro crosscurrents
There were several notable data points and macroeconomic developments since our last review:
Card spending data is holding up. From JPMorgan: As of 17 Jan 2025, our Chase Consumer Card spending data (unadjusted) was 4.8% above the same day last year. Based on the Chase Consumer Card data through 17 Jan 2025, our estimate of the US Census January control measure of retail sales m/m is 0.66%.”
From BofA: Total card spending per HH was up 5.6% y/y in the week ending Jan 18, according to BAC aggregated credit & debit card data. The South & MW saw a large y/y rise in total card spending, payback for the snowstorm-driven decline in the previous week.
Consumer vibes sour. From the University of Michigan’s January Surveys of Consumers: Consumer sentiment fell for the first time in six months, edging down 4% from December. While assessments of personal finances inched up for the fifth consecutive month, all other index components pulled back. Indeed, sentiment declines were broad based and seen across incomes, wealth, and age groups.”
Consumer sentiment readings have lagged resilient consumer spending data.
Politics clearly plays a role in peoples’ perception of the economy. Just look at inflation expectations by party affiliation.
Home sales rise. Sales of previously owned homes increased by 2.2% in December to an annualized rate of 4.24 million units. From NAR chief economist Lawrence Yun: Home sales during the winter are typically softer than the spring and summer, but momentum is rising with sales climbing year-over-year for three straight months. Consumers clearly understand the long-term benefits of homeownership. Job and wage gains, along with increased inventory, are positively impacting the market.”
Home prices rise. Prices for previously owned homes declined from last month’s levels but were above year ago levels. From the NAR: The median existing-home sales price progressed 6.0% from December 2023 to $404,400, the 18th consecutive month of year-over-year price increases and biggest year-over-year growth since October 2022 (+6.5%). All four U.S. regions posted price increases.”
Mortgage rates tick lower. According to Freddie Mac, the average 30-year fixed-rate mortgage declined to 6.96% from 7.04% last week. From Freddie Mac: After crossing the 7%-mark last week, the 30-year fixed-rate mortgage saw its first decline in six weeks. While affordability challenges remain, this is welcome news for potential homebuyers, as reflected in a corresponding uptick in purchase applications.”
There are 147 million housing units in the U.S., of which 86.6 million are owner-occupied and 34 million (or 40%) of which are mortgage-free. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged from 2021 lows. All of this is to say: Most homeowners are not particularly sensitive to movements in home prices or mortgage rates.
Gas prices rise. From AAA: Despite easing oil costs and lackluster domestic gasoline demand, pump prices eked out a three-cent gain since last week to $3.13. …According to new data from the Energy Information Administration (EIA), gasoline demand fell from 8.32 million b/d last week to an anemic 8.08 million. Meanwhile, total domestic gasoline stocks rose from 243.6 million barrels to 245.9, while gasoline production decreased last week, averaging 9.2 million barrels per day.”
Unemployment claims tick up. Initial claims for unemployment benefits rose to 223,000 during the week ending January 18, up from 217,000 the week prior. This metric continues to be at levels historically associated with economic growth.
This is the stuff pros are worried about. According to BofA’s January Global Fund Manager Survey: 41% of January FMS respondents say inflation causing the Fed to hike is the biggest ‘tail risk’, followed by a recessionary trade war.”
Offices remain relatively empty. From Kastle Systems: Peak day office occupancy was 61.6% on Tuesday, up more than five points from the previous week as workers continued to return to the office after the holidays. The average low was on Friday at 30.6%, up 4.3 points from last week.”
Surveys point to cooling growth. From S&P Global’s January Flash U.S. PMI: US businesses are starting 2025 in an upbeat mood on hopes that the new administration will help drive stronger economic growth. Rising optimism is most notable in the manufacturing sector, where expectations of growth over the coming year have surged higher as factories await support from the new policies of the Trump administration, though service providers are also entering 2025 in good spirits. Although output growth slowed slightly in January, sustained confidence suggests that this slowdown might be short-lived.
Keep in mind that during times of perceived stress, soft survey data tends to be more exaggerated than actual hard data.
Near-term GDP growth estimates remain positive. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 3.0% rate in Q4.
Putting it all together
The long-term outlook for the stock market remains favorable, bolstered by expectations for years of earnings growth. And earnings are the most important driver of stock prices.
Demand for goods and services is positive, and the economy continues to grow. At the same time, economic growth has normalized from much hotter levels earlier in the cycle. The economy is less coiled” these days as major tailwinds like excess job openings have faded.
To be clear: The economy remains very healthy, supported by strong consumer and business balance sheets. Job creation remains positive. And the Federal Reserve — having resolved the inflation crisis — has shifted its focus toward supporting the labor market.
We are in an odd period given that the hard economic data has decoupled from the soft sentiment-oriented data. Consumer and business sentiment has been relatively poor, even as tangible consumer and business activity continue to grow and trend at record levels. From an investor’s perspective, what matters is that the hard economic data continues to hold up.
Analysts expect the U.S. stock market could outperform the U.S. economy, thanks largely due to positive operating leverage. Since the pandemic, companies have adjusted their cost structures aggressively. This has come with strategic layoffs and investment in new equipment, including hardware powered by AI. These moves are resulting in positive operating leverage, which means a modest amount of sales growth — in the cooling economy — is translating to robust earnings growth.
Of course, this does not mean we should get complacent. There will always be risks to worry about — such as U.S. political uncertainty, geopolitical turmoil, energy price volatility, cyber attacks, etc. There are also the dreaded unknowns. Any of these risks can flare up and spark short-term volatility in the markets.
There’s also the harsh reality that economic recessions and bear markets are developments that all long-term investors should expect to experience as they build wealth in the markets. Always keep your stock market seat belts fastened.
For now, there’s no reason to believe there’ll be a challenge that the economy and the markets won’t be able to overcome over time. The long game remains undefeated, and it’s a streak long-term investors can expect to continue.
