Despite some mixed data over the past week, markets powered higher as major banks opened Q3 earnings season on positive footing. Inflation, supply chain issues and hiring remain headwinds, and that’s putting downward pressure on business and consumer sentiment. However, markets, particularly the Dow Jones Index, weren’t fazed by the latest CPI and Consumer Sentiment reads. While retail sales impressed, markets are likely pricing in expectations for robust earnings across the board.

Upward earnings revisions that occurred for the S&P 500 during the first half of 2021 accelerated in Q3, as most reported strong earnings and increased outlooks for the balance of the year. Earnings estimates for the S&P 500 started the year slightly below $170 and are now over $204. That’s a 20 percent increase, and corporate performance will be a big factor for markets in the weeks ahead. Already, the first round of earnings from the big banks came in strong, and CEOs had positive commentary about the economic backdrop and the strength of U.S. consumers.

Wall Street Wrap

Consumers Flex Spending Power: American consumers continued to show their collective strength in September, as retail sales surprised to the upside and rose 13.9 percent year over year and 0.7 percent over August’s tally. The rise in sales is both a reflection of strong demand and higher prices paid for goods and services. Sales at bars and restaurants climbed nearly 30 percent compared to the same month last year, while gas station sales rose 38 percent (a reflection of higher fuel costs). It’s worth noting that this report is heavy on “goods,” which represent one-third of overall spending. Services represent two-thirds of U.S. spending, and that still has room to recover further as COVID-19 dissipates.

However, markets are looking forward to the critical months ahead. Will snarled supply chains loosen enough to help businesses accommodate elevated holiday spending? President Joe Biden said last week Walmart, FedEx, UPS and other high-volume shippers would boost operations to get goods on store shelves. He also spoke with leaders of major U.S. ports to discuss ways to alleviate congestion.

We continue to view these supply chain hurdles as transitory, though it’s difficult to forecast when, exactly, these pressures will dissipate. Our focus is more on economic fundamentals, and September’s robust retail sales revealed no signs that consumers are weakening.

Consumer, Small Biz Sentiment Dips: In contrast to robust spending, consumer and small business sentiment dipped in October. The University of Michigan Consumer Sentiment Survey dipped to 71.4 in October, a 12.7 percent decline from the same time last year. The usual suspects are to blame: the delta variant, supply chains and the labor market. However, fiscal policy is creeping in as another factor. When consumers were asked about their confidence in economic policies, favorable evaluations fell to 19 percent in early October from the Biden administration’s high of 31 percent in April. Note, the decline was detected across all age, income, education and political affiliation subgroups. In general, consumers see the “go big” $3.5 trillion spending bill as a risky strategy, and we think that bolsters our view that the final price tag comes down closer to the $1.5 to $2 trillion range (which is still nothing to sniff at).

Small business owners cited many of the same concerns, pulling the NFIB Small Business Index down to 99.1 in September from a read of 100 the month prior. Hiring and getting product on shelves remain key challenges — only 10 percent of respondents reported no impact from supply chain disruptions.

Keep in mind, sentiment surveys aren’t necessarily the best leading indicators of real economic growth. While they inquire about the future, respondents’ answers are heavily influenced by current conditions. There’s a tendency to take the present and extrapolate it far into the future, leading to overly pessimistic or overly optimistic outlooks. Often, broad pessimism (and vice versa) serves as a contrarian indicator, as people expect things to keep getting worse or only get better. As outlined in our Q3 commentary, we think there are several catalysts that will help pull the economy, markets and, ultimately, sentiment higher in the months ahead.

Inflation Hangs Around in September: The Consumer Price Index rose 0.4 percent in September on a seasonally adjusted basis, which marked a 5.4 percent increase over the past 12 months (before seasonal adjustments). Food and shelter contributed to over half of the “all items” monthly increase (food rose 0.9 percent, housing up 1.2 percent). Core CPI, which excludes more volatile items, rose 4 percent from the year earlier. This is still elevated but a bit tamer than the 4.5 percent year-over-year print in June. According to minutes from the Federal Reserve’s September meeting (released last week), central bank leaders upped their short-term inflation forecast but continue to expect this year’s rise in prices to prove transitory.

There’s some evidence that transition could be occurring. The Producer Price Index (PPI), basically selling prices producers of goods charge, rose just 0.5 percent (seasonally adjusted) from August to September, the slowest pace on the year. PPI tends to be a good leading indicator because the costs of production are eventually passed down to consumers. PPI has been decelerating each month since July.

The week ahead

On the Radar: This week we’ll dig into a wave of earnings reports to see if underlying trends or themes emerge. We’ll likely get ample commentary on inventories, supply chains, COVID-19, material shortages, labor and more. This week, Johnson & Johnson, Netflix, Procter & Gamble, Tesla, Intel, Southwest Airlines and Honeywell are a few notable companies reporting.

We’ll also get another round of across-the-board housing data, leading economic indicators (one of our favored reports), industrial production and the Fed’s Beige Book.

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