Hurdles Not Over Yet

Although Friday's December Employment Report and Powell's comments enabled the stock market to recover from the hurdles it tripped over the day before (the drop in the Mfg ISM and lowered Apple guidance), the coast is not yet clear for a sustained rally.  To be sure, stocks should get a lift at the start of this week, hoping for a successful meeting between US and Chinese trade negotiators (January 7-8).  But, it is unlikely a full resolution of the dispute is imminent -- considering both sides may want to show how hard they negotiated by waiting to agree until just before the March 1 deadline.  And, there could be additional negative surprises as the earnings season gets under way the following week.

Meanwhile, the macroeconomic background will be difficult to ascertain since the Census Bureau will not be releasing its business surveys during the government shutdown.  Their absence means that GDP reports will not be released during this period either.  Monitoring the economy will rely on Initial Claims data, Employment Reports and private surveys.  The CPI presumably will be available to keep track of inflation.  The consensus estimate of 0.2% m/m and steady 2.2% y/y for the December Core CPI (due Friday) would be benign prints for the markets.

The window for a sustained rally may become apparent in late February, with the earning season behind and a US-China trade deal looking highly likely.  Moreover, the government shutdown could be over by then, allowing the markets to have better clarity about the strength of the economy.

A Q1 slowdown followed by speedup in Q2 and Q3 has been the case in recent years, with a shift from a harsh winter to wet/cold Spring to warm Summer likely responsible.  So far, this year's winter doesn't seem bad, suggesting this pattern may not hold.  But, other factors could take the weather's place.  For example, the government shutdown is causing a delay in tax refunds, which should hurt retail sales in Q119 but  then help them when they are finally sent.  A cut in government spending would hurt Q119 GDP, as well.

This scenario potentially may have problems for stocks as summer approaches.  A bounceback in economic activity this Spring could reignite fears of a Fed tightening.  A pickup in inflation would exacerbate these fears.   And, higher inflation ahead cannot be ruled out, even though it is currently benign.  A further tightening in the labor market could lift wage inflation, although stronger growth need not tighten the labor market if the growth is met by a pickup in labor force participation.  Also, a resolution of the trade dispute should weaken the dollar, as an ending of tariffs would raise expectations of a wider trade deficit ahead.  A weaker dollar would boost import prices.  So, a stock market rally into the Spring may be an opportunity to lighten up.