Market Challenges: US Elections, Virus and Key US Economic Data

The stock market faces two challenges near term -- the US elections and the resurgence of the coronavirus.  There are a number of conceivable paths for the market depending on the elections' outcome.  The significance of the virus' resurgence could lessen if a successful vaccine is announced.

Regarding the elections, the first issue will be whether the results are clear cut on November 3.  A clear victor of the presidency could trigger a relief rally.  In contrast, the market may sell off sharply in the absence of a clear winner -- with one caveat discussed below.   The market would likely remain under pressure until the election results are resolved.

Whether Trump or Biden wins will make a difference for the market.  A Trump victory would likely be viewed positively, given his pro-growth policy stance.  A Biden victory would likely be viewed conditionally on whether Republicans control at least one of the Congressional branches.  By standing in the way of a full-blown passage of Biden policies, Republican retention of the Senate would mitigate any negative market reaction to his win if not prompt a relief market rally.  It also could prompt a relief rally if the presidential election is not clear cut.  In contrast, if control of the Senate looks to being passed to the Democrats, the market may sell off even if the presidential election is not decided.  And, if Trump is the victor, there is sure to be market talk of another impeachment attempt down the road, putting a damper on any rally.

Any relief rally in the case of a Biden victory may very well be short-lived, however.  There is a risk of heavy year-end profit-taking in anticipation of higher capital gains taxation under his administration.  The market could turn down sharply later in November and into December.

The market's evolution subsequent to the elections may depend on whether a successful vaccine against the virus is announced.  A vaccine should lead to a further pickup in economic growth next year regardless of who wins the presidency.  So, a sell-off on a Biden victory could end later in November if approval of a vaccine is announced then.  Or year-end profit-taking could be restrained.  

The US economy's current strength is likely to be seen in this week's key US economic data.  Consensus looks for an uptick in the Mfg ISM to 55.8 in October from 55.4 in September.  The Markit Mfg PMI inched up in the flash report, in line with consensus.  The Phil Fed Mfg Index jumped, suggesting upside risk.  Consensus looks for +600k m/m October Nonfarm Payrolls (versus +661k in September) and a dip in the Unemployment Rate to 7.6% from 7.9%.  Census workers should subtract about 145k from Payrolls, after subtracting about 30k in September.  But, the Claims data suggest the risk is for stronger-than-consensus Payroll and Unemployment Rate prints.

 

Economic Strength to Shine Through A Slew of Events

The stock market could easily be muted this week ahead of the November 3rd elections and despite a heavy calendar of corporate earnings reports.  Hope for fiscal stimulus may have to wait until after the elections.  Even without a new stimulus bill, the market should get comfort from evidence of strong economic growth in the next couple of weeks.  Q320 Real GDP Growth risks printing above consensus.  And, the Unemployment Benefits Claims data are back on a downtrend.

Consensus looks for Real GDP Growth to surge +31.9% (q/q, saar) in Q320 -- a strong rebound from -31.4% in Q220.  The risk, moreover, is for an even stronger print.  The Atlanta Fed Model's estimate is +35.3%, and there are reasons to think it is too low.  For example, its estimate of 37.4% Real Consumer Spending does not seem high enough, given the surge in September Retail Sales.

The Claims data suggest a continuation of above-trend economic growth in Q420.  California resumed submitting its figures to the Labor Department, including revisions to the prior week's reported figures.  As a result, Initial now show a 56k downward revision to 842k (was 898k) for the week ended October 10 and a further drop to 787k in the latest week (ended October 17).  This is a new low for the move down.

Continuing Claims reflect the downtrend in Initial, falling to 8.373 Mn from a downward-revised 9.397 Mn.  The latest figure is for the week just prior to the October Payroll Survey Week.   Nevertheless, if they stay near this level, they will point to a speedup in October Payrolls.  The relationship between Claims and Payrolls has broken down in the past couple of months.  But, a significant upward revision in Payrolls cannot be ruled out because of this breakdown. 

The Insured Unemployment Rate dropped to 5.7% from a downward-revised 6.4% in the prior week (was 6.8%).  This compares with 8.7% in the September Employment Survey Week, pointing to a drop in the October Unemployment Rate.  Moreover, the official Unemployment Rate has printed below the Insured Rate in each of the past 5 months (see table below).  A sub-5.7% Unemployment Rate would be a political shocker -- except that the October Employment Report will be released on November 6. 

