'Extracurricular revenue' - a mood enhancer? I'm just saying
“We are mopey,” said an advisor in Denver, where I traveled this week, but she was not referring to stock market volatility. Indeed, for the first time in the index’s history, the S&P 500 began October with back-to-back drops of more than 1% each. The 2.99% decline over the first two days was the fourth worst start to a Q4 in S&P history. No, this advisor was referring to the two days of rain to start the month. The advisors all agreed, “We are so spoiled, with more sunny days each year than San Diego.” They want to hear what other advisors are experiencing around the country as I travel because, “We are an island here... feeling good (as the economy continues to prosper), except for the rising price of housing.” These upbeat Denverites attribute their moods and strong economy to the sun and “extracurricular revenue.” Stock prices generally lead economic data, resulting in a negative coefficient between the two—the better the data, the worse forward market returns and vice versa. This suggests short of recession, September’s surprisingly weak manufacturing ISM (more below) that prompted Tuesday’s sell-off could be viewed as a buying opportunity. Renaissance Macro says on an historical basis, the reading came in at a level indicative of forward 6-month returns that are double the long-term average. Similarly, September’s German PMI fell to a level consistent with forward 6-month returns 5 times the average in that country’s blue-chip index.
Of course, this is based on expectations the global and U.S. economies are experiencing slowdowns similar to those in 2012 and 2015, nothing worse. Reports this week show deteriorating trade further putting the squeeze on manufacturing, whose slowdown is starting to weigh on services (more below), CEO confidence (more below) and capital expenditures (capex). The worry is whether it ultimately may put the consumer at risk. In discussing some new concerns for the health of the consumer—today’s jobs report (more below) shows job growth moderating and wage growth leveling off—again Denver doesn’t see this, as a gentleman told us he was late for our meeting because “two Amazon delivery trucks crashed into each other” in this booming economy. Despite recent market volatility, Bloomberg’s weekly survey of consumer confidence remains at elevated levels, a sign employment is still OK and that house prices are still increasing. Also, this week’s continuing jobless claims were the lowest since October 2018, while the Challenger layoff tally was low, with terminations concentrated in industries with bankruptcies and closings. Still, a Wall of Worry is feeding on global macro worries and geopolitical uncertainties (impeachment, Brexit, Hong Kong, etc.), and Bank of America fears the potential for panic selling and liquidity risk in an unlikely area, the S&P 500. Post-crisis trading dynamics have changed dramatically with the rise of non-fundamental investors (“quants,” passive, high-frequency, etc.) and algorithmic trading. Some 44% of U.S. equity fund assets are now in passive vehicles, with buying and selling determined solely by inflows and outflows. Undue crowding is a concern, particularly with banks no longer capable of providing market liquidity like they used to through their trading desks in the pre-crisis era.
In Denver, there was shockingly little discussion of impeachment, a very serious and rare event for our country. No, the people I met, in advisor meetings and an end-client event, were jovial. An advisor laughed at his colleague who is buying munis for his clients, “So now you’re a bond guy,” and another added, “A boring bond guy.” The young man agreed, “That’s why I can’t find a girlfriend.” My evening host asked what plans I have for the weekend, “Will you be ‘rooting’ (with his hands gesturing ‘quote’) for the (at the moment, beleaguered) Steelers? Going to Cleveland to get brown bags?” The S&P has good support at 2,850-2,900, with the tailwind of stronger seasonality fast approaching. Wednesday’s sell-off included a spike in put/call ratios, typically a very reliable tactical contrarian indicator when measuring the probability of above-average forward returns 3-6 months out. The two most curious observations during the early-week pullback were semiconductors’ outperformance and the failure of weaker macro data to push global bond yields to new lows. Whenever markets misbehave and we wonder if we should sell, we should ask two questions first. Is the catalyst (in this case, the ISM) heralding a recession? And will the catalyst change P/E multiples? If the answers are no, as we believe to be the case, and the Fed goes ahead and cuts more on growth worries, that’s bullish. I visit Denver several times a year, and my mood always improves. An advisor friend asked me whether I had “new” shoes to show off. I disappointed him with my several-years-old Stuart Weitzman’s, and so now I must go shopping. He’s rocking his Rockport shoes, reminding me of my Mister’s shock when he first learned what I pay for my Jimmy Choos. “How can anyone pay more than $100 for a pair of shoes?” I told him to keep buying his Rockports and we will get along just fine.
