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Wed, September 27 at 8:00PM ET

Progress Toward a Debt Ceiling Resolution


A debt ceiling deal … PCE inflation surprises to the upside … bets on another rate-hike jump … mixed signals on the U.S. economy … are we about to see a stock market melt-up?

Over the long weekend, President Joe Biden and House Speaker Kevin McCarthy signed off on a debt ceiling agreement that would avoid, as Biden put it, “a catastrophic default.”Big picture, the bill would suspend the $31.4 trillion debt ceiling until Jan. 1, 2025, something that Democrats want. In exchange, non-defense discretionary spending would be “roughly flat” at current year levels in 2024 and only rise 1% in 2025. This is something Republicans wanted.As we stand now, the House is expected to vote on the measure tomorrow. Speaker McCarthy said he anticipates more than 95% of House Republicans will support the bill.On the other side of the aisle, Rep. Ro Khanna, D-Calif., a member of the House Progressive Caucus, has said that a “large majority” of Democrats are “in flux” as to whether to support the bill.Clearly, it’s not a done deal, so we’ll be watching closely for signs of support from both sides.

Meanwhile, last Friday’s PCE data came in hotter than expected, illustrating the challenge of killing off inflation

Let’s go straight to CNBC:

Inflation stayed stubbornly high in April, potentially reinforcing the chances that interest rates could stay higher for longer, according to a gauge released Friday that the Federal Reserve follows closely.The personal consumption expenditures price index, which measures a variety of goods and services and adjusts for changes in consumer behavior, rose 0.4% for the month excluding food and energy costs, higher than the 0.3% Dow Jones estimate.

The index also topped expectations on a year-over-year basis, climbing 4.7%, which was higher than the forecast of 4.6%.The Fed’s preferred “core” PCE number, that excludes good and energy, also was higher than expected. It came in at 4.4% year-over-year, higher than the forecast of 4.2%.

In the wake of the data, Wall Street appears to be doing an abrupt pivot about Fed rate-hike expectations

On Friday, Cleveland Fed President Loretta Mester looked at the PCE numbers and concluded:

When I look at the data and I look at what’s happening with inflation numbers, I do think we’re going to have to tighten a bit more.

Cue a recalibration from Wall Street.For some perspective, only a few weeks ago, the overwhelming odds were that the Fed wouldn’t hike rates another quarter-point at its June 13-14 meeting. As recently as one week ago the CME Group’s FedWatch Tool showed traders were putting 74% odds on such a pause.But following this resurgence of PCE inflation, that confidence has crumpled. The odds of a June pause now clock in at just 39.8%. Instead, traders now put the majority odds – 60.2% – on another quarter-point rate-hike.Frankly, highlighting these odds from Wall Street is now more about entertainment than insight. After all, Wall Street has second-guessed the Fed for over a year and been wrong every time. However, as my fellow Digest -writer Luis Hernandez put it, these odds still provide a great read on the market’s overall mood, even if they’re wrong.But as just one recent illustration of how quickly the mood changed, about one month ago, not only was Wall Street not anticipating another hike in June, there were 22% odds that the Fed would be cutting rates for the first time at the June meeting.At this point, the expectation of higher rates is good for the market, regardless of what the Fed does. If the Fed hikes rates, well, that’s what Wall Street expected. We shouldn’t see any major fireworks in the aftermath. But if the Fed pauses, then the positive surprise will likely juice the market, bringing us a short-term pop.In any case, whether the Fed pauses in June or not, what will really drive a market rally on a sustained basis is rate cuts. And if we take the Fed at their word (as the past year has proven we should, time and time again), then we’re nowhere near such cuts unless the economy falls off a cliff.

On that note, the economy is sending mixed signals about its proximity to any “cliffs”

Let’s jump to Bloomberg for these details:

The government’s two main measures of US economic activity diverged in the first quarter, with one gauge painting a picture of weakness. Gross domestic product rose at a revised 1.3% annualized pace in the first quarter, up slightly from the government’s previous estimate.However, a gauge of the income generated and costs incurred from producing goods and services — gross domestic income — decreased 2.3% after falling 3.3%, the worst back-to-back declines since the start of the pandemic.

So, on one hand, the upward revision to GDP suggests we have a resilient economy that’s more than holding its own despite the Fed’s rate hike campaign.But the two consecutive quarters of falling GDI (gross domestic income) seem to indicate that our economy is losing steam.If we’re looking for a tie-breaker, we can turn to the U.S. consumer.Back to Bloomberg:

American consumers continued to spend on the back of a strong labor market in the early months of the year.Consumer spending was revised higher to a 3.8% rate, according to Commerce Department figures published Thursday. Household spending on services was firmer than initially estimated, while outlays for merchandise were slightly weaker.

