Market Hurdles Arise

The stock market's tendency is to climb in the week after Christmas.  But, Trump set up a couple of hurdles.  His dislike of the stimulus bill raises the risk that he won't sign the bill.  And, his dislike of the absence of a internet-company provision in the Spending bill raises the risk of a government shutdown.  These actions are on top of the caution that might emerge in the approach to the January 5 Senate run-off races in Georgia.   The macroeconomic background still looks good, as the latest Unemployment Claims data improved in the latest week.

The Claims data suggest the impact of the renewed shutdowns has been small and temporary.  /1/ The 89k w/w drop in Initial to 803k puts them at their lowest level since the end of November.  /2/ The 170k drop in Continuing Claims to 5.337 Mn shows no significant or lasting impact of the jump in Initial that preceded it.  The Continuing's further decline suggests re-hiring is strong.  Nevertheless, the Claims data point to a slowdown in December Payrolls (ex census workers) from November’s 338k m/m pace. But, the slowdown may be small.  The Insured Unemployment Rate fell 0.2% pt w/w to 3.6%, putting it 0.7% pt below the November level.  It points to another decline in the Civilian Unemployment Rate in December.  This would be consistent with above-trend economic and job growth this month.

Fed Chair Powell made an important point during his post-FOMC Meeting news conference, arguing against those who believe the stock market is overvalued.  He said that while the Price/Earnings Ratio of the overall market appears to be high, this is not the case if the low long-term Treasury yields are taken into account.  While these yields are likely to stay low for now, his comment implies that a significant backup in them would likely stop the stock market rally.

 

One development that could push up longer-term Treasury yields is a falling dollar.  A falling dollar could be inflationary as well as depress foreign demand for US assets.  So far, there is no evidence that the weakness in the dollar has boosted inflation -- a weaker dollar should boost import prices.  But, the latest data do not show this.  The +0.1% m/m increase in November Import Prices shows no significant inflation pressures.  Non-Fuel Import prices fell 0.3% m/m, pushed down by a drop in food prices.  Capital Goods Prices rose 0.1% and Non-Auto Consumer Goods Prices were flat.  In particular, prices of imports from China ticked up 0.1 percent in November following no change in each of the previous 2 months.  It suggests companies were offsetting the weaker dollar by cutting profit margins.

 

Stock Market Rally Should Continue Into January

The stock market's rally should continue at least into early January.  The market will likely continue to ignore new virus cases and consequential deaths as well as soft US economic data now that two vaccines have been approved and are being given to the public.  The bad news is viewed as temporary.  While the fiscal stimulus bill will provide a modest boost to the economy, its passage means the possibility of its absence is no longer hanging over the market.  The most important hurdle for the market now is the Georgia run-off Senate elections on January 5.  This is far enough ahead to allow for a further rally until then.  

The drag from the renewed shutdowns appear to have shown up in the 1.1% m/m decline in November Retail Sales and the increase in Initial Unemployment Claims.  But, their import may be less than meets the eye.  Indeed, the Atlanta Fed model's estimate of Q420 Real GDP Growth was cut only slightly to a still huge 11.1% (q/q, saar) from 11.2%.

Some of the Retail Sales weakness could have resulted from price discounting.  Also, a decline in Retail Sales is not unusual after a surge in the prior month, as was the case in October.  Such "consolidation" in sales could last a few months.  It's noteworthy that car companies were not discouraged by the decline in sales last month.   The November Industrial Production Report shows a bounce in Motor Vehicle Assemblies to an above-trend level. 

The increase in Initial Claims likely reflects a resurgence of layoffs from the shutdowns.  Initial rose despite the potential for an unwinding of a post-holiday rebound.  This suggests that the increase in shutdown-related layoffs was even greater than the 24k increase in Initial Claims. In any case, it will be important to see if Continuing Claims rise in this week's Report and confirm the worsened labor market situation.  The prior week's decline in Continuing shows that re-hiring remained strong.

This week's US economic data are of minor significance for the market.  Some are expected to pull back from very strong prints in the prior month.  These include November Existing Home Sales and Consumer Spending.  But, others, like November Durable Goods Orders, are seen rising further.  It will be interesting to see if the December Conference Board Consumer Confidence Index confirms the increase in the University of Michigan Consumer Sentiment Index.  Although the Conference Board Index is known for its labor market components, the Claims data already point to a slowdown in December Payrolls (excluding census workers).

