“The way to see by faith is to shut the eye of reason.” – Benjamin Franklin (ed.), Poor Richard’s Almanack
Another week of mostly sideways markets ensued last week, with prices that are on balance slowly fading: We are now about 1.5% ahead of the pre-Brexit rebound/technical breakout level in July. That move peaked in mid-August (using the S&P 500) and has been on a slow-but-steady fade ever since. The index is now about 1% higher than a year ago on a price basis, and we may lose some more of that this week.
To begin with, a lot of money is going to sit on the sidelines until after the election. The stock market tipped its opinion again on Friday, when the breaking story about FBI director Comey’s highly unusual (and highly vague) letter about Democratic candidate Hillary Clinton’s email server was released. The market immediately began selling off on the prospect that lethally damaging news might elect her opponent, whom the Street definitely does not want to see elected (Wall Street being part of the nefarious establishment). When the news stream began to indicate that the server investigation was centered on email from disgraced former Congressman Anthony Weiner, estranged husband of a top Clinton aide, the market breathed easier and most of the damage was repaired – to stock prices, at any rate. Whether Ms. Clinton can recover remains to be seen.
As we head into the final week, polls have showed an undeniable tightening of the race. The damage may have been done, and the market is likely to remain tightly range-bound until further clarity emerges, which may not happen until after the election. That does raise the prospect of a relief rally if candidate Clinton prevails, and there will certainly be a prolonged sell-off should she lose. Meanwhile the Street is holding its breath to see if any more such surprises emerge from out of the blue.
A second drag has been earnings. The odd thing is that earnings are finally going to be positive this quarter after five consecutive quarters of moderate declines – I would guess that we will see a gain a bit north of 2% for the S&P 500 when all is said and done. Even so, the earnings season has so far failed to excite investors. Much of the gain has come from a financial sector that has heavily benefited from outsized gains in bond trading – not that they are bad earnings, to be sure, but they aren’t the type of organic lending-based gains that the Street likes to see for the group.
The main part of the earnings funk, though, is the shortfall in two of the Street’s chief happy stocks, Apple (AAPL) and Amazon (AMZN). Neither company lost money and neither earnings report should be considered any kind of verdict on the economy at large, but every bull market has its feel-good champions and Apple has been the poster boy of the current one. The company did report its first down quarter in many years. Amazon, for its part, is something of a cult stock and was supposed to be emerging, chrysalis-like, from its years of investment spending into quarters and quarters of beautiful earnings gains. Earnings came up well short of consensus however, the investment spending beast raised its head again, and like Apple, the company’s outlook disappointed. When these companies surprise to the upside the whole market seems to feel better – much like Microsoft (MSFT) and Cisco (CSCO) once did – and so it’s no surprise that investors feel left adrift.
Then there is the Federal Reserve meeting and statement this week While no move is expected only six days before a presidential election, last week’s GDP beat (see more below) would seem to increase the prospects for a December move higher. Ergo, comments indicating the same would seem to be on tap for this week. The central bank meeting will be followed by the last pre-election jobs report on Friday, and while consensus is looking for another good-but-not-great gain (also see more below), the Street is in no mood to relax until all of the horses are in the barn.
Until then, we watch and wait, fingers crossed – but for what? The end of the intense election mud-slinging will come as a relief, though it seems quite clear that many are going to be bitter about whatever outcome ensues. Ditto for the World Series. For every winner, there is a loser.
The Economic Beat
The report of the week was likely the first estimate of third-quarter GDP, which ought to be good for a lot of sound bites until the next revision. The stock market didn’t like the headline print much (+2.9%, seasonally adjusted and annualized), since if the number holds up, it raises the chances for a Fed move higher on interest rates. The employment cost index also had a steady gain of 0.6% in its first estimate for the quarter, maintaining the year-on-year rate at 2.3% and bolstering the Fed case for an increase.
Perhaps the stock market should rest easy, as the GDP headline was not as good of a number as it appeared. The biggest contribution to the increase was the decrease in the price deflator, from 2.1% in the second quarter to 1.6% in the third, adding half a percentage point on its own to the headline number. The increase also benefited from a downward revision to second-quarter GDP. Most important is that the four-quarter rate of nominal GDP growth remains at a very anemic 2.8%, marking the third quarter in a row it has been below 3%. The average for four-quarter GDP over the last three years is 3.7%, so feel free to discard all comments – and there will be a lot of them – talking about the “new momentum” in the economy. How many times have we seen that claim in the current cycle, only to see it come up empty shortly afterwards?