  Insured Unemployment Rate Civilian Unemployment Rate 

Jan   1.2 3.6

Feb     1.2 3.5

Mar   1.2 4.4

Apr 12.4 14.7

May 14.3 13.3

Jun 13.2 11.1

Jul 11.6 10.2

Aug   9.9 8.4

Sep   8.7 7.9

Oct   5.7 na

 

Do US Economic Data Argue for More Fiscal Stimulus?

The stock market should continue to react to developments bearing on the probability of a fiscal stimulus bill being passed.  A pre-election bill does not appear promising, however.  Treasury Secretary Mnuchin will be in the Middle East for most of the coming week.  The Republican small Senate bill won't go anywhere.  And, Democrats don't appear willing to compromise further.  This stalemate could weigh on stocks leading up to the election.

Three economic data reports last week appeared to have mixed implications for further fiscal stimulus. Exceptionally strong September Retail Sales argued against its need.  But, the counter-consensus jump in Initial Unemployment Claims and decline in September Manufacturing Output (part of Industrial Production) argued the opposite.  While the weakness in the latter two may be exacerbated by technical factors, they, along with the still-high Unemployment Rate, suggest further fiscal stimulus won't hurt.  And, it is too soon to draw a firm conclusion about fiscal stimulus from the strong September Retail Sales.

The Retail Sales strength was widespread, with increases in brick and mortar stores notable.  The latter suggests that the sales bounce may have reflected expanded re-openings of shopping malls around the country.  The high Personal Saving Rate, as much of the earlier stimulus payments appears to have been unspent, may have fueled the surge in shopping.  Retail Sales need not slow sharply in October, as the effect of re-openings could continue.  Also, Amazon's Prime Day, as well as heavy discounting by other chains, will show up.  But, some pullback after a surge would not be unusual.  It is too soon to draw a conclusion about the need for additional fiscal stimulus from the September print.

The jump in Initial Claims in the latest week is disturbing.  Unless it reverses soon, the higher unemployment will hit consumer spending and slow the economy.  There is a technical issue regarding the number, however.  California suspended processing Initial Claims for a couple of weeks in order to get through a large backlog of Claims.  Their last reported weekly Claims figure is being carried forward until it resumes processing.  This figure could distort the overall Initial Claims data, since it would not correctly reflect seasonal w/w movements.  So, the Claims data should be viewed cautiously.

The decline in September Manufacturing Output would seem to support the weakness implied by Initial Claims.  The decline was not widespread, however.  A drop in Motor Vehicle Assemblies accounted for the decline.  The motor vehicle drop appears to reflect a return to pre-virus levels, after production was boosted in July and August to rebuild inventories.  Nevertheless, the flat Manufacturing Output Excluding Motor Vehicles still looks low relative to the increase in Total Hours Worked in Mfg (even excluding motor vehicles) in September (see table below).  Some technical factor may explain the difference.  Or, the difference could reflect an offset to the relatively stronger output over July-August. Output exceeded the increase in THW in July-August after essentially matching them over May-June.  In principle, output should rise faster than THW over time because of productivity gains, but there still could be m/m mismatches.  If the latter was the case in September, the flat Ex Auto Manufacturing Output overstates weakness.  But, its decelerating path over Q320 supports expectations of slower economic growth in Q420, which, at the minimum, does not argue against more fiscal stimulus.

           [                         (m/m percent change)             ]

            Total Hours Worked in Mfg            Mfg Output         Mfg Output Ex Motor Vehicles

 May                 4.9                                         3.6                             1.9     

June                  5.9                                         7.8                             3.9       

July                   2.5                                         4.3                            2.2

Aug                   0.6                                         1.1                            1.7

Sep                    0.4                                        -0.3                            0.0

Total                15.1                                       17.4

Did the Stock Market Rally Too Much Last Week?

The stock market may have rallied too much last week on excessive optimism regarding two of the non-economic issues mentioned in my blog -- Trump's health and the potential for additional fiscal stimulus.  But, a pullback may be modest and short-lived.