What If There is No Fiscal Stimlus?

The stock market will have to navigate through a number of events this week, including possible fiscal stimulus bill, an FOMC Meeting, continuing Brexit negotiations, start of the vaccine in the midst of renewed shutdowns, inclusion of Tesla in the S&P 500 Index, quarterly witching  expiration of options and futures, and US economic data.  There are reasons to think that any hit to the market from them will be contained.

This week should see some sort of conclusion regarding passage of  a fiscal stimulus bill this year.  Passage is far from certain and may not be known until the end of the week as Democrats and Republicans play "hardball."  Interestingly, Fed staff discussed the economic implications of no passage at the November FOMC Meeting.  The implications are not as dire as one might think from news accounts.  Here is what the Meeting's Minutes say:

1.  Although this lack of additional fiscal support was expected to cause significant hardships for a number of households, the staff now assessed that the savings cushion accumulated by other households would be enough to allow total consumption to be largely maintained through year-end. 

 2.  Recent data on tax receipts also suggested that the fiscal positions of states and localities had deteriorated less than expected, which led the staff to boost the projected path of state and local government purchases. [Note the improved financial positions may explain the flattening in State Payrolls in November.]

3.  In the staff’s medium-term projection, the assumption that significant additional fiscal support would not be enacted pointed to a lower trajectory for aggregate demand going forward.

 4.  [However,] with monetary policy assumed to remain highly accommodative and social-distancing measures expected to ease further, the staff continued to project that real GDP over the medium term would outpace potential, leading to a considerable further decline in the unemployment rate.  

 5. The resulting take-up of economic slack was in turn expected to cause inflation to increase gradually, and the inflation rate was projected to moderately overshoot 2 percent for some time in the years beyond 2023 as monetary policy remained accommodative.  

The Fed staff's projection assumed that social-distancing measures would ease further.  This development, however, is not happening.  So, unless this changes as vaccines are rolled out, there is downside risk to its medium-term forecast. And, this could prompt the FOMC to expand its asset purchase program at this week's meeting -- a positive for the stock market.

The latest Claims data show the renewed shutdowns are having an impact.   The +137k rebound in Initial Claims to 853k probably reflects /1/ a post-holiday rebound to above trend and /2/ layoffs stemming from the resurgence of the virus. Each factor may have accounted for about half of the 137k w/w bounce.  Initial Claims could fall in this week's report, as the post-holiday rebound unwinds.  An unwinding would subtract about 35k from Initial.   Whether Initial falls will depend on whether virus-related new layoffs speed up further.

Consensus apparently expects the renewed shutdowns to weigh on other data, for November, due this week.   Retail Sales are expected to fall 0.3% m/m, with Ex Auto slowing to +0.1%.  Industrial Production is seen slowing to +0.3% m/m from +1.1%.   And, December business surveys -- Market Mfg PMI and Phil Fed Mfg Index -- are expected to slip.  Consensus looks for flat November Housing Starts.

   

The Irony of the November Employment Report

 The stock market should be supported this week by improving chances of fiscal stimulus,  the likelihood of FDA approval of a vaccine, and possibly additional ECB monetary policy easing.  Both Democratic and Republican Congressional leaders are said to want to pass a stimulus bill before year end, according to news reports, although there are still areas of difference.  However, for the most part, the stimulus seems to be just a reduced extension of current benefits.  If so, it will do little to boost growth.  So, the situation may be more of "buy the rumor, sell the fact."

News reporters described the November Employment Report as weak and, as such, a catalyst for a stimulus bill.  However, while there was a sharp slowdown in Payrolls from the out-sized gains of the prior few months, the m/m gain is still large from an historical perspective.  And, taking account of other parts of the Report, as well, the overall Report is, in fact, strong.  So, the irony is that a strong Report will be pitched as weak to push for passage of more fiscal stimulus -- a combination that is positive for the stock market.

