A Balancing Act
Unpredictable. That certainly describes market returns given the fluid nature of company earnings, geopolitical events and economic missteps. What we have seen in recent weeks only serves to prove the point.
History, at least, provides insights into market trends seasonality, but even this information is sometimes flawed. Last year’s expectations certainly did not predict a pandemic market collapse nor its immediate reversal back into positive territory. The continuing S&P recovery of roughly 20% through last month, including a return of nearly 3% in August, was hardly in the cards either, but it was a reminder once again that Fed Chair Jerome Powell is indeed focused on maintaining market stability. His virtual speech last month in Jackson Hole, Wyoming, reassured investors he was in no hurry to raise short-term interest rates. Those words were music to investors’ ears, and they responded accordingly.
By mid-September, however, concerns have resurfaced. The S&P has dropped slightly from its recent high, and investors are paying more attention to the VIX volatility index and to events now impacting overseas markets. Even though the markets have been relatively resilient this year, a recent drop in bullish sentiment is now rattling a few investors. Over the coming weeks investors will be again looking for evidence the S&P can regain its traction, trading once more above its 50-day moving average.
The perspective often lost here is that the markets have been on a rather heady rise since spring of 2020, and intermittent market pauses often allow earnings fundamentals to catch up. In the meantime, the energy, financials, communication services and technology sectors have booked strong gains. While most sectors and indexes were negative for the week of September 13, it is interesting to note that one of the few positive exceptions were the more speculative cryptocurrency markets.
Though market performance serves as one of the primary scorecards for the economic recovery and reviving corporate earnings, the underlying support mechanisms are far more complicated. COVID will likely remain in the headlines as ever-expanding variants remind us that this virus is still part of our daily lives. Despite the shutdown in commerce and travel and the disruption in personal routines early in the pandemic, we are seeing unmistakable signs that life is resuming. Even so, negatives persist, and I plan to review these in upcoming newsletters. These factors include the potential for a +/-$4 trillion stimulus package, geo-economic concerns, and the eventual tapering from the Fed’s liquidity support thus far helping the economy and markets recover.
Looking at the positives, although air traffic isn’t completely back to normal, trends are certainly improving. As of September 17, the number of passengers moving through TSA is nearly 88% of 2019 levels. Compared to the pandemic year 2020, passenger counts today are up more than 130%.
Housing also remains a bright spot in the economy with significant residential construction activity to catch up with the past few months of accelerating new home sales. However, issues continue with supply chain problems—primarily COVID issues related either to missing workers, transportation imbalances or a post-recovery demand acceleration for raw materials. While these imbalances will ultimately resolve themselves, we expect to see another three to six months of shortages, renewed global supply chain disruptions and market disturbances, renewed drags on consumption and higher prices which will plague consumers and create a hint of inflationary pressures yet to come. Unfortunately, the one lesson learned over the past months is that supply chains are only as strong as their weakest link. As just one example, computer chip manufacturing and its impact on the auto industry come to mind.
Although the post-COVID job and shopping upturns haven’t necessarily moved in tandem over the past year, the absence of the traditional work and family environment has certainly changed consumer patterns and shopping trends. Even so, we see some trends toward a semblance of normalcy as we look through the latest retail numbers. Sales were up an impressive 0.7% in August, even with the resurgence of COVID, a renewed working from home effort and a few tropical storms. Core sales (excluding autos, gasoline and building materials) were up stronger, with dollars spent on furnishings up 3.7%, food and beverage sales up 1.85%. and online sales up 5.31%. Detractors for the month included autos, mostly related to chip shortages. One interesting sign of a return to normalcy was the year-to-date growth in bar and restaurant sales of nearly 41%. Obviously, we’re observing some pent-up demand being quenched.
Although we have yet to match the pre-pandemic unemployment lows of 3.5% nor the mid-pandemic highs of 14.8%, today’s unemployment rate of 5.2% is certainly a move in the right direction. We expect to see a slowdown in job growth rates, given the rapid recovery from last year. However, the markets were taken by surprise with August’s job report of “only” 235,000 jobs added. Lost in the report was that Average Hourly Earnings (AHE) was up an annualized 4.3%, the unemployment rate fell to 5.2%, and initial jobless claims were 310,000, the lowest report since March of 2020 at the start of the pandemic. Meanwhile, job openings were up a record 10.934 million. A question for future discussions is whether or not those job openings will be affected by newly available applicants whose unemployment benefits expired on September 6th.
One detractor to August’s industrial production data was Hurricane Ida which, according to the Fed, lowered overall production by approximately 0.3%. Without considering the hurricane-related shutdowns, business equipment production rose by 0.50%, and one measure of productivity, Manufacturing Capacity Utilization, rose to 76.7%. As an aside, an 80% utilization rate is approaching “normal.”
Also noteworthy was an improving ISM Manufacturing PMI report. It recorded a new three-month high in new orders, although those were offset by a steep drop-off in the employment indicators (a mismatch between job openings and available hires). From the Fed district perspective, both the Empire Manufacturing Index (New York) and the Philadelphia Fed issued positive reports. The common denominator was an improvement in new orders and shipments. One shared issue was unfilled orders, most of which were a function of global supply chain disruptions and ultimately the accelerating costs related to shipping cost surges because of the supply imbalances.
Balancing Growth and Inflation
The pervasive question for investors today is whether recent inflationary pressures are a permanent fixture to be factored in by both the Fed and the markets. On the other hand, are these cost factors transitory and ultimately mitigated by economic growth, improving productivity, supply chain returns to normalcy and a fully engaged labor market? At this point, the answer is unfortunately still unknown and is one significant contributor to an increasing risk for volatile market swings.
Cooling signals include a slowdown in home price increases and lumber supplies. As an offset, however, there have been spikes in auto and gasoline prices, shipping costs, commodities, food and home rental prices. Many of these costs are considered transitory today as they have risen over the past 12 months from pandemic-induced distressed prices. Expectations are that as shortages “rationalize,” these transitory costs will ease, especially as reopening pressures fade. The one takeaway from Fed Chair Powell’s recent words was that the increase in inflationary pressures is likely to be transitory. He sees current inflation as largely the result of a narrow group of goods and services directly affected by the economic reopening and expects it to dissipate over time. Until there is certainty, though, investors will be watching for any escalation in core inflation inputs. The question will be whether or not corporate earnings can offset any inflationary pass-through to consumers. Perhaps telling were recent data points from the Bureau of Labor Statistics reporting a decline in real average earnings by 0.9% over the prior 12 month period. Also noteworthy were the posted August price declines for airline tickets, car insurance and even used cars.
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