Stock Market Concerns Continue

The stock market will likely continue to be weighed down by concerns over Fed tapering, a slowing economy and potentially large increases in federal spending and taxation.  But, there are reasons why sentiment could change at some point -- possibly in late September or early October:   /1/ A strong Q321 corporate earnings season is expected.  /2/ While the Fed appears to be focused on starting tapering in November, the reduction in asset purchases will likely be gradual.  Moreover, interest rate hikes would probably begin only after all the asset purchases end, putting the first hike in late 2022.  /3/ The other two concerns are not baked in the cake and could surprise. 

The Fed is expected to set the stage for tapering at the September 21-22 FOMC Meeting and then actually begin tapering at the November 2-3 Meeting, according to the WSJ.  Any weakness in US economic data leading into the September Meeting should not deter the Fed from this course.  As NY Fed President Williams said, he is more focused on the cumulative strength seen so far rather than m/m fluctuations.  In contrast, strong US economic data would likely be viewed positively by the stock market, as they would suggest economic growth will remain solid as the tapering proceeds.    

While consensus expects most of this week's real-side data to be soft, the Claims data so far have not supported the idea of slowing economic growth.  There are several explanations.  /1/ The dichotomy highlighted by Fed staff (see my prior blog) could be at play.  So, declines in August Total and Ex Auto Retail Sales (consensus -1.0% Total, -0.1% Ex Auto) would fit with the Fed staff's expectation of "an easing of the surge in demand over the first part of the year," while an increase in August Manufacturing Output, led by increased motor vehicle assemblies, would fit with the staff's expectation of an easing of supply constraints.  Overall, the economy is still growing above trend, accounting for the further downtrend in Unemployment Claims.  /2/ Some of the weakness seen in July Retail Sales and August Payrolls could be measurement error that will be revised away.  /3/ Some of the weakness in August Retail Sales, if such is the print, could be just the typical pause after strong gains (as in June).  The pause could last as long as 3 months and tends to be followed by strong sales. 

The other important data this week will be the August Consumer Price Index.  The consensus estimate of +0.4% m/m Total and +0.3% Core looks reasonable, although a lower Core cannot be ruled out.  The forces behind inflation are mixed.  /1/ Wage inflation, as measured by Average Hourly Earnings, has sped up.   But, a news report that Walmart eliminated its quarterly bonus payment to offset an increased wage rate shows that AHE overstates the increase in labor costs.  The elimination of the quarterly bonus payments will hold down the Employment Cost Index and Compensation/Hour, but not AHE -- for definitional reasons.  /2/ Some recently large price increases, like Used Car Prices, have turned down.  This fits with the Fed's view that the recent inflation surges would be temporary.  /3/ The dollar has weakened against the Chinese Yuan, which could lead to higher import prices from there (or narrower profit margins of Chinese exporters if they don't pass through the stronger Yuan).  /4/ Oil prices have flattened out, so their pass-through in a variety of other prices should settle down.