The sharp slowdown in November Payrolls to +245k Total and +334k m/m Private reflected 4 shifts:  /1/ A flattening in the two sectors that had rebounded the most from the virus — Leisure/Hospitality  and Retail.  Both likely slowed as a result of the renewed shutdowns.  /2/ A moderation in other sector job gains, but with still good-sized gains in cyclical sectors like manufacturing and construction.  /3/ A surge in Transportation and Warehousing, resulting from the increase in home delivery services.   /4/ The 99k drop in government jobs was due almost entirely to the winding down of census jobs, which fell 93k. 

Despite the slowdown in jobs, the Report is in line with above-trend economic growth in Q420.  The Nonfarm Workweek stayed at a very high 34.8 Hours.  As a result, Total Hours Worked rose m/m.  And, the November level of THW is 8.9% (annualized) above the Q320 average — supporting the idea of strong Q420 Real GDP Growth.  Indeed, the Atlanta Fed model's estimate of Q420 Real GDP Growth was raised to 11.2% from  11.1% after the Report.  This GDP pace and the size of the Payroll gain are above trend -- seen in the decline in the Unemployment Rate to 6.7% from 6.9%.

The declines in Initial and Continuing Claims in the latest report would seem to support the idea of strong growth continuing in November.  But, these data should be viewed cautiously.  They were for the Thanksgiving week, and seasonals may not have adjusted adequately for state offices closed for the holiday.  If so, it could take 1-2 weeks of additional data to see if the latest prints are telling the right story.   If the declines resulted from bad seasonals, Claims should rebound to above trend levels in this week's report and then pull back to trend in the subsequent report.  A smaller increase, such as the consensus estimate of +13k to 725k Initial, would signal that strong growth is overriding renewed shutdowns in terms of the labor market.

 

Besides Claims, inflation data for November will be released.  They are not expected to stand in the way of additional fiscal stimulus or continuing easy monetary policy.  In particular, consensus looks for a modest increase of +0.1% m/m for both Total and Core CPI.   

Stocks Being Helped By Strong Economic Growth

The stock market appears to be looking past the latest upsurge in virus cases, as mostly good news about vaccines have boosted expectations of an end to economic displacements sometime next  year.  In addition, growth has been exceptionally strong at the start of Q420.  And, Biden's choice of Janet Yellen to be Treasury Secretary bolsters expectations of a continuation of strong growth next year. 

The economy's recent strength is captured in the Atlanta Fed model's latest forecast.  On Friday, the forecast was boosted to 11.0% (q/q, saar) from 5.6%, as newly released data showed both consumer spending and business equipment spending climbing much faster than the model had estimated previously.  Its latest forecast is far less of a slowdown from the +33.1% Q320 GDP pace than most economists had expected.  To get the bearish forecasts of sub-3.0% for Q420 Real GDP growth requires a decline in the second half of Q420. 

This week's key US economic data are not likely to signal such weakness.  But, if they do signal a sharp weakening, the market could view it as increasing the odds of large fiscal stimulus in early 2021.

Consensus estimate of a dip in the November Mfg ISM to 57.9 from 59.3 in October would keep the Index at a high level.  The Phil Fed Mfg Index supports the consensus estimate.  While the Market Mfg PMI rose in November, it could have been catch-up to the strength seen in the October Mfg ISM.  

The consensus estimate of +500k m/m November Payrolls, with Private Payrolls +650k, risks being too low.  The Claims data point to a slowdown in Private Payrolls from October's enormous +906k.  But, they still suggest a large increase.  Census workers should subtract about 95k from the m/m change in November Payrolls, versus -138k in October.  With other government workers likely being cut, as well, the implicit consensus estimate of -150k for total government jobs may be reasonable.

The consensus estimate of a 6.7% Unemployment Rate, versus 6.9% in October, risks being too high.  The Insured Unemployment Rate, calculated from the Claims data, fell a full percentage point between the October and November survey weeks.  Even if the Unemployment Rate falls somewhat more than consensus, it still would be well above the 3.5% pre-virus level and support arguments for fiscal stimulus.

On the political front, Biden's choice of Janet Yellen as Treasury Secretary bolsters the view of continuing strong economic growth next year.  She is pro-growth, having argued for a low-interest rate monetary policy when at the Fed (using optimal control projections of the Fed's econometric model of the US economy -- among the first to demonstrate such projections was my PhD dissertation, a number of years earlier).  So, she should support the Fed’s current easy policy as well as anti-virus fiscal stimulus.  But, she probably won’t stand in the way of a re-distributional tax increase.   While the latter would be a market-negative, it is an issue for next year and could depend on the outcome of the two Georgia run-off Senate elections on January 5.

