Wall Street Exclusive – An Election That Will Matter (NYSEARCA:SPY)

« Inflation is a form of tax, a tax that we all collectively must pay. » – Henry Hazlitt

“Never make excuses. Your friends don’t need them and your foes won’t believe them.” – John Wooden

Welcome to another Seeking Alpha Wall Street exclusive. As the year unfolds, investors will be inundated with commentary and soon realize that this election will have implications for the US macroeconomy and equity markets.

This report should not be construed as a political statement or opinion. It is based on factual (historical) data from reliable sources and commentary from each party on their projected policies. If anyone finds anything is non-factual in this missive, please bring it to my attention, and it will be removed.

Much of the 20% run-up in stocks last year and the 10% so far this year has hinged on the market seeing a positive fundamental backdrop: reasonable economic growth, solid earnings growth, inflation down from peak levels but sticky, and a Fed largely on hold. The question now is, “What next?” Like what we discussed last week regarding AI, the political cycle will now be part of the MACRO INVESTMENT scene—ignoring it as part of the market backdrop is avoiding history and fact.

With the election cycle entering its last five months, markets will spend more time assessing and discounting the various options, meaning Trump or Biden. However, over the long haul, who the President is matters less if you stay fully invested, but it’s obvious that the outcome will likely ‘devastate’ the emotions of about half of the country. In the short term, government policy can impact markets and specific sectors. This year’s election might matter more than usual, and which party controls Congress will have much to say about « policy » in the future.

It becomes a huge issue because the economic policy differences between the two candidates are stark, especially on crucial market issues like tax policy, business sentiment, regulation, immigration, foreign policy, and trade.

Many research forms are already out with their forecasts, stating what sectors will do better than others depending on who wins. It’s not worth the time to ponder that and reinforce what is more important: what party controls Congress. Again, there is no need to spend excessive time on the topic because, similar to the presidential race, the House and Senate races are very close, and so much can change in the next five months. Rest assured, things will start getting even more heated politically in the months ahead, and we’ll see market reaction just as we have seen in every other presidential election year.

Here is some historical election data to set the tone. According to Gallup, President Biden’s 38% approval rating at this point in his Presidency ranks lower than any other US President (Carter held that distinction) at the equivalent point in their term in office since at least Eisenhower in 1948 (chart below).

The consumer confidence survey has matched the polling data for the last two-plus years. It is all about the economy, and despite what seems to be a decent backdrop, there are nagging problems under the surface. There is no need to go into every minor detail, so we’ll look at the most important data point.

For the average American, it’s ALWAYS been about how far their paycheck will take them. While earnings have grown 18.5% during Biden’s tenure (4th best of any President shown), in terms of average hourly earnings, the impact of inflation is even more pronounced, as inflation has erased all of the gains.

The bottom line is that the average consumer has made no progress despite healthy wage gains and is basically running in place. The headlines about the decrease in inflation growth are real but don’t tell the true story. The average consumer doesn’t care that inflation growth has slowed. That is meaningful ONLY to the economists who want to track the data.

To the consumer, it isn’t very meaningful, as they are impacted by the actual cost of everything TODAY, and in just about every case, it’s higher than it was three years ago. The headline should be about ’embedded’ inflation that keeps current costs high. Of course, the only people that will state that publicly are those that look at the reality of the situation.

Based on what voters have heard or read from each candidate, there are STARK differences that voters/investors will face.

On the one hand,

Raise corporate and individual taxes.

An anti-business climate that includes a war on fossil fuel companies

Retain green energy spending at high levels.

Increasing the rolls of illegal migrants by keeping the US border open,

On the other,

Keep the 2017 corporate and individual tax rates in effect.

A pro-business backdrop with fewer regulations, a lean back to US energy independence

Limit green energy spending

Close the US border, allowing only legal migration.

The Market Cycle Leading Up To The Election

Let’s look at the market history leading up to the election. The charts below show a composite of the S&P 500’s performance during Presidential election years, with the five months leading up to Election Day colored in dark blue.

