Weekly Update: Hello? Is anyone out there?

09-01-2017

The five days surrounding Labor Day see more market participants take off than during any other period on the calendar, except for weekend bookended by Christmas and New Year’s. Well, economic reports never take a break! This week was chock full of data from Q2 GDP to August nonfarm payrolls that somehow suggested both improvement and softening. Added to that was 24/7 coverage on Hurricane Harvey. As tragic as it has been, Harvey could bring rare bipartisanship to Capitol Hill, where congressional leaders are said to be considering tacking a debt-ceiling increase and short-term continuing resolution onto a massive supplemental funding bill to help recovery efforts. Because it’s certain to quickly become law, the bill could reduce the odds of a disruptive budget fight for the next several months and create a window to get moving on tax reform. As for Harvey, it’ll take some time before the full extent of the damage to the economy is known. Sources suggest the impact could trim second-half growth a tick or two before turning stimulative as relief appropriations start trickling down into the hands of the people who actually will use them. The Institutional Strategist is not as sanguine. It wonders if because of massive numbers of homeowners without flood insurance, this event will expose the financial weakness of America’s lower and perhaps even middle class. Are paycheck-to-paycheck earners about to be placed in financial circumstances from which they cannot recover? At the least, it sees the Fed going on hold on rate increases and balance-sheet reduction until these unknowns are known.

A flight to quality has pushed the 10-year Treasury yield to 2017 lows and caused the overall area under the yield curve to fall below levels when the Fed first started tightening in 2015. That’s bolder than just a flattening curve and, absent a substantive near-term rise in wages, is sure to be a focus of Fed policymakers as they weigh the next step toward policy normalization. Stubbornly low inflation and long yields have the futures market pushing out the next Fed hike to mid-2018, with potentially only one subsequent move afterward before reaching what would be a historically low neutral rate. As for the equity markets, they are experiencing the largest spread between risk-off and risk-on assets in the last 20 years. Cornerstone Macro thinks the reason large-cap stable growth is outperforming is because economic prospects are slowing. Growth is still subpar. Productivity is very low. And wages aren’t rising. One of the fastest growing industries is food services, where jobs that pay less than factory jobs are on track to outnumber manufacturing jobs in less than three years. We have been in a bullish Goldilocks environment of stable growth and low inflation. But central banks are moving, however slowly, to withdraw stimulus and the earnings bar is set very high. This foreshadows a challenging period for equities once sustained volatility returns, FBN Securities says. It expects portfolio managers to keep shoveling cash into equities until companies slash profit forecasts. True, second-quarter earnings-per-share growth (EPS) were remarkable—up a fourth consecutive quarter at nearly a 19% pace. But unless economic growth accelerates organically or via fiscal stimulus, the current earnings recovery could be approaching its halfway mark, when stock market gains begin to fade. Ned Davis notes previous mid-cycle recoveries lasted a median of 24 months.

Going back to 1962, September’s the only month of the year with statistically significant negative returns, and we are entering it with multiple technical warning flags indicating near-term struggles. Market breadth continues to deteriorate, with a quarter of NYSE stocks having moved from uptrends to downtrends this year. Seasonality stays negative until early-October. JP Morgan says an S&P 500 break below the 2,390-2,420 support zone could lead to an acceleration to the downside. Oppenheimer, on the other hand, sees depleted internals as oversold firepower, with a seasonal backdrop that improves significantly in Q4. But it also thinks if the S&P reaches new highs in Q4 without improving participation, it could be time to reduce equity exposure. Ned Davis reminds us that the current bullish outlook remains supported by expanding profit margins and that the greater cyclical risk will be in 2018, when the economic and earnings cycles will be more mature, a growing contingent of central banks will be tapering or tightening, valuations could be stretched, complacency could be excessive and the cyclical bull that started last February will be approaching or exceeding its median 2.4 years duration for a secular bull, based on Dow bulls and bears dating to 1900. History suggests this market could have another 37% in gains and nine months to go before reaching the norms for a cyclical bull within a secular bull. Happy Labor Day … I’m off the clock.