Fears of Virus, But...

The stock market will likely continue to be restrained by fears of renewed virus-induced shutdowns in the next few weeks.  These fears risk being underscored by some pullback in upcoming key US economic data.  But, there are reasons to think a market retrenchment will be modest.  The next round of data pullbacks are not likely to be sharp, with their levels still signaling above-trend growth.  And, the likelihood of FDA approval for emergency use of two vaccines should continue to serve as a backstop. for the market.  On the political front, Trump's attempts to reverse the election results should soon come to an end.  More importantly, news reports suggest that Biden will pick a moderate for Treasury Secretary.  Both would be stock market positives. 

Early evidence points to some softening in two upcoming economic data -- November Mfg ISM and Nonfarm Payrolls, both due in the first week of December.  Two regional manufacturing surveys -- NY Empire and Phil Fed -- both slipped in November.  But, they stayed at relatively high levels.  The Claims data point to a slowdown in Private Payrolls after December's surge.  But, the Claims data also suggest a further decline in the Unemployment Rate, which would signal above-trend growth.

Data released so far point to strong Q420 Real GDP Growth.  The Atlanta Fed model's current estimate is 5.6% (q/q, saar).  In contrast, one of the weakest forecasts on the Street  -- by JP Morgan economists -- is for 2.8% in Q420 and -1.0% in Q121, due to virus-induced shutdowns and lack of near-term fiscal stimulus.   For this forecast to be realized requires a sharp slowdown in economic activity from the 2nd half of November into early next year.  The earliest evidence should be Initial Unemployment Claims.  While Initial rose in the latest report, it is too soon to say the increase resulted from virus-induced shutdowns.  It could have been just a partial offset to the prior week's drop -- in other words, just noise.  The level is still the second lowest for the move down.  But, the Claims data will be important to monitor.

Besides Claims, this week's releases of some November surveys could offer clues on whether or by how much the economy is slowing.  Consensus looks for the Markit Mfg PMI and Services PMI to edge down, but not be enough to signal a sharp weakening in growth.  This week's other important data are for October -- Durable Goods Orders and Personal Income/Consumer Spending.  All are expected to post gains.  Retail Sales already were up in October.  And, the New Orders components of manufacturing surveys were strong for this month.  But, some of the components of Durable Goods Orders appeared to be overly high in August and September and risk unwinding.  So, there is some downside risk to the consensus estimate of October Durable Goods Orders (+1.0% m/m Total, +0.4% Ex Transportation).

 

  

   

Stock Market Focus: Virus Versus Economic Growth

The stock market should continue to be  buffeted by fears of more virus-induced shutdowns versus evidence of strong economic growth in Q420.  While election resolutions are moving in the direction of a split government -- a market positive -- some of Biden's advisors have exacerbated the shutdown fears.  With the virus' contagion rising and a window for year-end profit taking opening, there is some downside risk for the market near term.

The latest Claims data suggest the impact of renewed shutdowns or curtailments has been negligible in the aggregate so far.  Initial fell  48k w/w to 709k and Continuing fell 436k to 6.786 Mn -- new lows for the move down.  While it is unlikely they will point to a speedup in November Nonfarm Private Payrolls from the huge +906k m/m in October, they still could open the door for a very strong jobs gain this month.  The Phil Fed ADS Index shows a stabilization in economic growth around an above-trend pace so far in Q420.  These high-frequency indicators will provide early evidence whether the upsurge in Covid infections is denting economic growth.

Even without this evidence, the markets are highly sensitive to the possibility that policymakers will act aggressively to contain the virus by shutting down the economy.  This concern was boosted when some of President-Elect Biden's health advisors argued that a 6-week shutdown at the start of 2021 could stop the spread of the virus,.  They probably contributed to Thursday's market sell-off.  (Ironically, other medical analysts say the virus will peak by itself in January.)  Other Biden health advisors dismissed this extreme position, however, arguing for a more targeted approach to fighting the virus.   Their comments likely helped the market rebound Friday. 

