Assessing Equity Index Risks Ahead of Fed Meeting

◾ The S&P 500 near a record high contrasts with a weakening labor market. Job growth has slowed from 158k in April to just 22k in August. Meanwhile, the S&P 500 has notched 21 new highs. ◾ Many investors have raised concerns about the apparent divergence between record-high stock prices and soft labor data. Equities appear to be looking through the temporary economic slowdown and pricing reacceleration in 2026. Expected Fed easing at next week's September FOMC meeting has further supported equities. ◾ In addition to opening the door for Fed rate cuts, a cooling labor market is a tailwind to corporate profits, all else equal. Profit margins typically track the difference between prices and input costs, including labor. The GS Wage Growth Tracker equals 4.0% while leading indicators point to deceleration to 3.3%. ◾ S&P 500 labor costs equal 12% of revenues at the aggregate index level. Labor costs equal 14% of revenues for the median S&P 500 stock. The ratio of labor costs to revenues varies by sector, ranging from Industrials (20%) to Energy (4%). We estimate labor costs using reported data on each company's number of employees and median employee compensation. ◾ We estimate that a 100 bp change in labor cost growth would impact S&P 500 EPS by 0.7%, all else equal. The impact of labor costs on earnings depends on a combination of factors including revenue growth and profit margins. Small-caps typically have lower profit margins and therefore have earnings that are more sensitive to changing labor costs, all else equal. A 100 bp change in labor cost growth would impact Russell 2000 EPS by 1.5%, all else equal. ◾ Intra-market rotations tracked by our labor cost baskets mirror optimism observed at the headline level. Our basket of low labor cost stocks (GSTHLLAB) has outperformed our basket of high labor cost stocks (GSTHHLAB) by 8 pp YTD. Equity investors appear to be optimistic that the recent labor market slowdown will be only temporary. ◾ We rebalance our sector-neutral labor cost baskets. The median low labor cost stock has labor costs equal to 6% of revenues, trades at an NTM P/E of 18x, and consensus expects 2026 EPS to grow by 13%. The median high labor cost stock has labor costs equal to 32% of revenues, trades at an NTM P/E of 21x, and is expected to grow 2026 EPS by 13%. ◾ We also use labor cost data to estimate the potential upside to corporate earnings from AI. Companies with elevated labor costs, high AI exposure, and low margins have the largest potential earnings boost from AI productivity. Ten stocks overlap between our High Labor Cost basket and our AI productivity basket (GSTHLTAI): ACN, AON, BRO, CRWD, CTSH, DLTR, DVA, EPAM, MMC, NWSA.

Markets are heading into the final week of October with confidence that feels a bit too calm. A Trump–Xi meeting, a delayed US inflation print, and the Fed’s next policy call all collide within days — a rare alignment that could flip the soft-landing narrative fast. Asia’s rally shows the optimism; the 4% yield line on US 10-year Treasuries shows the tension. Here’s where the real battlegrounds lie. 1. The Trump–Xi meeting could decide whether risk appetite holds or cracks. Cooperation on tech or tariffs keeps Asia’s rally alive; confrontation sends volatility surging in CNH and semiconductors. 2. US CPI is the last major input before the Fed meets. Even a small miss could move the “3% is the new 2%” debate. A print above 0.4% MoM might test whether the 10-year yield can stay below 4%. 3. Tech stocks are leading global gains, but margins and valuations are stretched. Earnings from Tesla, Intel, and Netflix will show if fundamentals justify the price. 4. China’s new five-year plan leans on “new-quality productive forces.” Local equities are pricing in tech stimulus, but the risk is policy lag or currency volatility unwinding those trades. 5. The dollar looks fragile. With rate differentials narrowing and inflation cooling, any soft CPI could trigger another leg lower, especially against the yen — now near the intervention zone at 153. 6. Korea’s paradox: a strong Kospi but a weak won. Foreign investors enjoy cheap hedging from inverted forwards, but if the Trump–Xi talks fail, that “free lunch” disappears quickly. 7. Commodities are diverging. Copper is near record highs on supply stress, oil is stuck near $66, and gold is testing investor patience. The next inflation signal decides which hedge wins. 8. The Bank of Canada faces a “hawkish cut.” Policy divergence with the Fed could either help or hurt the loonie, depending on curve dynamics and CPI direction. 9. European bonds are stabilizing. France’s spreads are tightening, but the ECB’s tone next week will show if this is relief or complacency. 10. US earnings highlight a K-shaped economy — luxury spending is strong while mid-tier demand softens. The test is whether high-end consumers can keep carrying growth as labor data cools. The takeaway: next week is binary. Either geopolitics and data confirm the soft-landing story, or markets rediscover fragility. With positioning stretched and volatility cheap, even small surprises could bite. The smart play is to stay invested but light on leverage — quality over beta, and duration as quiet insurance. For more see our Nomura CIO Corner: https://lnkd.in/e4TCax_g #Markets #Macro #TrumpXi #CPI #Fed #Asia #Commodities #FX #Equities #Nomura #CIO #Investing