Heading into that five-month home stretch, the S&P 500 is typically at its highs of the year, but throughout those summer/early fall months, stocks don’t make a ton of headway. That’s not to say that the five-month period is weak, though. Of the 19 Presidential Election years since 1948, the S&P 500’s average performance has been +2.2%, with gains 15 out of 19 times (79%). Not only that but even including 2008, the maximum upside during the five months (+6.4%) has been greater than the maximum downside (-6.0%).

That’s another reason not to let our emotions or political preferences rule the market strategy. With less than six months to the election, political developments will matter more than usual in the near term. And there’s plenty of time between now and then for the likely election outcome to shift. So stay grounded and avoid the noise.

The Week On Wall Street

After a quiet start to the day, buyers stepped in and sent the S&P 500 to its 5th new high in the last six trading days, rising 0.77%. Daily breadth was positive for the first time in four trading days. Of the eleven sectors, eight were higher on the day. Those that fell were all defensive in nature with Utilities the single largest decliner, falling 1.14%. Consumer Discretionary and Tech continued to lead with gains of 1.18% and 1.43%, respectively.

The new high parade continued Tuesday as the S&P (#31) and NASDAQ Composite (#19) posted modest gains. The NASDAQ has made seven straight days of new highs, and the S&P has made six out of the last seven days with records. The only sectors lower on the session were Communication Services, Consumer Discretionary, and Materials, while Financials, Tech, and Industrials outperformed with gains of more than 0.5%.

Trading resumed after the mid-week holiday break, and it was a ‘reversal’ of sorts as the HOT S&P and NASDAQ cooled off while the laggard DJIA index added 300 points on the day. Investors watched the S&P 500 pivot off a record high, dropping 0.25% for its largest daily decline since May 30th. The Nasdaq underperformed, falling 0.79%, as Technology was the worst-performing sector, falling 1.6%. Energy was the best-performing sector, rising 1.86%, gaining 3+% for the week.

After Thursday’s reversal, the indices meandered around the flatline on Friday, with the DJIA and Russell 2000 (IWM) posting modest gains while the S&P 500 and the NASDAQ Composite posted modest losses. The S&P (three in a row), DJIA, and the Russell 2000 posted weekly gains, while the NASDAQ was flat.

The Economy

Manufacturing

The Empire State manufacturing index bounced 9.6 points to -6.0 in June, better than expected. This follows the 1.3-point drop to -15.6 in May. This is the seventh straight month of contraction. The components were mixed.

Philly Fed’s manufacturing index dipped 3.2 points to 1.3 in June, weaker than forecast. This is on top of the 11-point drop to 4.5 in May, unwinding most of April’s 12.3 jump.

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This is the lowest since January. However, the components were mixed.

US Flash PMI

Composite Output Index at 54.6 (May: 54.5). 26-month high.

Services Business Activity Index at 55.1 (May: 54.8). 26-month high.

Manufacturing Output Index at 51.9 (May: 53.0). 2-month low.

Manufacturing PMI at 51.7 (May: 51.3). 3-month high.

Investors are once again faced with a decision on what data is meaningful. LEI and manufacturing reports indicate a weakening economy and potential recession, while PMI readings offer a different picture.

Housing

Housing starts slid 5.5 % to 1.27 million in May, well below estimates and the slowest since 2020. Single-family starts were down 5.2% to 0.98 million after dipping 0.5% to 1.03 million. Multifamily starts tumbled 6.6% to 0.29 million from the 22.5% surge to 0.31 million in April.

Building permits fell 3.8% to 1.38M, following the 3.0% prior drop to 1.44 M.

The Global Economy

China Monthly Activity Data.

Monthly industrial production and retail sales were released overnight. Industrial activity rose almost 4% annually, following a very strong April reading (itself a bounce-back from a very weak March). Retail sales were stronger, rising 6% annualized and at the fastest pace since October 2023.

The UK

The last major central bank decision was from the Bank of England, which left rates on hold at 5.25% as expected in a 7-2 vote.