This week's US economic data are expected to underscore strong growth.  Consensus looks for 0.5-0.6% m/m in October Total and Ex Auto Retail Sales, a very decent gain after September's surge.  The Report should capture Amazon's Prime Day (as well as other retailers' heavy discount days).  But, lower prices (as seen in the October CPI) work against Sales.  Consensus looks for a hefty 1.0% m/m rebound in October Industrial Production, after -0.6% in September.  Manufacturing Output is seen up 0.9%, versus -0.3% in September.   October Housing Starts/Permits are expected to rise.  While October Existing Home Sales and November Phil Fed Mfg Index are seen pulling back a bit, the consensus estimates remain at high levels.

 

Market Focus: Election Resolution and Strong US Economic Data

The elections and US economic data have resolved in ways that permit a further stock market rally -- although year-end profit taking is still a risk later this month and into December.   Biden's projected win and Republican's presumable retention of the control of the Senate are positives.  Biden may reduce the rancor in the country while a Republican Senate will likely prevent the most extreme Democratic proposals from being legislated.  Although 4 Senate races remain undecided, with some to be resolved by a run-off in early January, expectations that the Republican candidate will win should be enough for the market for now.  In addition, the market should react positively if Biden chooses moderates for his Cabinet -- but perhaps negatively if he does not.

Meanwhile, Friday's October Employment Report shows the economic growth remains strong going into Q420.  The Report showed a speedup in Private Payrolls and a drop in the Unemployment Rate -- the strength in both cases exceeding consensus expectations.  Private Payrolls rose 906k, versus an upward-revised +892k in September (was +877k).  Civilian Employment surged 2.2 Mn m/m.  The Unemployment Rate dropped to 6.9% from 7.9%, despite an increase in the Labor Force Participation Rate.  The Nonfarm Workweek stayed high at 34.8 Hours.  And, Total Hours Worked in October are 7.7% (annualized) above the Q320 average -- pointing to very strong Q420 GDP Growth.  Note that the Atlanta Fed model's early estimate of 3.5% is too low and will likely be revised up as more data come in.

One newswire reported a misleading article.  It argued that while unemployment is falling, long-term unemployment is surging.  It based this conclusion on data from the Report showing that Permanent Job Losers as a Percentage of Total Job Losers rose to 40% in October.  But, the number of Permanent Job Losers actually fell m/m -- and the uptrend has been modest.  What pushed up the Percentage is that the number of Temporary Layoffs fell by more than Permanent Job Losers.  

This week's US economic calendar will feature inflation data -- the October CPI and PPI.  Consensus looks for +0.2% m/m for Total and Core for both.  This pace will keep the y/y steady or lower for all these measures.  And, they will underscore the likelihood that it will take several years for the past inflation shortfall relative to the Fed's 2% target to be undone.

 

 

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. 

 

 

 

Some Market Positives This Week

Stocks may get some support this week from the resumption of the AstraZeneca vaccine clinical trial in the UK and a reiteration of easy monetary policy by the FOMC.  The US economic background is becoming somewhat less positive for the market, but it is still positive.  Growth may be moderating after a sharp Q320 bounce, while prices of goods and services have begun to recover from the virus-related shutdown.  The latter should restore profit margins.  Uncertainty about the November elections remains a cautionary overhang.

Some market participants hope the Fed will provide more details about its easy monetary policy.   But, this is unlikely.  For example, it would be helpful to know how many past years of sub-target inflation the Fed will want to offset by above-target inflation.  The Fed, however, probably wants to keep this number fluid to give them flexibility in policy making.  Powell will likely talk generally around policy-related issues in his post-meeting news conference while restating the Fed's desire to see above-trend economic growth continue even if inflation picks up.

The Atlanta Fed model and Street economists have been moving up their estimates of Q320 Real GDP Growth.  The model's projection is now 30.8% (q/q, saar), while Goldman Sachs economists are reported to have revised their estimate to 35% from 30%.  The debate in the market will soon shift to the extent growth will moderate after the Q320 bounce back.  It will be important to see Initial and Continuing Claims staying on downtrends.  They will show that economic growth remains above trend.

