S&P 500 earnings per share (EPS) continues to make all-time highs, now at $214.69. The forward EPS is now +35% year to date.

S&P 500 earnings update

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Approximately 23.4% of the S&P 500 have reported Q3 results so far. 84% of companies have beaten estimates, and results have come in a combined +14% above expectations. (I/B/E/S data from Refinitiv)

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S&P 500 price to earnings (PE) ratio is now 21.2.

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S&P 500 earnings yield is now 4.72%, which still compares favorable to treasury bonds, even though the 10 years has risen to a 6 month high.

Economic data review

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Industrial production declined -1.3% for the month of September.

“The production of motor vehicles and parts fell 7.2 percent, as shortages of semiconductors continued to hobble operations.”

“Overall, about 0.6 percentage point of the drop in total industrial production resulted from the impact of the hurricane (Ida).”

August results were revised modestly lower, while June & July results were revised slightly higher. Despite the monthly decline, Industrial production remains +4.6% higher from where it was at this time last year.

Capacity utilization declined from a revised 76.2 in August, to 75.2 in September. Still well below the historical average of 79.6.

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Leading Economic Indicators increased +0.2% for September, making another record high. While August and July results were revised higher.

“The U.S. LEI rose again in September, though at a slower rate, suggesting the economy remains on a more moderate growth trajectory compared to the first half of the year. The Delta variant, rising inflation fears, and supply chain disruptions are all creating headwinds for the US economy. Despite the LEI’s slower growth in recent months, the strengths among the components remain widespread. Indeed, The Conference Board continues to forecast strong growth ahead: 5.7 percent year-over-year for 2021 and 3.8 percent for 2022.”

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The LEI year-over-year growth rate is now an impressive +9.3%. Off from the highs of April and May, but still well in expansion territory.

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Existing home sales increased +7% in September, to 6.29 million. Over the last 12 months, existing home sales are down -2.3%. Average days on the market for existing homes declined from 21 days in September 2020 to 17 days in September 2021.

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The median price for existing home sales declined -1.4% to $352,800 for the month. But prices are still up +13.3% over the last 12 months. No doubt strong demand and lack of supply is keeping sales strong.

Summary: Over the last few weeks, many companies had been lowering their 2022 sales and earnings guidance because of supply chain disruptions. I believe this was one of the main reasons the S&P 500 dipped about 5%. But starting last week, Q3 results started coming out and the stellar performance streak continues. We continue to see an 80%+ earnings beat rate, while results come in a combined 10%+ above estimates. This alleviated some of the near-term growth concerns.

But lingering in the shadows is the inflation threat. Last year I wrote that inflation would be the key theme for 2021. The theme for 2022 is how the Fed responds to inflation. For six straight months now, inflation has come in double the rate of the prior decade. The Fed continues to insist on this all being “transitory” without ever elaborating on what “transitory” really means. I certainly hope they are correct, but so far there is nothing in the data that I monitor that shows inflation is going away anytime soon. Yes, supply chain disruptions are certainly a factor but let us not pretend the 30%+ expansion of the money supply didn’t have anything to do with it either.

Thankfully the bond market has looked past the inflation problem so far. The 10-year treasury rate has gone up, but still nowhere near the 4% to 5.4% where annualized core and total inflation currently stand. If the 10 year (which currently trades around 1.65%) shot up to 4-5%, we would be having a very different conversation about stock valuations. And not a good one.

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But short-term treasury bond rates (2-year treasury bond rate chart above) have started to price in the fact that the Fed will need to raise rates sooner than the market anticipated. Last year, the Fed was projecting no rate hikes until at least 2024. I said there was a “fat chance” they would be able to hold off for that long. And here we are. Right now it appears late next year will be the liftoff date. But who knows, in a few months that could change and rates will need to raise even sooner. Or not.

Unfortunately, we are back to Fed watching. I remain bullish into 2022 but not as bullish as I was at this time last year. A lot of good news is priced in. The first half of 2022 will likely see below-average growth rates for the economy and earnings (because 2021 comparisons will be tough), and the second half of 2022 will likely see a less accommodative Fed (along with the risk they completely botch this).