After a rally that defied high interest rates and recession calls, stock valuations are now edging toward levels seen before some of the greatest market meltdowns in history – by one measure at least. A time-tested way of assessing whether equities are fairly valued is by comparing them with government bonds, considered one of the safest forms of investment. And by that metric, stocks are looking historically expensive, according to experts from PIMCO and GAM Asset Management. A key measure of the richness of stocks relative to debt is the so-called equity risk premium — or the extra return on shares over Treasury bonds. The metric has plunged this year, indicating stretched stock valuations, toward levels seen during the Great Depression of the 1930s and the dot-com bubble of the late 1990s. "Delving deeper into historical data, we find that in the past century there have been only a handful of instances when US equities have been more expensive relative to bonds – such as during the Great Depression and the dot-com crash," PIMCO portfolio managers Erin Browne, Geraldine Sundstrom, and Emmanuel Sharef write in a recent research note. "History suggests equities likely won't stay this expensive relative to bonds." The historically low equity risk premium is a deterrent to investing in stocks, according to Julian Howard of Switzerland's GAM Asset Management. It means stocks are offering investors little incentive to choose them over risk-free assets such as government debt – and that may turn away potential buyers. "The equity risk premium is very, very narrow. Now, in fact, it is actually almost negative," Howard said in comments on the GAM website. "And that is a major concern because what it is saying is that actually you don't need to invest in equities in the short to medium term, because if you invest in the six-month Treasury bill, which is giving you 5.5% completely free of risk, then that's actually a risk-reward that is completely unbeatable," he added. US stocks are on track for their best month in a year amid expectations the Federal Reserve may have reached the end of its interest-rate increases at a time when the economy remains resilient and inflation has moderated. The S&P 500 is up 7.4% in November, taking its year-to-date gains to 17.3%, amid optimism that corporate earnings will remain buoyant in the coming quarters. However, PIMCO cautions against that outlook. "We feel that robust forward earnings expectations might face disappointment in a slowing economy, which, coupled with elevated valuations in substantial parts of the markets, warrants a cautious neutral stance on equities, favoring quality and relative value opportunities," Browne, Sundstrom, and Sharef wrote. https://lnkd.in/eeMEmMGu

Buffett valuation indicator of global stock markets is at 115% at the moment. This value is significantly above the long-term median at 87% and even above the significant level of the median plus one standard deviation at 105%. Therefore global stock markets seem to be markedly overvalued right now. Of course, it is also true that equity valuations are by no means a perfect indicator that can predict stock markets performance with certainty over a short-term horizon of one year. But it is also definitely true that equity valuations provide an invaluable indication of expected stock markets performance over longer time horizons, such as seven years or more. With that being said, I would like to highlight several fundamental factors underpinning my current cautious equity view. First, the growth rate of the world economy remains below average on a long-term historical comparison, although the dynamics have improved slightly in recent months. Second, the Bloomberg analyst consensus expects below-average earnings per share (EPS) growth of 6% over the next 12 months, based on the broadest global equity index, MSCI All Country World. Third, analysts continue to expect key central banks to continue with quantitative tightening (QT), resulting in a further decline in liquidity in global financial markets. Fourth, the relatively strong persistence of inflation across the global economy, especially in the US, could make it impossible for the Fed, contrary to the current consensus, to start cutting the key fed funds rate as early as this year from the current highly restrictive level of 5.50%. Fifth, the significant increase of bond yields since the beginning of 2024 implies lower fundamentally justified equity valuations. Average global bond yield has increased by 30 basis points to 3.81% and the 10-year US Treasury Bond yield has increased by 42 basis points to 4.67%. Sixth, at just 1.7%, the global equity risk premium (ERP) is at its lowest level in at least 17 years, indicating a somewhat unfavourable risk-return profile for equities relative to bonds and cash. All in all, therefore, investors should definitely remain very selective in their global equity allocation and invest primarily in such regional markets and segments that promise a solid earnings growth at meaningful valuations. With that being said, I like small-caps, central Europe, China and Latin America at the moment.