This week's US economic data are expected to be consistent with a moderation in growth after a Q320 jump.  August Retail Sales are seen up a strong 1.0% m/m, after +1.2% in July.  Ex Auto is expected to slow to a still-strong 0.9% from 1.9% in July.  August Housing Starts/Permits are seen little changed from the July pace, with Starts down a bit but Permits up somewhat.  August Industrial Production is seen up a strong 1.0% m/m.  The September Phil Fed Mfg Index is expected to dip to 15.5 from 17.2. 

The upcoming elections remain a subduing factor for the stock market.  Control of the Senate may be just as important as the Presidential victor for the market.  Even if Trump loses, retention of Republican control could hold back legislation viewed unfavorably by the market.

 

 

 

 

 

Economic Growth to Slow But Be Above Trend in Q420

Stocks ran into trouble last week as the overbought tech sector began to unwind and Washington appeared deadlocked over further stimulus.   These factors may have more room to run.  In the background is another potential negative -- a deceleration in US economic growth (but still strong).  This is almost inevitable after the sharp bounce-back in Q320 Real GDP.  Along with the likelihood of growing caution ahead of the November elections, this macroeconomic story could hold back further stock market gains in the near future. 

The economy's recovery has been V-shaped so far.  The Atlanta Fed model's forecast is now up to 29.6% (q/q, annualized) and will likely be revised up further.  The rebound goes a long way to unwind the -31.7% plunge in Q220.  But, there is still not a full recovery in the labor market:

                                                                     Shortfall Relative to Pre-Virus February Peak 

                    Unemployment Rate                             4.9%  pts      

                    Private Payrolls                                  10.7 Mn

                   Total Hours Worked                              7.7%

Real GDP Growth in Q420 is most likely to be well below the Q320 pace, although it still should be above trend -- and thereby eliminate some of the labor market shortfalls.   One piece of evidence pointing to slower Q420 GDP Growth is the deceleration in Total Hours Worked over Q320.  THW in August is 2.4% (annualized) above the Q320 average, versus 27.7% above the Q220 average.  This sets the stage for slower Q420 Real GDP Growth, unless THW pop in the next couple of months.  But, it also suggests a solid take-off point for above-trend growth in Q420 -- which will help to reduce labor market slack.  In part, Q420 growth would reflect a full quarter's worth of re-openings, after they happened over the quarter in Q320.

Inflation data will be the highlight of US economic calendar this week.  Consensus looks for a pre-virus trend-like 0.2% m/m for August Core CPI, keeping the y/y at 1.6%.  The risk is that recovery-fueled price hikes, as well as the weaker dollar, will push the Core CPI up by more.  In either case, the report should not change the Fed's intent to keep rates low and allow inflation to rise above 2.0% to make up for past shortfalls.

 

 

 

The Fed's New Strategy and This Week's Key US Economic Data

The Fed's newly revised Statement on Longer-Run Goals and Monetary Policy Strategy sets a pro-growth stance for monetary policy.  Its new goal is to achieve 2% inflation over time, allowing for inflation to exceed this target "for some time" if it missed on the low side beforehand.  It means the Fed will not tighten in the face of above-trend growth that pushes up inflation above 2%.  In some ways, this sounds like an acknowledgement that its tightening in 2018 was a mistake -- which, in fact, it was. 

The roots of the issue go further back.  In the past, the Fed tended to tighten quickly once the economy began rebounding strongly from recession.  As a result, economic growth slowed sharply -- a mid-cycle pause --  leading to a reversal of the Fed tightening.   The Fed is concerned now that it wouldn't be able to ease adequately in such case because rates are so close to the zero bound.  Therefore, it won't raise rates in the early stages of recovery.

The Fed also understands the tremendous social benefits of allowing the unemployment rate to fall to exceptionally low levels, as enumerated by Fed Chair Powell in last week's speech.  In the past, fear of inflation persuaded the Fed not to let the Unemployment Rate fall below what was estimated to be its natural rate, for much of the time seen to be about 5.5%.  The one notable exception was in the late 1990s when Greenspan shifted away from tighter policy even though economic growth was strong.  He was among the first to realize the tech revolution boosted productivity and thereby allowed faster growth without inflation.  He also understood the social benefits from doing so.  The Unemployment Rate fell to 3.9% then. 

The Fed's new hands-off approach will be important in coming months because some upward price adjustments following the virus-induced shutdowns are likely.  They should only temporarily boost inflation and, regardless of policy goals, should not be targeted by tighter monetary policy.  The new policy stance ensures this will not happen.

