News & Insights

Credit Demand is Perking Up

Commercial and industrial loan origination continues to grow, though at a slower pace than prior quarters, despite tightening lending standards. Home equity loans are also rising, recently reaching 2008 levels, with falling short rates creating demand as American homeowners leverage the equity they hold in their homes. Credit card delinquencies are still rising, but overall repayment of credit by the consumer has stabilized. Investment grade corporate bond issuance had the largest single post-Labor Day volume ever, with the average auction order book 3.5 times oversubscribed.

In addition to kicking off a rate cut cycle, growth in the money supply (M2) has rebounded from multidecade lows and is once again expanding. The Federal Reserve’s quantitative tightening policy continues, but the pace of the balance sheet runoff has slowed significantly. Reserves held by depository institutions has been stable, supporting credit expansion and reducing the risk of a liquidity crisis in the banking system. Ample liquidity, expansionary monetary metrics and stabilization in the bank sector present a strong setup for a pickup in lending, which would provide an important tailwind for a sector that has been lagging the broader economy.

Home Equity Lines of Credit are Up 20% Since End of 2021

Source: New York Fed Consumer Credit Panel/Equifax

M2 Money Supply Growing

Source: FRED

Factories Remain Downbeat

Not much relief is in sight for the beleaguered manufacturing sector, which shrank in September for the sixth consecutive month. The Manufacturing PMI is near the low it registered in late 2022 amid recession fears. New orders improved but remain in contraction, which doesn’t augur well for production in the coming months. Manufacturers’ inventories fell, but that change wasn’t reflected in the retail inventories reported for the period which remained flat. Production posted a strong month-over-month number but is still in contraction territory. This segment is now a relatively small slice of the diversified U.S. economy and no longer a reliable indicator of the direction for the broader economy.

Profit margins of manufacturers are under pressure, with rising wages, elevated shipping rates and difficulty passing the higher costs on to end markets. Customers continue to run lean inventories, presumably to maintain margins, leading to reduced hours worked and lower employee counts for manufacturers.

The Eurozone’s manufacturing PMI, pulled down by its largest economy, Germany, is contracting even more rapidly than the U.S. India, a booming emerging market, is the global exception, with a surging manufacturing PMI. Similar to housing, manufacturing is a sector that is pinning its hopes on a boost from the global interest rate cutting cycle. Recovery in this sector is also dependent on a return to economic growth, boosted by durables spending in a housing market recovery.

US Manufacturing PMI

Source: S&P Global PMI

Company Profits Continue to Flow, Especially for the Mag 6

The release of second-quarter national accounts data shows a stout 14.2% rise in after-tax profits when compared to a year ago. Recent performance in the stock market reflects the gulf between the Magnificent 6 (the former Mag 7 minus Tesla), which grew revenue 14.9% year-over-year, compared to just 2.9% for the rest of companies in the economy. Revenue growth follows a similar pattern, with the Mag 6 revenue up 27% since the end of 2019, while the remaining non-financial corporations across the entire economy boosted sales by just 6%. Apart from the Mag 6, the rise in earnings has been generated by margin expansion resulting from tight cost control, including headcount. Growth in corporate revenues, at 6%, is scarcely ahead of the 4.1% rate of increase in labor costs. Anemic revenue growth may help to explain the weak BLS employment data in recent months, but the higher profit margins (13.9% in the second quarter) imply it may not trigger mass layoffs.

The pattern is similar for constituents of the S&P 500, which saw earnings expand by 11% in the second quarter. Current EPS estimates anticipate that they will rise 15% in calendar year 2025. Revenue estimates for the third quarter are a much paltrier 4.6% year-over-year. Small public company earnings, measured by the constituents of the Russell 2000 Index, are surging, posting positive earnings growth year over year of more than 20%, with analysts expecting continued robust growth into 2026.

According to the NFIB, the story is bleaker for small businesses, as they grapple with rising costs and weak sales volumes. This group continues to identify inflation as their most important challenge. This has resulted in the net number of small businesses able to report higher profits, relative to three months ago, near their lowest level in over a decade.

Oligopolies and massive scale have tipped the economy, with the biggest companies, as represented by the Mag 6, exhibiting robust growth in both revenues and profits, while the average company is forced to boost profits through tight cost controls rather than by enjoying robust sales growth, and the smallest businesses struggle to return to profitability. During second quarter S&P 500 earnings calls, few companies mentioned “recession” as a concern, but many have alluded to “election” concerns, at a higher incidence rate than the same quarter prior to the 2020 election. If continued rate cuts firm up economic growth, this will give the smaller economic laggards an opportunity to join their larger siblings, increasing their profitability as revenues rebound and interest costs fall.

Corporate Profits After Tax

Source: FRED

S&P 500 Quarterly Bottom-Up EPS Actuals & Estimates

Source: FactSet

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This commentary is as of Oct. 17, 2024, for informational purposes only and is not investment advice, a solicitation, an offer to buy or sell, or a recommendation of any security to any person. Managers’ opinions, beliefs and/or thoughts are as of the date given and are subject to change without notice. The information presented in this commentary was obtained from sources and data considered to be reliable, but its accuracy and completeness is not guaranteed. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not indicators or guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification strategies do not ensure a profit and cannot protect against losses in a declining market. All indices are unmanaged, and investors cannot invest directly into an index. You should not assume that an investment in the securities or investment strategies identified was or will be profitable.

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