Stocks To Slog Up in Face of Mixed Corporate Earnings and Fed Uncertainty

The stock market will likely slog up over the next few weeks, dealing with mixed corporate earnings reports and uncertainty regarding the Fed rate decision at the November 6-7 FOMC Meeting.  A 25 BP cut is probably the best bet as of now, despite the stronger-than-expected September CPI and Employment Reports.  Expectations of modest prints for this week's US economic data -- Retail Sales, Phil Fed Mfg Index, Industrial Production -- should support this view and help stocks.  However, the most important data for the Fed will likely be the October Employment Report, due November 1.  It is too soon for evidence on Payrolls.

Fed Chair Powell has said that while the intention is to bring the Fed Funds Rate down to a neutral level over time, the pace will depend on the impact of economic data on the Fed's outlook.  The most recent data will not likely derail the Fed's expectation of slower economic growth and lower inflation.

Consensus among market observers is that the September Employment Report and CPI were stronger than the Fed liked.  My view, as discussed in last week's blog, is that the Employment Report was not as strong as appears at first glance.  It is consistent with slower economic activity at the end of Q324 and leaves open the possibility this could continue in Q4.24.  It's unlikely that Fed officials would mention the mitigating parts of the Report in their upcoming speeches, but they should be aware of them.  This week's key US economic data -- September Retail Sales and Industrial Producton --are expected to post slight gains, supporting the idea that growth is moderating.

Although the September CPI showed a wider distribution of speedier increases among components than in recent months, the Fed could discount the speedups as being part of the "bumpy" ride they expect in the decelerating trend in inflation.  Moreover, the one piece of good news in the Report was the sharp slowdown in Owners' Equivalent Rent (OER) to a below-trend 0.3% m/m.  If OER's slower pace persists, the Fed's 2% inflation target may very well be achieved.

Looking ahead to nest year, four possible scenarios are conceivable:  

1.  Aggressive fiscal policy could boost inflation expectations and longer-term Treasury yields -- raising the possibility of renewed Fed tightening.   This would be a negative for stocks.  Both presidential candidates' policies have this potential outcome.

2.  The Fed policy easing in H224 boosts economic growth and inflation in H125, raising longer-term Treasury yields and pulling in expectations of further Fed easing -- a negative for stocks.

3.  Economic growth and inflation continue to moderate, keeping Fed rate cuts on track, positive for stocks.

4.  The US economy somehow slips into recession.  This seems unlikely, unless Fed policy shifts away from easing.

A Strong September Employment Report?

The stock market should climb  this week, after Friday's ostensibly strong September Employment Report dispelled fears of recession.  However, there was less strength than met the eye in the Report.  So, along with benign inflation data expected this week, the Fed should still be on an easing path.  Although Q324 corporate earnings are expected to slow, the slowdown may be temporary.

A large increase in September Payrolls and lower Unemployment Rate were the risk, given the recent decline in Unemployment Claims.  Unless the October Report (to be released prior to the next FOMC Meeting) is as strong, the Fed will not likely stop cutting rates in Q424.  The Fed apparently is focused on its expectation of future weakness stemming from prior tight monetary policy, not current economic activity.  Moreover, although the September Report shows a strong labor market, some parts of the Report suggest the headline Payroll print may overstate strength.  Some of the jobs gain may reflect a shift toward part-time workers.

The Household Survey shows that the number of part-time workers in nonagricultural industries jumped 527k m/m in September, after a string of sub-100k increases in prior months.  To be sure, this should be viewed as only suggestive, given the relatively small sample size of the Household Survey (on which the Unemployment Rate is based) compared to the Establishment Survey (on which Payrolls are based).

A shift toward part-time workers, nonetheless, could explain the dip in the Nonfarm Workweek to 34.2 Hours from 34.3 Hours in August.  But, the dip could be just noise.  It was 34.2 Hours in July, as well, although the industry breakdown was different from that of September.  The dip in Workweek in September did not appear to be mainly among Production Workers.  Their workweek was flat.

Total Hours Worked slipped m/m because of the decline in the overall Workweek.  The Q324 average of THW is only  0.2% (annualized) above the Q224 average, versus +1.6% (q/q, saar) in Q224.   This raises doubt about 2+% Real GDP in Q324.  However, THW may overstate weakness.  This is because THW for Production Workers rose 1.0% (q/q, saar) in Q324, not much below the 1.5% in Q224.  So, Q324 Real GDP Growth still may be in the 2.0% range.  The Atlanta Fed model's latest estimate is 2.5%, but does not yet take account of Friday's data.  The next model update is on Tuesday.

