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.