As we review the highlights of the third quarter, the biggest surprise of the year is the resilience of the economy. The pandemic stimulus, the effects of on-shoring and re-shoring, and the addition of $3 trillion spent on infrastructure this year have been enormous tailwinds.
In the first quarter, the economy grew 2%, with another 2.1% in the second (though it was revised down to 2.1%). But the Federal Reserve Bank of Atlanta's GDPNow model — a highly watched data set, because it comprises data only, with no spin — is forecasting 4.9% growth for the third quarter.
No one expected that, but our macro view feeds into the earnings story. Second-quarter company earnings were down 4%, but most analysts were forecasting a negative 10% – 15%. Companies have proved they are great at rightsizing, restructuring and cost cutting, all of which give them pricing power, and coupled with better demand, positively affect margins and earnings.
Stock Market Performance
Market results in the first and second quarters were driven by seven stocks (the FANG names, plus Tesla, Nvidia and Microsoft), generating around 90% of the S&P 500 Index's return.
Now, however, we are witnessing a broadening in market leadership, with better-than-expected earnings, which is healthy and further feeds the corporate earnings story. For example, the Energy Select Sector SPDR Fund (XLE) outperformed the Technology Select Sector SPDR Fund (XLK) by 700 basis points, and the Industrial Select Sector SPDR Fund (XLI) outperformed it by 200 basis points.
We haven't yet seen the recession that so many analysts were predicting earlier this year. And this is contributing to rising earnings forecasts by 60% of strategists.
Economic and Market Growth Drivers
First and foremost, consumers, representing nearly 70% of the economy, are strong, because they have jobs. The four-week average for initial unemployment claims, a leading indicator for jobs, is running at 217,000 — nowhere near recessionary levels of 350,000-375,000.
Recall that in the first quarter, skyrocketing unemployment was predicted. It didn't happen. In fact, anyone who wants a job can get one, with 1.5 job openings for every unemployed person (down slightly from 1.6 last quarter). And those seeking a new job can expect a 4%-5% wage hike, and job switchers can get double that amount. So if you want a job, you can get one and get paid more for it.
Consumers also are seeing a rise in real wages as inflation dropped from last year's consumer price index peak of 9.1% in June to just 3.7% now. Banks that have reported earnings are not mentioning a stretched consumer, so the earlier forecast of the demise of consumer spending has been misstated. We continue to be a nation of spenders, whether using cash or credit, and it's always been a bad call to bet against the consumer.
Credit card companies are experiencing expansion: As an example, American Express (AXP) domestic consumer spending rose 18%, and its international spending climbed by 23%. And 60% of its growth is coming from millennials.