The 0.4% m/m increase in Average Hourly Earnings (AHE) after an upward-revised 0.5% in August is somewhat troubling.  The Q324 average rose 4.0% (q/q, saar), compared to the 3.4% increase by the Q224 average.  The y/y rose to 4.0% from 3.9%.  Nevertheless, large wage gains were not widespread, as fewer than half of the major sectors had large increases.  AHE rose 0.4% m/m or more (on average) in only 6 of 13 sectors in Q324, versus 4 in Q224.

Consensus expects a benign print for the September CPI.  It sees +0.1% m/m for Total and +0.2% for Core.  The risk would be for a higher print if Owners' Equivalent does not fall back to 0.4% m/m after speeding up to 0.5% in August.  Consensus looks for +0.1% m/m Total and +0.2% Core for the September PPI, as well.

Consensus estimates +4.6% (y/y) for Q324 S&P 500 earnings, down from 11.2% in Q224.  The macroeconomic background appears to support a slowdown in earnings.  On a y/y basis, Real GDP Growth slowed, oil prices fell and the dollar strengthened further (thereby making foreign earnings appear lower in dollar terms).  In contrast income from abroad could help profits this quarter.  Based on the European PMI, foreign economic activity improved on a y/y basis, although it slowed q/q.  Profit margins look to have been little changed.  A soft quarter of corporate earnings could be temporary, as consensus, at this point, looks for double-digit y/y returning in Q424 and continuing through 2025.

                                                                                                                                       Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level) 

Q123            2.3                -19.5                +3.0                              4.5           5.5               47.9  

Q223            2.8                -32.0                 +0.5                              4.4           5.2               44.7

Q323            3.2                -12.0                 -2.5                               4.3           4.4               43.2

Q423            3.2                -12.0                 -2.5                               4.3           3.9               43.8

 

Q124            2.9                +14.0                  0.0                              4.3           3.8               46.4

 

Q224            3.0                  +2.5                +3.0                              3.9           3.4               46.3 

 

Q324            2.6                  -6.0                 +2.5                              3.8           3.3               45.3                                                      

                                                                           

* Based on the Atlanta Fed Model's latest projection of 2.5% (q/q, saar).

 

How Important Are Upcoming Key US Economic Data?

The stock market should have no problem with this week's key US economic data -- if the data print close to the consensus estimates.  They would show a moderately growing economy, without putting undue stress on the labor market or lifting inflation.  Stronger-than-consensus data could lower market expectations of the size of the next Fed rate cut, and vice versa.  However,  the Fed will see another month's data before it meets again.  So, this week's releases lose some significance.  Away from the data, the stock market has major support behind it by the fact that central banks around the world are shifting to pro-growth policies.   China joined the Fed last week in monetary policy easing, and the ECB should soon do so, as well (meeting on October 17).   Market pullbacks on disappointing data (particularly in this seasonally weak period) could be buying opportunities.

Although US economic data may influence the Fed's decision on the speed of policy re-calibration, it will probably not stop the process.  The Fed's focus is on future economic activity.  Paraphrasing Chicago Fed President Goolsbee's recent comment, the economy will slow sharply ahead if the Fed does not lower the funds rate quickly.  This may not be a majority opinion at the Fed, as other officials have indicated a more cautious approach to easing.  However, the data may have to be particularly strong to preclude another 50 BP cut.  How the longer-end of the Treasury market behaves could influence the Fed's decision, as well.  Longer-term yields already have moved up a bit after the September funds rate cut.  If they move up more sharply, the Fed could settle for a 25 BP rate cut.

Consensus estimates for this week's key US economic data -- September Mfg ISM, August JOLTS and September Employment Report -- should keep a 50 BP rate cut in play:

Consensus looks for a steady 47.2 Mfg ISM.   The Index would remain below the 48.8 Q224 average, signaling a sluggish manufacturing sector.  

Consensus expects the JOLTS data to show little change in Job Openings in August, 7.65 Mn versus 7.67 Mn in July.  This would keep Openings in line with pre-pandemic levels, indicating that the post-pandemic excess demand for labor indeed has been eliminated.  The Fed views elimination of excess demand for labor as a way to hold down wage inflation without having layoffs lift the Unemployment Rate.

Consensus expects the September Employment Report to look similar to the August Report.  Nonfarm Payrolls are seen rising 145k m/m, versus 142k in August.  The Unemployment is expected to be steady at 4.2%.  And, Average Hourly Earnings (AHE) are back to a 0.3% m/m trend, after volatility in June and July (0.2% and 0.4%, respectively).  