There may be less significance in the apparent resolution of these two issues than believed.  There is still much uncertainty about the size and timing of a stimulus bill.  Also, Biden's growing lead in the polls increases the odds that Trump will lose power in Washington even if he stays healthy.  Perhaps reflecting this changed status, some Republicans have voiced opposition to his upping of a stimulus package.  And, the Democrats don't look keen to compromise further. 

However, there are developments that could be market positives this week.  Apple's product announcement (October 13) and Amazon's Prime Day (October 13-14) should provide a boost.   Also, there is hope that corporate earnings reports, which start this week, will be better than expected -- as  have some early releases.  

Some more distant developments should limit a market pullback, as well.  A Democratic victory for the presidency and Senate would likely result in a large stimulus bill.  For awhile, the immediately positive effects of such a bill could outweigh the anti-growth implications of other policies they espouse.

Another development that will likely cushion any negative fall-out will be expectation of a successful vaccine.  News reports suggest a vaccine will be ready by the end of the year and be available to all the country by Spring.  A forecast of a post-vaccine return to normalcy should be a significant market positive after the November elections.  Even if Biden wins and the Democrats take control of the Senate, a return to normalcy would give the economy a boost ahead of any drag from their policies.

The most interesting US economic data release this week should be the September CPI.  If the consensus estimates of 0.2% m/m for Total and Core are correct, they would underscore the long time, if not difficulty, the Fed may face in making up for the past shortfall in inflation relative to their 2% target.  The annualized pace in September would be 2.4%.  It would likely be less for the PCE Deflator, which is the measure targeted by the Fed.  

Other data should confirm good economic growth in the last month of the quarter.  Consensus looks for +0.6% m/m Total and +0.4% Ex Auto September Retail Sales and +0.6% September Industrial Production.  While these gains are less than in August, they are still strong.    

 

 

 

 

 

 

 

Market Focus Turning to Non-Macroeconomic Issues, But Macro Looks OK

Over the next few weeks, the stock market focus should turn more exclusively to non-macroeconomic issues: /1/ President Trump's health, /2/ election-related developments and risks, /3/ corporate earnings, and /4/ potential for further fiscal stimulus.  These issues should exacerbate market volatility.  But, economic growth is ending Q320 at a good pace, which should keep market downside in check.

The early statements regarding Trump's fight of the Covid-19 infection are positive.  But, it's not clear how or how long it will evolve.  So, the market may just chase headlines until there is a firm conclusion.

Consensus looks for another large y/y decline in Q320 corporate earnings (-22%), but smaller than that of Q220 (-32%).  This expectation is supported by macro-economic evidence (see my September 20 blog).  Expectations of a large rebound in earnings next year could temper the import of weak Q320 profits, however. 

The market may put more weight on polls showing Biden ahead than it has in the past.  But, control of the Senate by Republicans or Democrats could be just as important to the market as who wins the Presidency.   Republican retention of the Senate would likely cushion the market impact of a Biden win.

The macroeconomic background should be supportive of stocks and mitigate negative fall-out from the other issues.  There was a strong V-shaped bounce in Q320 Real GDP.  The Atlanta Fed model's estimate of Q320 Real GDP Growth is now up to 34.6% -- and still could be too low.   GDP Growth should slow in Q420.  But, the pace is still likely to be above-trend. 

The September Employment Report was deemed weak in news stories.  But, this is not the case.  Most of the weakness reflected the impact of the virus on the education sector (mostly in government) and a decline in census workers.  Job Growth outside of education in the private sector was little changed from August: 946k versus 952k.  While the drop in the Unemployment Rate to 7.9% from 8.4% was largely a result of a drop in Labor Force Participation, the Rate would have edged down even without the latter.  The lower Participation was concentrated among women and likely resulted from the need to stay home with children while they do on-line schooling.

The most significant part of the Report was the increase in Total Hours Worked (THW), driven by both the increase in jobs and a higher Workweek.  THW in September were 4.1% (annualized) above the Q320 average -- a strong take-off point for Q420.  It is too soon to derive an estimate of Q420 Real GDP from this figure.  It could come down if the Average Nonfarm Workweek pulls back from its high September level.  Or, it can rise further.  Even a modest uptrend over Q420 could put THW 5% above the Q320 average -- suggesting the potential for a similar increase in Real GDP.  Note, the reliance on a longer workweek in September could have reflected business caution, but it also could have reflected a quick response to the re-openings -- in which case it bodes well for job growth ahead.

