Israel at War, Wobbly US Defense, Earnings Expectations, Disney, Busy Week Ahead

There is no reason to try to skirt around the main story as we head into what had on its own merits already been considered a key week ahead. There had already been enough to consider. Macroeconomics and corporate earnings were the be the focus, along with getting a functional legislative branch of government in place. Now, unfortunately... most unfortunately, geopolitical concerns must be placed front and center.

For those who completely tune out on weekends, the Hamas terrorist organization launched a highly complex, multi-faceted attack upon the nation-state of Israel on Saturday. Hamas attacked, through the use of rockets from land, from sea and through the air. Hamas forces also infiltrated residential neighborhoods with lethal intent and violent consequence.

Those attacks appeared to be largely focused upon unsuspecting civilians, obviously including large numbers of women and children. By Sunday night, at least 700 Israelis had been confirmed dead, thousands had been wounded and an unknown number had been taken as hostages. An approximate 250 bodies had been found after the attack at the sight of a music festival.

The Israeli Defense Forces had been taken by complete surprise. There had been a failure in the ability to collect and disseminate accurate and timely intelligence. In response, the IDF launched a bombardment of Gaza as the nation's security cabinet formally declared war. Israel has also cut off supplies of daily necessities such as electricity, food and goods to Gaza, while also responding to mortar fire from members of the Hezbollah terrorist organization launched from across the Lebanese border into Israel. According to the Financial Times by Sunday evening, officials in Gaza had said that there had been 413 confirmed dead and roughly 2,300 wounded from the Israeli counterstrike.

Israeli Prime Minister Benjamin Netanyahu claimed by Sunday afternoon that the IDF had destroyed the "majority of the enemy forces that infiltrated our territory" and that the "offensive phase" of military operations had begun. Netanyahu said also that his nation faced a "long and difficult" conflict with Hamas ahead. Before we move on, let us make an effort to retain a sliver of our humanity. There is already enough human suffering. There will certainly be more. Innocent lives have been taken. Innocent lives have been changed. More innocent lives will be negatively impacted. These things are certain.

I would ask those reading who do believe in a supreme being to pray for the souls lost, for the families who grieve and for the safety of those still standing, and for those in leadership positions. While the global focus is on Israel, Gaza, Lebanon and that whole neighborhood right now, the ramifications could be far broader. The ramifications could be regional, or even global.

Concerning

On Sunday evening, the Wall Street Journal reported what no one wanted to hear. The report states that according to senior members of both Hamas and Hezbollah, that Iranian security officials had likely helped in the planning of the Hamas surprise attacks on Saturday and had even given "the green light" for the assaults at a meeting in Beirut last week.

Supposedly, officers of Iran's Islamic Revolutionary Guard Corps had worked with Hamas since August, planning what was really a highly complicated attack that wound wind up being the most significant breach of Israel's physical national integrity since the 1973 Yom Kippur war 50 years ago.

According to the Financial Times, President Biden spoke to Prime Minister Netanyahu by telephone on Sunday and promised "additional assistance" to the Israeli military, "with more to follow over the coming days." As far as I can tell, it remains unknown if Americans are among the dead. It is said to be known that Americans are indeed among those taken hostage. US Defense Secretary Lloyd Austin has ordered US aviation and naval assets closer to the action. As for Iran's participation, US Secretary of State Antony Blinken stated, "We have not yet seen evidence that Iran directed or was behind this particular attack, but there certainly is a long relationship."

Problems

One has to wonder. Is there an attempt by US adversaries to spread the capabilities of US forces a bit too thin? The US has already made itself quite vulnerable and perhaps less able to defend its friends and interests globally. The focus has been on Ukraine, and not wrongfully so. Propping up one side in a huge, conventional war has come at great cost. There has been error there in allowing US stockpiles of ammunition to run down to frighteningly thin levels during a fiscal crisis.

One also must think of the sloppy, completely mishandled withdrawal from Afghanistan that not only emboldened forces not friendly toward the US or US interests but also armed those forces with arms and equipment that would have otherwise cost them dearly.