The risk is for Payrolls to climb by more than the consensus estimate, based on the Unemployment Claims data.  Both Initial and Continuing Claims fell below July levels in August.  However, Payrolls may have to have to climb substantially, say 200k+ m/m, to raise doubt about a 50 BP rate cut.

The risks for the Unemployment Rate, are mixed.  There is a possibility of a decline, as the consensus Payroll estimate is above the 125k m/m pace consistent with a steady Unemployment Rate (assuming steady Labor Force Participation Rate).  In contrast, the Labor Force Participation Rate could resume climbing after it stabilized in August.  A higher or steady Unemployment Rate stemming from an increase in the Participation Rate would show the economy has more room to grow without stirring inflation.  Unfortunately, there is no reliable evidence regarding the m/m direction of the Participation Rate or Unemployment Rate. 

There is no reliable way to predict AHE, as well.  AHE has been in a tight 0.2-0.4% m/m range since March 2024, average 0.3%.  The same is true for all of 2023.  As long as AHE does not break to the upside of this range, it should not be a problem for the Fed.

The Atlanta Fed model still estimates Q324 Real GDP in the 3% (q/q, saar) range.  Its estimate was raised to 3.1% from 2.9% after the last couple of weeks' data.  Consumption was revised down sharply, but upward revisions in exports and inventory investment more than made up for it.  There is a possibility, however, that the downward revision to Consumption was underestimated and the upward revision to Net Exports overestimated.   Nevertheless, a near-3% pace is above trend and should be accompanied by good-sized increases in jobs.  At this point, it also suggests strong productivity growth, which should help hold down inflation.

Range-Bound Stock Market This Week?

The stock market may be range bound this week, as there are few data releases and the major indices are at or near record highs.  Although the market should be underpinned by the Fed's intention to lower rates further, there could be caution ahead of historically seasonal weakness in early October.  Also, key US economic data in early October may dampen expectations for the pace of future Fed easing.

The Fed expects to cut another 50 BPs by year end, another 100-150 BPs in 2025 and 50 BPs in 2026.  The funds rate would level off between 2.6% and 3.6%.  This week's US economic data are not expected to be a problem for this plan, but there could be problems in the following week.

The Fed appears determined to "recalibrate" the stance of monetary policy, based on Fed Chair Powell's comments at his post-Meeting news conference.  He said policy needs to be adjusted to reflect a  labor market that is no longer very tight and inflation that is close to target.  This sounds like a policy path that is set regardless of unwelcome surprises in economic data.  However, Powell said the pace of the re-calibration will depend on incoming data.  He may repeat all this in a speech this week (Thursday).

What seems to be important is whether and by how much upcoming data change the Fed's outlook -- not what the data say about the current state of the economy.  Unfortunately, it may be more difficult for market participants to ascertain the data's impact on the Fed's outlook than what they mean for the current economy.  Perhaps it will take substantial unfriendly data surprises to change the Fed's policy intentions. 

Powell indicated that what matters most are the paths of the Unemployment Rate and inflation -- the two mandated measures against which Fed policy is judged.  If economic growth is stronger than the Fed's published forecasts, it may not matter as long as the Unemployment Rate remains little changed from current levels.  This could be the case if potential growth is higher than the Fed's estimate of 1.7-2.0% longer-run growth.  With Powell repeating that the Fed expects housing rent to come down over time, small upside deviations in upcoming inflation data may be ignored by the Fed, as well.  The market and Fed are likely to take a consensus 0.2% m/m print for the August PCE Deflator in stride.

The Fed's projection of Real GDP Growth of 1.8-2.3% over the next three years is in line with its estimate of the longer-run trend, which may be "solid" as Powell says but is not especially conducive to strong earnings growth.  Like all long-term forecasts, though, these have to be taken with a grain of salt.  They may be meant to justify continued monetary policy easing rather than be a realistic forecast.

Why the projected rate cuts shouldn't lead to a significant speedup in GDP growth is a question.  Perhaps the Fed could justify it by saying the easing just offsets the lagged restraint of earlier tightening.  Or, it's possible that bad fiscal policies in a new Administration could restrain growth at the same time monetary policy is lifting it.  Arguably, the opposite happened in the past couple of years, with stimulative fiscal policy offsetting tighter monetary policy (although the Fed would never admit to this).  

The dubious accuracy of these forecasts is apparent in the downward revision of the 2024 Real GDP forecast to 1.9-2.1% from 1.9-2.3% made in June.  With H224 Real GDP Growth at 2.2% and the Atlanta Fed model estimate of Q324 Real GDP at 2.9%, there needs to be a sharp slowdown in September and Q424 to match the Fed's forecast for the year.  Perhaps, a protracted Boeing strike will do the trick.  There would be a sharp rebound in GDP once the strike ended, however.  