This week's calendar of US economic data is very light.  Consensus looks for a dip in the Non-Mfg ISM to 56.3 in September from 56.9 in August -- still a high figure.  Consensus sees a slight uptick in Initial Claims to 845k from 837k in the prior week.  This would still keep them on a downward trend.

The September FOMC Minutes and Fed speakers scheduled this week, including Powell, should reiterate the Fed's commitment to keep policy steady and rates low for an extended period.  The shortfall in inflation relative to the Fed's 2% target could take several years to unwind, assuming inflation picks up.

 

 

Potentially Market-Positive Developments

Although the stock market will still face potentially negative issues after quarter-end, as enumerated in my prior blog, two potentially positive developments -- fiscal stimulus and a vaccine -- appear to be more promising than a couple of weeks ago.  Another round of fiscal stimulus would have a more immediate impact on the economy, so it is likely the more important of the two in terms of the stock market's near-term prospects.  Additional fiscal stimulus can be justified even if US economic data continue to point to above-trend growth.  The huge amount of slack in the labor market means growth should be even stronger.

The potential for a fiscal stimulus compromise between Democrats and Republicans may have implications for the market reaction to strong or weak US economic data.  The stock market could react positively to slowing evidence to the extent it is seen leading Republicans to accept a higher stimulus amount than their announced $1.3 Tn proposal.  The market also could get a lift from strengthening evidence if it is seen pushing Democrats to lower than $2.4 Tn proposal.  Very weak data still should be a market negative as it would suggest a dire consequence of no additional fiscal stimulus.  Very strong data could be a positive for the opposite reason.  

This week's US economic data will likely keep open the door for a stimulus package compromise but not necessarily narrow the gap between the proposals.  Consensus looks for the September Mfg ISM to edge up to 56.2 from 56.0.  This would be smallest m/m increase since the recovery began in May, arguing for more stimulus.  But, it would be a high level, confirming a widespread recovery in the sector.  Evidence from the Markit Mfg PMI and components of Phil Fed Mfg Survey point to an uptick.  Note, however, there is some downside risk from the possibility that the pullback in motor vehicle assemblies in August gets captured by the September Mfg ISM.  

Consensus expects September Nonfarm Payrolls to slow to +913k m/m from +1.027 Mn in August, again in a direction favoring more stimulus but a pace that is historically still very strong.  There is some evidence for a September slowdown in Payrolls.  Census workers fell by 41k between the August and September Survey Weeks.  And, the decline in Continuing Claims between months slowed, suggesting net hiring in the private sector slowed, as well.  One piece of evidence that suggests a speedup is the 3.8 Mn surge in Civilian Employment in August as shown in the Household Survey, which did not show up in Payroll that month.  Will it appear in September Payrolls?  Not necessarily.  There could be a number of technical reasons for the difference between Civilian Employment and Payrolls.  And, other recent months have shown divergences too that were not offset in the subsequent month.  So, it represents only a risk, and not a particularly reliable one.

Consensus looks for a dip in the Civilian Unemployment Rate to 8.2% in September from 8.4% in August.  Here, the risk is for a larger decline.  The Insured Unemployment Rate fell by 1.3% pts m/m in September.  The Civilian Unemployment Rate fell by more than the Insured Rate in 2 of the past 3 months.    To be sure, there is also a risk that Civilian Employment could unwind part of its 3.8 Mn surge in August, which would limit the decline in the Unemployment Rate if not boost it.  A still high Unemployment Rate could encourage a fiscal stimulus compromise.

 

 

The Pullback in Stocks

The pullback in the stock market after the FOMC meeting can be attributed to a renewed correction of the tech rally over the summer, possibly exacerbated by window dressing by funds ahead of quarter end; seasonal weakness; concern over a moderation in US economic growth; and setting up for another quarter of weak corporate earnings reports.  All these reasons are likely overdone or temporary, but could last into October.  Uncertainty over the November elections may weigh heavily next month, as well, but good news about a vaccination would work in the opposite direction.