Global PMIs

Overnight, we got preliminary (~85% of respondents) PMI data from Markit for Australia, Japan, India, France, Germany, the Eurozone, and the UK.

Only India and the UK saw improvements, and Services PMIs were universally weaker.

The Macroeconomy

This section presents a series of issues that may not necessarily impact the market today but can pose problems for the MACRO scene.

The Fed

Fed officials upgraded their 2024 growth estimate from 1.4% to 2.1% at the March meeting and maintained above-trend projections for 2025 (+2.0%) and 2026 (+2.0%). The data released since the last FOMC meeting (May 1) has seen a downward revision to Q1 GDP (from 1.6% to 1.3%), softer consumer spending (including a retail sales miss), and anecdotal reports of businesses needing to offer incentives to spur sales. While growth should moderate in the coming quarters, a soft, non-recessionary landing remains the Fed’s (and our) base case. The Fed’s updated growth projections should not move much from their current level and remain near potential in a 1.9% to 2.1% range.

In March, the Fed projected that inflation (measured by the core PCE price index) would slowly decline from 2.6% in 2024 to 2.0% by 2026. The latest FOMC commentary confirmed that. Many economists continue to state that the pendulum is swinging back the other way. With growth slowing and the labor market moving into balance, the threat of reaccelerating inflation has diminished. It has been their base case scenario for over a year, and it’s been incorrect.

While we have seen improvement with the inflation problem, the wild card still is energy costs. While I do not see them going lower anytime soon, they can spike higher, given the fundamental global energy policy.

An army of analysts still suggests that current economic conditions will warrant ~2 cuts this year, starting as early as July (more likely September).

They reason these will be ‘insurance cuts’ is to help the economy avert a recession. They have been wrong for over two years now regarding rate cuts, so I see no reason to enter into debate. This could be more wishful thinking, and it doesn’t align with the Q2 survey of economists.

The economy will expand at an annual rate of 2.1 percent this quarter and 2.0 percent next quarter, up from the predictions of 1.5 percent in the last survey. On an annual-average over annual-average basis, the forecasters expect real GDP to grow at an annual rate of 2.5 percent in 2024 and 1.9 percent in 2025. These annual projections are 0.1 percentage point higher than the previous estimates of three months ago. »

This debate was resolved at the latest FOMC meeting when Chair Powell announced ONE rate cut in ’24. Nevertheless, the Fed funds futures are pricing in two cuts, as investors seem not to believe the data.

Whatever the case, I’ll offer that a 25—or even a 50-basis point cut won’t affect the economy this year. This entire Fed rate cut mania is absurd. If the economy is going to slow that dramatically, these cuts won’t avoid a recession. If anything, they increase the chance for inflation to remain well above target.

On that note, according to data compiled by StLouisFed.org, average hourly wages run at +4.1% y/y.

The scene is about 0.5%-1.0% “too hot” on wages for a typical 2% inflation environment. This and other factors make interest rate cutting tricky and dangerous if done too soon.

Minimum Wage and Spending

Because the « promise » of anything sounds so good, Leaders like to ACT before they THINK. Such is the case regarding the minimum wage for healthcare workers in California, which is set to rise to between $18 and $23 an hour on June 1st. California’s current minimum wage for all workers is $16 an hour. Nearly all workers at healthcare facilities, including janitors, will have to be paid at least $25 an hour by 2028.

However, Governor Newsom and California’s Legislature scrambled to delay the state’s higher healthcare minimum wage. When Newsom presented his latest budget proposal last week, the governor said negotiations around potential changes to the health worker minimum wage law, Senate Bill 525, are still taking place and will now be addressed when the next fiscal year budget is signed in late June.

This walkback on promises is due to the state’s budget deficit ballooning to $45 billion. California now projects that the new healthcare minimum wage would cost the state $4 billion more yearly, owing to higher Medicaid costs and compensation for workers at state-owned facilities. This latest proposal comes right after minimum wage increases for fast-food workers in California rose from $16.hr to $20/hr. Just two months in, more than 10,000 workers have been laid off. Menu prices are hiking 8% or more, affecting customers who are already struggling. Chipotle is planning another 9% price hike in California — its 5th hike in 2 years. Hollywood’s iconic Arby’s is closing after 55 years, citing inflation and the new $20 minimum wage.