The latest Unemployment Claims data argue against a late-summer slowdown.  Initial and Continuing Claims fell further below the August levels in the latest week, despite the possibility of a post-holiday rebound.  At this point, they suggest a speedup in September Payrolls (due October 4), which could dampen expectations of future Fed easing.

A Friendly FOMC Meeting?

The stock market should continue to recover this week, even if the Fed cuts the funds rate by only 25 BPs.  This is because in addition to the rate cut it is very possible the Fed will signal more monetary policy easing in the rest of the year.   Moreover, the revisions to the Central Tendency Forecasts should be market positive.  And, there is a reason to think that the Fed's estimate of longer-run economic growth is too low, although it will not likely be changed at this meeting.  Putting aside specifics,  since the purpose of the easing would be to sustain solid economic growth, this policy background is an important positive for stocks.  

The Fed's signal of future rate cuts would be in the Central Tendency Forecasts and "dot" plots.  The latest Forecasts, made in June, showed the funds rate being cut to 4.9-5.4% by Q424, compared to the current range of 5.25-5.5%.  The updates will likely move this forecast down to 4.5-4.75% -- implying another 50-75 BPs in cuts over the two remaining FOMC Meetings this year.   The June "dot" plot put the median forecast at just above 5.0%.  This, too, is likely to move down to under 5.0%.

Updates to the economic components of the Central Tendency Forecasts should be stock-market positive:

1.  The forecast for Real GDP is likely to be raised to around the current upper estimate of 2.3%, as the H124 actual pace is 2.2% and the Atlanta Fed model estimate of Q324 is 2.5%.  The June range is 1.9-2.3%. 

2.  The Unemployment Rate forecast may be raised a bit.  In June, the forecast was for the Rate to be 4.0-4.1% in Q424.  It was 4.2% in August.  An upward revision could reflect expectations of increased labor force participation rather than weaker economic growth.

3.  The inflation forecasts could be lowered.  The June forecasts are 2.5-2.9% for Total PCE Deflator and 2.8-3.0% for Core PCE Deflator.  In July, the y/y was 2.5% for Total and 2.6% for Core.  They will move down more if they print less than 0.16% m/m from August through December.

Although the 1.7-2.0% estimate of the longer-run trend in Real GDP Growth is not likely to be changed at this meeting, this possibility may become an important focus either in the markets or at the Fed.  With US Population Growth at 1.2% and Nonfarm Productivity possibly continuing to exceed 1.0%, the longer-run trend in GDP could be in the 2.0-2.5% range.  A rising Unemployment Rate while Real GDP Growth is in the 1.7-2.0% range would suggest a higher range for the longer-run GDP trend than now estimated by the Fed.  If the Fed recognizes this, officials are likely to be more comfortable, if not more aggressive, in cutting rates.

On the data front, it is noteworthy that both Initial and Continuing Claims remained below their July average in the latest week.  It is possible that labor market weakness has bottomed.  Consensus looks for modest increases in August Retail Sales, both Total and Ex Auto.  This would still indicate a solid consumer after Sales jumped in July.

 

 

A Fed-Friendly Employment Report

The stock market may try to stabilize this week, after it seemed to overreact to Friday's Fed-friendly August Employment.   The latter points to near-trend economic growth with little wage pressures, arguing for a measured 25 BP rate cut at the September 17-18 FOMC Meeting (as well as keeping the door open for more cuts in Q424).   This macroeconomic/policy background remains positive for stocks.  

To be sure, some market participants are concerned that a 50 BP rate cut is needed.  Disappointment that the Employment Report did not give unequivocal support for this size cut may have been a factor behind Friday's sell-off.  There could be disappointment again this week, since consensus expectations for August inflation data, if correct, may not be soft enough to satisfy market participants hoping for a 50 BP rate cut.  However, the underlying inflation data should be negligible and not be a problem for the Fed or markets.

The August Employment Report contained an almost ideal set of data from the Fed's perspective:

1.  The 3-month average of Payrolls is 116k m/m -- close to the +125k m/m pace that is consistent with a steady Unemployment Rate.  The +142k increase in August was likely in part a rebound from a negative weather impact in July.  The July-August average (+116k) about equals the June pace (+118k).

 2. With the Nonfarm Workweek recovering, Total Hours Worked rose to a level that is 0.8% (annualized) above the Q224 average -- supporting estimates of about 2.0% Real GDP Growth (taking account of productivity).

