Coming into the second half of the year, our expectations were for the breadth of earnings growth to expand as the comparison sets for small cap companies eased. The follow-on effect of this positive rate of change would lead to low layoff numbers and a reduction in the amount and pace of rate cuts implemented by the FOMC. With the fourth quarter nearing its end, we have seen evidence of that dynamic unfolding.
Starting with the latest business sentiment data, the NFIB Small Business Optimism Index increased to 101.7 from 93.7 in November. This was led by a meaningful rise in the outlook for business conditions, moving from -5 to 36. Actual sales moved to -13 from -20, actual earnings rose to -26 from -33, and sales expectations increased to 14 from -4. While the actual sales and earnings data is still low relative to history, they are moving in the right direction. Sales expectations, however, now sit well above their historical average and are at their highest level since February 2020. The improvement across the survey was widespread, including employment, hiring plans, and capex plans. In terms of price measures, price changes and price plans rose, adding evidence to our view that inflation would likely remain above the FOMC target. Overall, the growth and inflation setup on the small business front lines up with the view that rate cut expectations for 2025 are likely overstated. Of course, the caveat here is that this data was collected throughout November, which means it is highly influenced by the Presidential election outcome – a dynamic we also saw in 2016. Therefore, we will remain diligent in monitoring economic and market-based data to further confirm these potential trend changes.
Source: Macrobond
Looking at earnings growth, the iShare Core S&P Small-Cap ETF (IJR) has 593 of 600 companies reported for 3Q24, with an aggregate growth rate of -5.7%. This represents a 200-basis point improvement from 2Q24 and is well above the -22% mark from 1Q24. Looking ahead, the comparisons in the fourth quarter this year and the first quarter next year should make it easier to see a continuation of the rate of change improvement. Importantly, we see the breadth of earnings growth expanding in the Russell 3000 Index. For 3Q24 so far, 55% of companies have grown their bottom-line y/y, up from 54% in 2Q24, 53% in 1Q24, and 51% in 4Q23. While the magnitude of growth is not fully captured in the distribution charts below, the primary point here is that more companies had positive EPS growth this quarter compared to the end of last year, and that is likely a positive for labor market conditions in the near term.
Source: Bloomberg
Source: Bloomberg, Boyd Watterson
Turning to the latest labor data, initial claims remain low at 224,000. Of course, hiring has slowed and has been moving closer to levels seen prior to the pandemic. With that trend in place, continuing claims have increased from their 2022 multi-decade lows, but the absolute level is below the average from the 2015 to 2019 period. The takeaway from this is that jobless claims are not at levels consistent with periods of continuous rate cutting.
Source: Macrobond
While the market currently expects a 25-basis point rate cut at the December 18th FOMC meeting, the outlook beyond that is less certain. However, if economic activity continues its current trajectory, earnings growth expands, and jobless claims remain low, the justification for further rate cuts in 2025 likely gets tougher.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Investment Strategist
Boyd Watterson Asset Management, LLC