To be honest, I thought it certain that both General Milley and Defense Secretary Austin would have resigned after that fiasco. Not in this day and age. Soldiers in positions of leadership no longer even acknowledge errors in judgement. Replenishing these run-down stocks for US forces, US allies and those serving US interests will not be as easy as just turning on the defense contractors.

This animal, since the end of the Cold War, has evolved in such a way as to be built for finesse, not for a full-production, industrial launch to build up stocks of weapons and ammunition that really were created for another era. We have allowed both our operational and even strategic reserves of such munitions to reach levels alarming to our own officers.

There was also error in releasing so much crude oil from the Strategic Petroleum Reserve in the attempt to tamp down inflation with increased supply. The SPR is now down 43% from where it was in October of 2021. That was really the second error made by this administration in this space. A great deal of that early energy sector inflation was created by this administration's hostile posture towards the US domestic energy sector upon taking office. That was error number one.

Compounding these errors altogether was a third error, which was the failure to refill the SPR at advantageous prices when the opportunity arose. There was a time where the administration would have appeared to be top notch oil traders if they had only acted when oil dipped. A time when literally every commodities trader I know was asking why weren't they?

The US was needed in Europe. Now, the US is also needed in the Middle East. What if something goes down in Asia? Beijing would pay dearly in any attempt to take Taiwan and assert its power over the autonomous province. Taiwan is built for defense. That said, and let's hope nothing like this happens, if an adversary were to try to stretch US capabilities even further, they would only think about getting bold while US forces were focused on at least two other conflicts, while also being simultaneously low on both ammunition and fuel.

I told Fox Business viewers on Liz Claman's show last week that I had exited Raytheon RTX though it pained me to do so because my 8% rule had been violated. Lockheed Martin LMT , a long time Sarge favorite, increased its dividend over the weekend, while its board authorized the purchase of another $6B worth of common stock, almost doubling its current program to $13B.

Aerospace and Defense has been awful this year after a fantastic 2022. There are never any sure things in these markets, but spending on defense is going to have to soar and soar big-time. It's either that or surrender the ability to exert influence and to "bring the peace" when the world cries out in anguish for American help. Oh, almost forgot, we don't even have a Speaker of the House. That has to be remedied.

Obviously, financial markets are going to be volatile as we work our way through the wee hours and approach Monday morning's opening bell. Crude oil is popping, up more than 3%. US equity index futures are a bit soft. The US Dollar Index is moving higher. Expect headlines to drive the action as we know keyword seekers will move more quickly than can anything else and their purpose is to drive both momentum and overshoot.

The Week Past

Last week was wild. It all started with the House of Representatives essentially firing now former Speaker Kevin McCarthy for reaching across the aisle and compromising with the other side. The incredible take-away for me was that a small minority within the right-leaning party has now largely reached out and taken control of their party, with the staunch support of the left leaning party almost in its entirety. Even though the next Speaker will almost surely be less willing to compromise.

Do both sides want a government shutdown so they can blame the other? Sure, does seem like it. Is either side putting the interests of the nation above the interests of their political party? Sure, does not seem like it.

From that point through Thursday, equity markets were generally weak, as were Treasury markets, forcing yields and interest rates higher. How long have I been writing in this column that the S&P 500 level of 4,200 was still in play? For months. Even when the index peaked in early summer above 4,600. It felt ugly last week because it was. Breadth was awful. The S&P 500 bottomed between 4,216 and 4,225 on four different days last week.

Then came Friday. Jobs Day. First, the Non-Farm Payrolls print of 336K shocked the world, printing well above the 155K or so that Wall Street had in mind. Keyword reading algorithms pushed markets lower, aided by a financial media that seems quite content to take everything at surface level without digging very deeply into a story as long as the surface data provides the required sensationalism to satisfy their needs.

Problem one was that the rest of the report was not at all reflective of such a robust headline number. Problem number two was that the BLS Household Survey and the AFP Report (released on Wednesday) were in lock step with each other. The ADP Employment Report showed September private sector job creation of 89K. The BLS household Survey showed an increase in employed persons of just 86K for September as the number of unemployed persons increased by just 5K.