3.  The dip in the Unemployment rate to 4.2% from 4.3% resulted from Civilian Employment outpacing Labor Force.  Both the Labor Force Participation Rate and Employment-Population Ratio were steady.  This is not a sign of a softening labor market.  To be sure, the broader U-6 Rate edged up, apparently because of an increase in  people working part time for economic reasons.  All other broad measures of unemployment edged down.

4. The speedup in Average Hourly Earnings to 0.4% m/m could be just an offset to the low 0.2% in July -- in other words, just volatility.  The latest 3-month average is a trend 0.3% m/m.  Last week's revision to Q224 Productivity/Labor Costs had good news for the inflation outlook.  Compensation/Hour -- the broadest measure of labor costs -- slowed to 3.0% (q/q, saar) from 4.2% in Q124.  The y/y fell to 3.1% from 3.8%.

This week's inflation reports are expected to be moderate -- but perhaps not low enough for those hoping for  50 BP rate cut.  Consensus looks for +0.2% m/m for both Total and Core CPI in August, with the risk of a lower print for Total.  The y/y should fall for Total but be steady for Core.  Nevertheless, inflation should be essentially a non-issue.  This is because inflation outside housing rent is flat.  Although some prices climb, others fall -- balancing out.   And, the bulk of the measured rent is imputed, not actually paid.

The more interesting report may be the weekly Unemployment Claims data.  Both Initial and Continuing fell in the prior week, but this could have resulted from Labor Day being in the week.  This holiday effect could reverse in this week's report, boosting Claims.  If it does, the two weeks' data should be averaged and compared to the July averages (232k Initial, 1.853 Mn Continuing).  If it does not, it would suggest that labor market weakness may have bottomed.

Stocks Helped By This Week's Key Data?

The stock market should be helped by this week's key US economic data, which are expected to recover to some extent from the prior month's prints that had sparked fears of recession.  Bad weather may have contributed to the earlier weakness.  Consensus prints would be strong enough to suggest no more than a 25BP rate cut at the September 17-18 FOMC Meeting. 

Consensus expects a rebound in the August Mfg ISM to 47.8 in August from 46.8 in July.  Although in the right direction, it would continue to indicate sluggish manufacturing as both remain below the 48.8 Q224 average.  In contrast, consensus expects the Services ISM to edge up to  51.5 in August from 51.4 in July.  The latter did not seem to be impacted much by bad weather in July and both the August consensus and July actual are above the 50.7 Q224 average.  The stock market should be buoyed by this evidence of an improving economy outside manufacturing.

Consensus sees the August Employment Report recovering modestly from the weak July Jobs Report.  Nonfarm Payrolls are seen rising 163k m/m after +114k in July.  Both are below the 168k m/m Q224 average.  The Nonfarm Average Workweek also is expected to recover a bit, to a trend 34.3 Hours from 34.2 Hours in July.  Total Hours Worked should rise by enough to put them above the Q224 average.

Consensus also expects the Unemployment Rate to edge down to 4.2% from 4.3%, remaining well above the 3.6% Q224 average.  Fed Chair Powell already pointed out that the increase in the Rate was largely a result of stronger labor force growth.  So, the high Unemployment Rate may be more a signal of greater capacity in the economy to grow, rather than a sharp weakening in the labor market.  Average Hourly Earnings are seen returning to their 0.3% m/m trend from 0.2% in July.  The y/y still would rise to 3.7% from 3.6% in July, but stay below the 3.9% Q224 average.  The Unemployment Claims are mixed for August, with lower Initial Claims signalling fewer layoffs, but a speedup in Continuing Claims suggesting soft hiring.  

Earlier in the week, consensus expects the July JOLTS data to confirm a softer labor market with a dip in Job Openings.  This could be impacted by bad weather, however, and conceivably tick up as the latter may have prevented job openings from being filled.  An uptick should be ignored for this reason.

Last week's Personal Income Report showed a strong consumer and moderate inflation, arguing for a 25 BP cut at the September FOMC Meeting.  The consumer began Q324 on a strong note, with Real Consumption 3.0% (annualized) above the Q224 average.  And, the 2.5-2.6% y/y for Total and Core PCE Deflator are not far above the Fed's 2.0% target, allowing the Fed to act to sustain economic growth.  

The Atlanta Fed model's estimate of Q324 Real GDP Growth was revised up to 2.5% from 2.0% as a result of these and other recent data.  This growth rate, if it holds up as more data come in, would be slower than the 3.0% Q224 pace but above the Fed's 1.7-2.0% estimate of longer-run growth.  It  argues against recession and for only a gradual pace of policy easing, the latter meant to ensure a continuation of moderate economic growth.