And in Friday’s data release, we learned that consumer spending rose 0.8% in April. Even after adjusting for inflation, it rose 0.5%.First, hats-off to the resilience of the U.S. consumer. This continued spending is certainly impressive.But second, for all the pundits looking at this and concluding “no way we can have a recession given this consumer strength,” that’s true…but also incomplete.As of this moment, based on today’s degree of economic strength, we’re not about to fall into a recession.But the very same strength these pundits are applauding will likely result in the Fed raising rates again in either June or July, and then holding them there. And that will continue to weaken the U.S. consumer, who is already showing signs of fatigue.So, declaring that the economy/U.S. consumer is too strong for a recession based on today’s condition is a bit like watching a football game and declaring that your team has won because they’re leading at the end of the third quarter.

Despite that, we could be on the verge of a stock market melt-up

The market roared higher at the end of last week, and you can feel sentiment shifting. The optimism is even spreading to the analyst community.For example, last week, Bank of America analysts raised the firm’s S&P year-end price-target from 4,000 to 4,300, in large part due to the artificial intelligence boom that’s fueling a tech stock surge.It’s not just B of A. Morgan Stanley’s Andrew Slimmon just upped his S&P forecast to 4,600. Why?FOMO (fear of missing out).Here’s Bloomberg:

“If I were a financial advisor and it gets to October, November and I haven’t made money for my clients because I’m heavily in cash, I would start to get nervous,” [Slimmon] said. “My conjecture is that cash starts to get back into the market later into the year.”

If we go to FactSet, their survey of analyst expectations over the next 12 months is even higher:

The bottom-up target price for the S&P 500 is 4705.93.

That’s about 12% higher than where the market trades as I write.Now, when we dig into the details of these anticipated gains, we find an interesting tension surrounding today’s hottest trend, which has been behind the market’s gains so far – AI.

Here in 2023, the market gains we’ve enjoyed come purely from tech (AI in particular)

Those gains are accelerating here on Monday with Nvidia, the poster child for AI, reaching the milestone of a $1 trillion market cap.But again, these gains have not been enjoyed equally across the market.Here’s CNBC to illustrate:

[The stocks of UiPath, Pagaya Technologies, and Exscientia, which are AI companies that have IPO’d in the last three years] have rallied in 2023, up an average 41%, but the seven-largest tech companies, a group that includes Nvidia, have surged an average 58%.“So far, Big Tech has collectively benefited most from the buzz around gen AI. We think this trend will continue given their ability to leverage their global scale and large competitive moats when utilizing this disruptive technology,” DataTrek co-founder Nicholas Colas wrote.“Gen AI may end up making US Big Tech even bigger and more systematically important, rather than allowing upstarts to play the classic role of disruptive innovators.”Indeed, market veteran Art Cashin noted without the big seven stocks, the S&P 500 would surrender all of its 8% gain this year.

The frenzy to get a piece of these gains is creating a new AI-based FOMO. And while we believe that AI will drive trillions of investment wealth in the coming years, be aware of what analysts are predicting for returns in the shorter-term.

If we break down that 12% return that FactSet analysts are estimating for the S&P by sector, the lowest expected return comes from none other than Information Technology

And the highest expected return?Energy, which if you’ve been following has had a rough go of it for a while. To illustrate, XLE, which is the Energy Select Sector SPDR Fund, is down 12% over the last six months.Here’s FactSet:

At the sector level, the Energy (+25.9%) sector is expected to see the largest price increase, as this sector has the largest upside difference between the bottom-up target price and the closing price.On the other hand, the Information Technology (+3.2%) sector is expected to see the smallest price increase, as this sector has the smallest upside difference between the bottom-up target price and the closing price.

These return forecasts make sense when viewed through the lens of “a sector that has already exploded higher probably has less room to run than a sector that has taken a double-digit beating.”To be clear, we are highly bullish on the long-term return potential of top-tier AI stocks. But this is a good reminder that no stock or trend can maintain a vertical climb forever.Speaking of vertical climbs, below is Nvidia’s chart over the last month.

Chart showing Nvidia stock going vertical in the last week of May
Source: StockCharts.com

What you’re seeing will not last. It can’t. Healthy gains need time to consolidate, regroup, and push higher.This is why our analysts, Louis Navellier, Eric Fry, and Luke Lango – though all bullish on AI – are being very deliberate about which specific AI stocks they’re adding to their respective portfolios.AI is not a fad, but there’s froth bubbling in the sector. And even a great AI company can be a less-than-great AI investment if the price tag gets too expensive.We’ll help you navigate this complexity here in the Digest with the help of our analysts.Have a good evening,

Jeff Remsburg

Article printed from InvestorPlace Media, https://investorplace.com/2023/05/progress-toward-a-debt-ceiling-resolution/.

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