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.