This left the unemployment rate at 3.8%, the employment to population ratio at 60.4% and the participation rate at 62.8%. Part time hiring, according to the Household Survey suggests that 24.4% of those new hires were part-timers, leaving just 65K full-time hires. This is full-time job growth, but after what had been two straight months of negative full-time job growth, and certainly not much of a rebound.

Wage growth was not strong, nor really was anything else in the release. After the keyword readers had done their thing, human traders and investors who by this time had read through the report, turned the market as the headline had been misleading. For once, the humans absolutely schooled traders reliant upon algos who often spend their days reading the New York Daily News Sports section only rousing if one of their algos happens to ring an alarm... and it felt darned good.

Earnings

Third quarter earnings season will kick off towards the latter half of this week. The big banks will start posting their quarterly results this Friday. Ahead of Friday, there will be a couple of strays from other industries, but for the most part, earnings will stay below the radar until Friday. Using FactSet as my guide, as I always do and always have, expectations for third quarter is currently seen as yet another quarter of year over contraction.

Third quarter earnings expectations for the S&P 500 are seen at "growth" of -0.3%, down from "growth" of -0.1% last week and from +0.2% only three weeks ago. If this consensus view proves to be close to accurate, this would be a fourth consecutive quarter of year over year earnings contraction for the index. Revenue growth is seen at 1.7% year over year, which is actually up from 1.6% last week.

Analysts still have high hopes for the fourth quarter, but those hopes have come in a bit. The consensus there is for earnings growth of 7.8%, down from 8.3% last week on revenue growth of 3.9%, up from 3.7% last week. This implies an increased expectation for margin compression.

Still, this kind of fourth quarter boost would, according to consensus, take the full calendar year into positive territory at earnings growth of 0.9%, down from 1.1% a week ago, on revenue growth of 2.4%. CY2024 is expected to be much better, with earnings growth of 12.2% on revenue growth of 5.5%.

As I wrote to you last week, on next year... I'll pretend that I'm from Missouri. Show me.

Currently, the S&P 500 trades at 17.7 times 12 month forward looking earnings. This is down substantially from 17.9 times a week ago and significantly down from 18.8 times just three weeks ago. This valuation now stands well below the S&P's five-year average of 18.7 times and draws ever closer to the S&P 500's ten-year average of 17.4 times.

Marketplace

For the past week, the S&P 500 gained 0.48%, after popping 1.18% on Friday to swing the week into the green. The S&P 500 closed last week up 12.22% year to date. The Nasdaq Composite screamed to a gain of 1.6% for the past week after posting a gain of exactly 1.6% on Friday. How's that for getting everything done in a hurry? That put the Nasdaq Composite up 23.33% for 2023.

The higher tech, more narrowly focused Nasdaq 100 closed up 1.75% last week. The Nasdaq 100 is still up a quite impressive 36.87% year to date despite having given up 5.07% for the month of September. The Philadelphia Semiconductor Index was not our leader last week, which is unusual... but the semis did alright. That index gained 1.19% over the past week, after moving an even 2% higher on Friday. The "SOX" now stands up 37.25% for the year after.

That leaves us with the Russell 2000. The small-cap index gave up a nasty 2.22% for the week past, even after gaining 0.81% on Friday. That put the Russell 2000 down 0.89% year to date. Other equity indexes of note that closed in the red for the past week, were the KBW Bank Index (-2.82%), the Dow Transports (-1.08%), the Dow Industrials (-0.3%) and the S&P Small Cap 600 (-2.37%).

Ten of the eleven S&P sector SPDR ETFs shaded green on Friday, which was nice, but was only nice enough to push three of these eleven funds into the green for the week. Growth sectors were the leaders with Technology XLK up 2.64% and Communication Services up 2.04%. Energy XLE took a pasting on softer oil prices (that reversed last night/this morning), giving back 5.16% over the five days. The Staples XLP were also slapped around, surrendering 3.11%.