This isn’t a debate about whether these workers deserve higher wages. It’s a debate about fiscal responsibility and priorities. If we want higher wages for these workers, then cut back on the green initiative mandates that are a large part of the budget deficit. Eliminate the wasteful California Climate Commitment, which will cost 54 Billion and hasn’t produced any measurable results.

At some point, governing bodies will realize they can’t have both. Of course, if they continue spending, everyone will lose. Unfortunately, that is the road we find ourselves on today.

The Election and Taxes

In last week’s « election » update, the policy differences between the two candidates were highlighted, and in my view, the most critical difference is the outlook for taxes. » I’ll start the discussion by stating the obvious. There has NEVER been an instance in history where anyone grew their economy by raising taxes.

The Tax Cuts and Jobs Act of 2017 lowered the corporate rate from 35% to 21%. It spurred businesses’ investment in innovation, technologies, software, equipment, and facilities. More importantly, it restored U.S. corporations’ international competitiveness by reducing the corporate tax, a stealth levy on workers’ wages.

Economists like to discuss the outsized wage growth that the US has experienced in the last two years but shy away from mentioning that all of the wage gains have been offset by inflation, making the « net » gain nil.

From January 2018 to January 21, the 9% increase in inflation-adjusted earnings was the fastest growth since the government began publishing data in 1979. The corporate rate cut has been the wind at American workers’ backs for years. While some will debate this, in my view, it was THE primary reason corporate America was strong enough to withstand a total shutdown of the economy during COVID-19. Companies handcuffed with higher taxes are weaker, and at the end of the day, everyone loses. What can’t be debated is tax cuts’ positive impact on government receipts. While the critics complain that giving tax cuts adds to deficits, the exact opposite is true. Government receipts rocketed to all-time highs.

The administration’s own forecast from the OMB (Office of Management and Budget) tells a similar story. Under current law, corporate tax revenues will climb to 1.63% of GDP in 2025. Government revenues were $3 trillion through April, an increase of 10% over the same period last year.

After the election, if taxes are raised as proposed, the corporate rate and state taxes would make the U.S. the second-highest-taxing nation among the 38 members of the Organization for Economic Cooperation and Development. The average corporate rates in the OECD and European Union are 23.7% and 21%, respectively. It would serve no one except our international competitors if the U.S. reverted to an uncompetitive tax code. Under this scheme, the U.S. tax would also significantly exceed China, an adversary bent on dominating U.S. manufacturing and advanced technologies.

This is a pivotal moment for the US macroeconomy. The next administration’s direction will set the tone for whether the US experiences real growth or returns to stagnation experienced from 2010 to 2017.

Reducing the hundreds of billions tossed at green initiatives ends any discussion about touching entitlements such as Social Security. Budget deficits are due to spending—period—end of conversation.

Please note: These aren’t opinions but FACTS gathered from government data sources.

Sentiment

Have you ever seen the CNN Fear and Greed Index displays FEAR as the S&P made several new highs in succession?

CNN’s Fear & Greed index measures several market indicators to measure investor enthusiasm. It’s actually in “Fear” territory right now.

The breadth readings that go into CNN’s index have gotten so bad that they have pushed the overall gauge into “Fear” territory. A contrarian would view this as bullish. Another view that comes to mind is « bizarre. »

Speaking of strange, the S&P 500 rallied 1.58% for the week, yet just 183 stocks in the index finished the week in positive territory, and only 99 stocks outperformed the index. That’s the definition of a top-heavy market.

The Daily chart of the S&P 500 (SPY)

The holiday-shortened week saw two more new highs for the S&P 500 before buying faded at the end of the week.

There is still plenty of room for 104 points or a mere 2.4% from Friday’s close. There should be no talk about a correction until the index drops to the next level of support at the 50-day moving average of 5232.

Investment Backdrop

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