A modest investment of $50K could have resulted in a $300K cash return today in futures. If you were curious why an interest rate cut would be perceived negatively by the broader markets: Stocks can decline after a Federal Reserve interest rate cut for several reasons, despite the initial expectation that rate cuts are generally good for equities: 1. Concerns Over Economic Health A rate cut is often interpreted as a sign that the Fed sees potential weaknesses in the economy. This can worry investors about slowing growth, stagnant corporate earnings, or an impending recession. 2. Lingering Inflation Risks If inflation remains high or is seen as "sticky," as noted in the reports, investors may fear that the rate cut could reignite inflation. This can lead to uncertainty about future Fed actions, including the possibility of future rate hikes, which can be a drag on stocks. 3. Monetary Policy Lag Investors may believe that the Fed’s policy changes are too slow or late to address inflation or economic imbalances effectively. The lag in the impact of monetary policy could mean the economy faces near-term challenges despite lower rates. 4. Cautious Fed Messaging Fed Chair Jerome Powell's comments and the reduced number of expected rate cuts in 2025 signal a cautious approach. The central bank’s hesitancy to ease aggressively can dampen investor sentiment, especially if the market expected more dovish signals. 5. Sector-Specific Impacts Certain sectors of the economy are affected differently by rate cuts. Financial institutions, for example, might face lower profit margins on loans when rates drop, which can pull down stock indexes if financials have a large weighting. 6. Profit-Taking If stocks rallied ahead of the rate cut in anticipation of easing monetary policy, the actual announcement can trigger profit-taking. Investors might sell to lock in gains, leading to a decline in stock prices. 7. Global Market Dynamics Stocks may also react to broader geopolitical or economic concerns that coincide with a rate cut. For example, if the global economy shows signs of instability, investors might favor safer assets like bonds, pulling money out of equities. 8. Misaligned Market Expectations If investors anticipated a larger rate cut or more aggressive future easing, the Fed’s more modest action could disappoint, leading to a sell-off. In this case, the Fed’s decision to cut rates while signaling fewer reductions in 2025 likely contributed to concerns about inflation persistence and a cautious economic outlook, which outweighed the potential benefits of a lower cost of borrowing. This uncertainty often triggers volatility and a pullback in stock prices.

The last two weeks have provided a vivid reminder of how sensitive markets can be to small changes in the macro-economic outlook. With a nudge down in oil prices, the Fed’s 2% inflation goal suddenly seems achievable within a matter of months. With a slight weakening in the labor market, the unemployment rate has shifted to a trajectory that has foreshadowed recession in the past. In response, the 10-year Treasury yield fell from 4.29% on July 24th, to 3.78% on August 5th while the VIX index, a measure of stock market volatility, more than doubled over the same period, with stock prices falling sharply by the close of business last Monday. Over the rest of last week, both interest rates and stock prices recovered, but they are clearly vulnerable to any new surprises on inflation or the labor market. More broadly though, this game of inches on inflation and the labor market reflects a similarly close call on economic growth itself. 2.5% real GDP growth would revive fears of inflation. 1% growth would stoke fears of recession. Growth of 1.5%-2.0% would probably be judged to be just right, allowing for a continued slow slide in interest rates and steady growth in corporate earnings.  #economy #markets #investing

US equity risk premiums have slipped into negative territory, meaning the earnings yield on the S&P 500 is now below the 10-year Treasury yield. Historically, that is unusual outside of late-cycle or highly optimistic market phases. This does not mean equities must fall immediately, but it does signal that investors are accepting very little compensation for equity risk relative to risk-free rates. In past episodes, negative or near-zero equity risk premiums have tended to coincide with elevated valuations, strong momentum, and high confidence in future earnings growth. What matters from here is rates and earnings. If bond yields ease or earnings expectations continue to rise, the premium can normalize without a market correction. If yields stay high while growth expectations soften, valuation pressure builds quickly. In short, this is not a timing signal. It is a reminder that today’s equity market is priced for a relatively benign macro and earnings backdrop, leaving less margin for disappointment. Source: Bloomberg