Positives

Consumers confident and spending Contrary to expectations for a pullback, the Conference Board gauge jumped in August to its second highest level since December 2000. This morning’s Michigan sentiment gauge wasn’t as strong—it fell off August’s preliminary jump but was still up from July and remained at post-election elevated levels—while the weekly Bloomberg Consumer Comfort Index hit a new 16-year high. The reports, upwardly revised Q2 consumer spending and a second month of solid chain-store sales bode well for the back-to-school and holiday sale seasons.

Manufacturing accelerating Led by production and new orders, ISM's manufacturing index came in well above forecasts at 58.8, a 6-year high. ISM said both backlog and exports orders were unusually strong, a positive sign for activity this fall. While Markit’s PMI and Dallas Fed gauges weren’t as high, the ISM report was in line with a similarly robust reading from the closely watched Chicago PMI. The reports fit with this morning’s employment report, which showed substantial gains in factory payrolls.

Growth accelerating The second estimate of Q2 GDP put the pace of real growth at an above-consensus 3%, the most in nine quarters, on upward revisions to personal consumption and capital expenditures. If the trend holds, it would be welcome news for corporate executives, who are confronting an elevated bar for corporate earnings in 2018 and forward P/E multiples that are flirting with levels last seen during the dot-com bubble. Although the 3% number was impressive, Evercore ISI doubts its sustainability amid sluggish productivity and population growth.

Negatives

August jobs tend to be ‘noisy’ August nonfarm payrolls disappointed, coming in at a below-consensus 156K, and the prior months’ gains were trimmed by 41K. Wage gains also slowed. That said, the August report is known for seasonal issues. The other major August jobs report was strong as ADP’s separate count of private payrolls jumped the most in five months to 237K, raising its 12-month average to an 18-month high. Looking ahead, volatility in labor market data may continue as disruptions to activity from Harvey are likely to persist and affect the September survey week, meaning it may not be until November before we get a clear picture on hiring momentum.

Housing slows further Pending sales fell in July for the fourth time in five months, suggesting fall could see added weakness in an area of the economy that started the year with a bang before fizzling in the spring and limping through summer. The National Association of Realtors says contract signing activity continues to be depressed by the lack of inventory, which is boosting home values and weighing on affordability. It now expects existing sales to rise 0.7% this year, a notable deceleration from last year’s 3.8% increase. On a plus note, increases in single-family homes helped July residential construction rise 11.6% year-over-year pace.

Auto sales soften After bouncing back a bit in July, auto sales in August looked to be on track to slip a bit with about 2/3 of the data in as of this writing. Moderation off last year’s cycle high isn’t just a U.S. phenomenon. Despite a weaker dollar, vehicle exports fell by the most in nearly three years in July, causing overall exports to decline by the most in nine months and the trade gap to widen to $65.1 billion.

What else

Déjà vu Today’s debate looks almost identical to 2013’s, when the government shut down. In 2013, the Fed was withdrawing stimulus at a time when the next chair’s appointment was due, and the government faced a host of must-pass items including the debt ceiling. Republicans in Congress were fighting with the president and among their own caucuses. Geopolitical threats also were rising. Stocks sold off considerably in the lead up and first half of the government shutdown, but then rallied for the remainder of the year.

A degree in debt A study by Experian found the amount of student-loan debt has risen by 149% over the past decade to $1.4 trillion, while the average personal student-loan debt has risen 62%. Delinquencies, however, have declined 3% since 2007, showing that debtors are getting better at managing the loans, according to Michele Raneri, Experian's vice president of analytics.

I don’t particularly like to cook For the first time in history, Americans are spending more money dining out than in grocery stores, the USDA says, as eating habits evolve in step with a world where virtually anything is available with a few taps of the smartphone. According to Bank of America, consumers are eating alone more often and more “on-demand.” In fact, “immediate consumption” now accounts for 15% of all meals and commands premium prices.

Connect with Linda Duessel on LinkedIn