One inflation channel that could become problematic, however, is a weaker dollar -- particularly since the Fed's new policy stance essentially gives a green light to dollar depreciation.  Regardless of the cause -- easy Fed policy, large Federal deficits, widening trade deficit, low national saving rate, unwinding of "flight to safety" demand as efforts to defeat the virus advance -- a sustained decline in the dollar could lead to higher US inflation.  It is too soon to be concerned, but something to keep in mind.  It could cause the Fed's new stance to backfire, if a weak dollar forces the Fed to tighten before the economy reaches full employment.  The problem of a declining dollar could stem from the Fed's forward-looking communication policy.  It eliminates a degree of uncertainty that otherwise would keep markets in check.

From a market perspective, the new approach is a positive for stocks and Treasury Inflation Protection Securities (TIPS) immediately ahead.  But, it is a negative for longer-term Treasuries,  pushing up their yields.  The steepening of the yield curve could eventually be a significant negative for the stock market, particularly if at some point it signals that inflation fears are getting out of hand.

This week's key US economic data should continue to show a strong Q320 recovery.  Consensus looks for an uptick in the August Mfg ISM to 54.5 from 54.2 in July.  Most other mfg surveys improved in August, and some suggest a stronger-than-consensus print.  August Motor Vehicle Sales could move up from July's 14.5 Mn Units, considering that vehicle production appears to be back to normal.  Consensus expects Initial Claims to fall below 1 Mn.  But, consensus sees August Payrolls slowing, although to a still-strong 1.425 Mn m/m increase from 1.763 Mn in July.  Note that the Claims data argue for a speedup in August Payrolls.  So, an upside surprise can't be ruled out.  The Unemployment Rate is expected to a fall to 9.8% from 10.2%. 

Strong Growth Versus Fears of Slowdown

The stock market should continue to see strong US economic data this week and possibly good news on the virus front, pushing against fears of renewed weakness -- the latter epitomized by the Fed staff's forecast presented at the July FOMC Meeting.  Risks to the outlook will probably be repeated by Fed Chair Powell in his speech at the Jackson Hole Conference this week.  In contrast, the Republican Convention could cushion these fears if the speakers emphasize a pro-growth agenda.

The Fed staff laid out several reasons why they lowered their GDP forecast for H220 -- even as they raised their estimate of Q220 GDP in response to data that came in stronger than they had expected:

"Although the staff assumed additional fiscal stimulus measures would be enacted beyond those anticipated in the June forecast, the positive effect on the economic outlook was outweighed somewhat by the staff's assessment of the likely effects of several other factors.  Those factors included the increasing spread of the coronavirus in the US since mid-June; the reactions of many states and localities in slowing or scaling back the reopening of their economies, especially for businesses , such as restaurants and bars, providing services that entail personal interactions; and some high-frequency indicators that pointed to a deceleration in economic activity." 

Until there is hard evidence that these concerns will be realized, the Fed's forecast perhaps should best be viewed as a reason to expect continuing extremely easy monetary policy.  The Fed's Central Tendency forecast at the June FOMC Meeting was for -7.6% to -5.5% for 2020 Real GDP Growth (Q4/Q4).  This forecast is too weak if Q320 Real GDP Growth comes in 25+%, as the Atlanta Fed model now projects.  The Central Tendencies will be revised at the FOMC Meeting on September 15-16.

Many data released so far for July indeed moderated from the extremely strong pace seen in June.  But, their July gains were still strong.   The few pieces of August data are mixed.  For example, the Phil Fed Mfg Index slipped, although the survey's components  rose (the Index is not based on the survey's components).  The Markit Mfg PMI climbed further above 50, as did the Services PMI.  Initial Claims rebounded in the latest week, but did not fully offset the prior week's drop.  Initial Claims need to move more significantly higher to confirm a noticeable renewed softening in overall labor market conditions.  Consensus looks for them to decline in this coming week's report, however.  At this point, the Claims data suggest a speedup in August Payrolls.

Other data this week are expected to post gains.  These include July New Home Sales and Durable Goods Orders as well as August Chicago PM and University of Michigan Consumer Sentiment.  Q220 Real GDP is expected to be revised up slightly.