- Fed has cover to continue cutting rates This morning’s jobs report for September was Goldilocks: though slightly short of consensus, the 136K gain was solid; August’s initial nonfarm jobs miss was revised up significantly; the jobless rate at 3.5% hit a 50-year low; and hourly earnings leveled off, a sign of no inflation here and an “all clear” for the Fed. Also this week, ADP business payrolls rose a relatively robust 135K, with 95% of new jobs in services, and Manpower’s employment survey for Q4 remained in a rising trend.
- Housing providing a lift Sharp declines in mortgage rates—down 22% year-over-year (y/y)—have been stimulative for housing stocks and the broader market, as well as housing activity. Private residential construction spending jumped nearly 1% in August, led by an outsized gain in single-family homes that feeds directly into the GDP calculation. On a y/y trend basis, mortgage purchase applications are up 10.5%, the most since November 2017.
- Is the end to the global slowdown in sight? The global manufacturing PMI edged up in September (although still in contraction territory), marking its first back-to-back gain since December 2017. In China, two closely watched gauges of manufacturing activity beat expectations on improving new orders, suggesting domestic demand is supporting its economy. Further, exports in the global PMI posted their largest gain in almost two years, with the share of countries where manufacturing is expanding at a 4-month high.
- Trade war intensification is the biggest manufacturing risk The ISM fell deeper into contraction territory, with weakness largely driven by trade-war uncertainty—exports shrank at their quickest rate in 10.5 years. Among industries, 15 of 18 were contracting. The Markit PMI, which has a more domestic focus, held above 50 and rose for a second straight month. The lagged impact of China’s massive stimulus should incrementally help the ISM going forward, as should low corporate bond yields and spreads relative to comparable maturity Treasuries.
- Services slip The ISM non-manufacturing index fell the most in three years to its lowest level since August 2016, with respondents saying they were mostly worried about "tariffs, labor resources and the direction of the economy." The survey suggests manufacturing weakness is starting to spill over into this much larger segment of the economy, with the combined readings for both ISMs corresponding to just 1.4% annual GDP growth, less than half Q1’s 3.1%. One positive: 13 of 18 services industries were still expanding, a sign of good breadth.
- I don’t like the sound of this at all CEO confidence sank in Q3 to its lowest level since Q1 2009, as the "Trump bump" in the aftermath of the 2016 election has snowballed into a "Trump slump" on the ongoing trade war and global growth slowdown. CEOs told the Conference Board they are curtailing capex and expect the trade war will have a lasting impact on their business.
Impeachment talk brings in the money … for GOP Four California fundraisers with Trump in attendance secured $15 million in two days after House Speaker Pelosi announced the House impeachment inquiry. The haul surpassed the $12 million Democratic Sen. Kamala Harris raised in her home state for her candidacy over the entire April-June quarter, and was more than enough to pay for a $10 million impeachment-themed TV and digital spending campaign launched by the Republican National Committee.
Election watch With the presidential election about 400 days away, there’s arguably more that’s unknown than known about the shape of the Democratic field. At this same point in 2008, Hillary Clinton and Rudy Giuliani were clearly in the lead among the candidates for their party’s presidential nomination.
It’s still the economy, stupid With employment declining in key electoral states such as Wisconsin, Michigan and Ohio, a slowdown in the U.S. economy arguably is a larger headwind for Trump’s re-election than impeachment.