The Week Ahead.

Where do we begin? There is so much to stay on top of this week. Let us begin.

- The Geopolitical

Israel. Iran. Gaza. Lebanon... Ukraine. Taiwan. There are good reasons for there to be some risk-averse behavior exhibited by investors and traders early this week. So, don't be surprised. Leaders will try to keep this new war in Israel from spreading. Ukraine has not gone away. North Korea still wants to play "tough guy" and every day Russia becomes weaker in the field, Russia becomes more dangerous in unmentionable ways. There's a lot to navigate here, not just for market participants, but for humankind.

- The Political

We still do not have a Speaker of the House in the US and the House needs to kick it into high gear. Especially now that it looks more likely that the legislative process needs not to be bogged down with procedural roadblocks should immediate action be required. There needs to be a bipartisan urgency in DC. The people are sick and tired of these two parties treating each other as enemies when it is very likely that we have real enemies.

- The Fed

The Fed will be out in force again this week. Through Wednesday, I count 10 public appearances to be made by Fed officials plus the release of the FOMC Minutes of the September meeting on Wednesday. Keep in mind that there are always a few speakers who pop up who were not on the radar coming into the week.

As Sunday night slowly turns into Monday morning, I see that market pricing in a 79% probability for no rate change on November 1st, and a 64% likelihood that the FOMC is done raising rates for this year. These markets are also pricing in a 60% probability that the Fed starts cutting rates by June 12th, which will be the first of three 25 basis rate cuts in 2024.

- Macro Attack

There will be no macroeconomic data released on Monday as the day is a federal holiday. Traders and investors will have to deal with September PPI on Wednesday and September CPI on Thursday. Those were going to be the big news events for investors this week prior to the war in Israel breaking out on Saturday. On Friday, the University of Michigan's' release for October Consumer sentiment and consumer inflation expectations will take center stage. In addition to that, the US Treasury Department will auction off $35B worth of Ten-Year Notes on Wednesday and $20B worth of Thirty-Year Bonds on Thursday.

- Corporate

By way of corporate events, Adobe ADBE will hold its investor day on Tuesday, where the firm is expected to highlight its opportunities and upside concerning generative AI. There are a few other far more minor events on the docket, but this one is in my opinion, the potential newsmaker.

As far as earnings are concerned, we'll hear from PepsiCo PEP on Tuesday morning. On Thursday morning, Delta Air Lines DAL , Domino's Pizza DPZ and Walgreens Boots Alliance WBA will all report.

Then comes Friday. Investors will at that time, hear from the likes of Citigroup C , JP Morgan JPM and Wells Fargo WFC on the banking side as well as UnitedHealth Group UNH . After that, it's "game on."

Interesting

It appears that activist investor Nelson Peltz, whose Trian Management holds more than a $2.5B stake in the Walt Disney Company DIS , will renew his push for board seats at the House of Mouse. Readers will likely recall that Peltz had previously tried to run for a seat on Disney's board and had withdrawn his nomination after Disney CEO Bob Iger had announced a major cost cutting program.

This time, it is believed that Peltz will request multiple board seats including one for himself. If as expected, Disney does not agree to the request, Trian can nominate potential directors at the firm's annual meeting in the spring. Nominations can be submitted from early December through January 4th.

Economics (All Times Eastern)

No significant domestic macroeconomic data scheduled for release.

The Fed (All Times Eastern)

09:00 - Speaker:Dallas Fed Pres. Robert Lorie Logan.

09:15 - Speaker:Reserve Board Gov. Michael Barr.

13:30 - Speaker:Reserve Board Gov. Philip Jefferson.

Today's Earnings Highlights (Consensus EPS Expectations)

No significant quarterly earnings scheduled.

(LMT, XLE and PEP are holdings in the Action Alerts PLUS member club. Want to be alerted before AAP buys or sells these stocks? Learn more now.)

At the time of publication, Stephen Guilfoyle was Long WFC, LMT, DIS equity.