June is where the window closes for Fed's rate cut if any in CY24: Yesterday's core CPI no at 0.4% (0.358 to be precise) was not surprising. But what was surprising was risk assets reaction to it. 10 year UST yields moved up by 6-7 bps post data but more due to heavy auction supply. US equities were up by 1% & DXY hardly moved. If this is risk assets reaction to a CPI data which should be extremely worrying for Fed, Fed in it's next meeting is likely to push back. After all it needs only 2 FOMC members to change from 3 cuts to 2 cuts in CY24. Now the data in itself is worrying. The core rose 0.4% (rounded off) in Feb for the 2nd consecutive month, meaning Jan’s core jump was not a one-off anomaly. Rental inflation – both for actual tenants and the imputed rental value of owner-occupied homes – continue to defy predictions of imminent reversal, rising 0.4% for the month and running at or above a 5% annualized rate over three-, six-, and twelve-month timeframes. “Super Core” services (Fed Chair's fav part of CPI) which excludes food, energy, other goods, and housing rents, after jumping 0.8% in January, again increased by 0.5% MoM in Feb, driven by higher prices for airfare (+3.6%) and motor vehicle insurance (+0.9%). In the last 12 months, this measure is up 4.3% and has been accelerating as of late; up at 6.9% and 5.9% annualized rates in the last three and six months, respectively. Although core CPI declined slightly in February, the 3M and 6M annualized rates both accelerated, to 4.3% and 3.9%, respectively. Even the goods disinflation has stalled & core goods came at +0.1% MoM. Now for risk assets to react to such data in such a way is setting up for a pushback from Fed. And if it does not then Fed might soon loose credibility for it's 2% core PCE mandate. Fed Chair made a recent statement where he mentioned that they were close to being confident about inflation sustainably towards 2%. Yesterday's data should not bring that confidence. US economy remains strong as likely to be seen in Feb's retail sales being released tomm & Q1 GDP data currently running at 2.4%. And with US equities on a roll with both earnings & Fed Chair's on and off pivots, wealth effect hardly gives an incentive for service inflation to come down sharply. With US Presidential elections in Nov'24, Fed has a limited window to start its rate cut cycle. Being too near to elections in Nov, Fed wont want to give a perception of helping any side. So if by June 1st cut don't materialize, we can as well say bye to rate cuts in CY24 altogether. Add to this the narrative of BOJ exit from YCC mostly in March itself. In fact ECB might be the first to cut than Fed. All of this implies higher UST yields especially on long end and DXY strength in H2CY24. With Trump leading, tariffs reintroduction & immigration blocks again likely being reinforced, bond yields & DXY might only go up in the run up to US elections. So if we don't see a June cut, prepare for a barren CY24.

Our equity drawdown framework has indicated higher risk of a correction since January due a combination of elevated valuations, less supportive macro momentum and rising policy uncertainty due to tariffs. Despite the S&P 500 drawdown so far the probability of further declines has stayed elevated due to some deterioration of macro and market conditions. Our Risk Appetite Indicator has also not declined to deeply negative levels, which would indicate better asymmetry for equities. We continue to recommend a balanced portfolio approach with increased focus on diversification across and within assets. #assetallocation #gsmacro https://lnkd.in/e_Kh_XF9

Mike Wilson, MS| Is Policy Or Data More Important For Markets "Heading into the last Fed meeting, I thought that the best short-term case for equities was the Fed delivering a 50bp cut without prompting growth concerns. Indeed, Chair Powell was able to thread that needle, and equities have responded favorably. However, I still believe that over the next 3-6 months, equity performance, at both the index and sector/factor level, will be determined more by labor data than anything else. The next round of employment data arrives at the end of this week. I believe we would need an upside surprise to drive a sustainable cyclical rotation in the US. To be specific, we think the unemployment rate probably needs to decline alongside above-consensus payroll gains, with no material downside revisions to the prior months." #macro #fed #monetarypolicy #unemployment #equities