If the market pullback reflected concern over a slowdown in US economic growth, the concern may be overdone.  It may have been exacerbated by the Fed's lowering its Central Tendency forecasts of growth over the next couple of years (although it raised it forecast of 2020 GDP Growth -- and most likely not by enough).  The forecasts, however, have a wide band of uncertainty around them and should be viewed with much caution.  Their main import may be to justify the maintenance of very easy monetary policy.  

Growth concerns also may have stemmed from a few US economic data coming in below consensus -- in particular, August Retail Sales, Industrial Production and Housing Starts/Permits.  But, if so, these concerns are overdone.  August Retail Sales were strong enough to lift the Atlanta Fed Model's projection.  Manufacturing Output, within IP, was strong.  And, the softness in Housing Starts/Permits was in the volatile Multi-Family sector.  The more important 1-Family sector rose to the highest level since February.  It contributed to the upward revision in the Atlanta Fed model's projection, as well.  While the September Phil Fed Mfg Index dipped to 15 from 17.2, as expected, the components of the survey strengthened.  The declines in Initial and Continuing Claims in the latest week support the idea of above-trend growth continuing as the quarter ends.

The stock market soon will be facing corporate earnings reports for Q320.  While some companies will "beat" consensus, the macroeconomic evidence supports the consensus expectation of a sizable y/y decline in the aggregate.  The latter is not likely to derail the rally, since consensus looks for large rebounds in corporate earnings in the next two years.

Consensus looks for -23.0% y/y for Q320 S&P 500 Corporate Earnings, better than the -32.0% in Q220 bur still worse than the -15.4% in Q120.  The macroeconomic evidence shows clear improvement from Q220, but is mixed relative to Q120 (see table below).  So, an earnings decline somewhere in between them seems reasonable.  Real GDP Growth remains negative on a y/y basis, using the Atlanta Fed model's latest estimate of 32.0% (q/q saar).  It would be flat if Q320 Real GDP Growth is 35%.  Oil prices are lower on a y/y basis, but closer to the decline in Q120 decline than in Q220.  Foreign growth is better than in both prior quarters.  And, the dollar was less strong, making  currency translations of earnings abroad less of a drag.  Profit Margins may be squeezed, as Average Hourly Earnings rose faster than prices.  But, the jump in AHE may reflect compositional shifts in the labor market and thus overstate the increase in unit labor costs.   

                                                                                                                                          Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)
Q117            1.9                +65.3                  2.3                              2.7          2.2                55.6
Q217            2.1                +13.1                  3.1                              2.5          1.8                56.8
Q317            2.3                 +6.0                 -1.9                              2.5           1.7               57.4
Q417            2.5               +12.7                 -4.1                              2.5           1.7               59.7

Q118            2.6               +21.5                 -6.6                              2.7           1.9               59.1
Q218            2.9               +41.0                 -1.8                              2.7           2.2               55.9
Q318            3.0               +45.4                 +5.1                             2.8           2.2               54.3
Q418            3.0                 +6.7                 +6.5                             3.3           2.2               51.7

Q119            3.2                -12.8                 +7.9                             3.2           2.1               51.9 
Q219            2.7                -12.2                 +5.9                             3.1           2.1               47.8    
Q319            2.1                -19.2                 +3.6                             3.2           2.3               46.4
Q419            2.4                  -3.6                 +1.7                             3.2           2.3               46.2

Q120           -5.0                -16.5                 +2.9                             3.1           2.3               47.2
Q220         -10.6                -53.5                 +5.9                             6.5           1.4               40.1

Q320           -0.6 *             -27.8                 +1.8                             4.8           1.7               51.8

* Based on Atlanta Fed Model's latest projection

This week's economic calendar highlights housing and manufacturing data that support the idea of a moderation in growth to a still strong pace.  Consensus looks for little change from a high level for August New Home Sales and Markit US Mfg PMI.  It sees August Durable Goods Orders (both Total and Ex Transportation) posting good-sized gains, but smaller than July's.  And, it looks for another gain in August Existing Home Sales.  Initial Claims are expected to dip.