Durable goods orders fell by 0.1%, but rose by 0.2% when transportation orders were excluded. Year-to-date, new orders are down 0.4%, (-0.9%) when excluding transportation, so the month seems like a fit with the overall trend. Business cap-ex new orders for the month were down year-on-year (unadjusted) for the seventh month in a row, and are down 3.9% year-to-date on a seasonally adjusted basis. Oil prices are higher than they were at the beginning of the year and have been so most of the time since early spring, so the weakness is more than the oil patch. The Richmond Fed manufacturing survey was negative again, at (-4) vs. (-8) the previous month, but the Kansas City survey – after Dallas, the region most sensitive to oil prices – checked in with a second consecutive gain of +6. The Markit “flash” PMI surveys were positive, with reads of 53.2 in manufacturing and a 54.8 reading in services, the latter being a distinct improvement.
The international trade balance in goods was better than expected in September and helped boost the initial estimate of Q3 GDP. Exports rose by 0.9% and imports fell by 1.1%, with the result being a $4 billion beat of consensus. The weakness in import spending is something to be watched, with autos ( +4.3%, mostly financed by credit) being the main exception.
Over in housing, new home sales remained on pace in September (after some steep downward revisions to July and August) with a seasonally adjusted gain of 3.1%, leaving the trailing-twelve-month unadjusted rate with a 12.3% gain. That’s about in line with the overall 10%-11% trend it’s enjoyed since the spring of 2015. Revisions have been running downward and cooler weather is here, so I look for the year to finish in that 10%-11% window. Pending home sales (of existing homes) showed a 1.5% increase. The Case-Shiller home price index showed a 0.2% gain (seasonally adjusted) for August, with the year-on-year rate edging up to 5.1%. Nothing new there, but the federal mortgage price index was another story, with a sharp 0.7% gain taking the year-year rate up to 6.4%, a high on the year and indeed the highest rate in nearly 2 ½ years. The federal index largely excludes luxury homes, so the difference may lie within that category: the New York City market, for example, has been falling off at the upper end for some time.
The big report for next week is the October jobs report, and it just might be a downward surprise. I emphasize “might,” because predicting the jobs report is a futile exercise. That said, the consensus has gone up to about 175,000 (175K), raising the bar from the 155K approaches of the last two months. A couple of other factors could come into play: while weekly claims have been nicely low, low jobless claims don’t always equal big gains in hiring. The reports of January and July use much more seasonally adjusted guesswork than usual, and in the cases when hiring growth is leveling off, it can take the Labor Department several months to find that out from the data, leading to sudden drops four or five months after the fact.
Another factor is that the year-on-year improvement in the October measurement improvement period was a bit below average, and while claims are not the definitive estimate factor (if it were, we’d have a much easier time forecasting), they are important. For those reasons, I wouldn’t be shocked if the number were to come in below 150K as a catch-up. The ADP report on Wednesday may clarify matters a bit, but it’s hard to feel confident about anything at this point.
One thing I can predict with confidence is that if the number is well above consensus, accusations will immediately fly that the government is cooking the books to “rig the election,” and if it is well below expectations, it will be taken as absolute gospel by Mr. Trump that the economy is on the brink of disaster. Something similar has pretty much been the case every four years since forever.
The week will lead off with September personal income and spending, largely anticipated by the GDP estimate. We’ll also get two regional manufacturing surveys that morning, from Dallas and Chicago. The next day we’ll get the national ISM manufacturing survey, with little change from last month (51.6) expected. As usual, we’ll get construction data at the same time. The non-manufacturing survey is Thursday.
The Fed could change everything with a surprise move on interest rates on Wednesday, but nobody – not even the governors – are expecting them to stir the waters six days before Election Tuesday. The ADP report that morning will add a little color to their statement. Factory orders for September, partly anticipated by the durable goods report, are Thursday and the total international trade report for September is released alongside the jobs report on Friday.