September ended up being the worst month of performance for the major indexes since the pandemic-driven swoon in March 2020. A handful of uncertainties are coming to a head, which explains the muddled trading through the month. Investors still aren’t sure what to make of inflation, fiscal policy, supply chain woes, COVID-19 and signs of subdued growth in China — to name a few top-of-mind concerns. The month’s sluggishness is indicative of a market that’s feeling around in the dark for some direction.
We continue to believe these are temporary headwinds. When you filter out the noise and focus on the raw data, we’re still seeing an economy that’s growing at historically elevated levels and poised to continue its growth when many of these headwinds dissipate in the months ahead. As we look forward, we’ll be paying close attention to prices producers are paying and digging for signs that labor and supply chain constraints are easing.
But October opened in positive territory. Pharmaceutical company Merck provided a lift after announcing an experimental pill that reduced COVID-19 deaths by 50 percent in some patients, which could alleviate pressure on hospital capacity (an FDA submittal should be forthcoming). Congress averted a government shutdown, and economic data continue to show relative strength. That and more helped push the major indexes higher, a welcome signal to close the week and glimmers that some clouds may be clearing.
Wall Street wrap
Spending Trends Upward: Consumer spending accelerated 0.8 percent in August, up from a 0.1 decline in July, an encouraging sign of strength heading into the critical holiday months. Personal incomes rose 0.2 percent as wage gains and child tax credits outweighed the expiration of enhanced unemployment benefits in many states. The consumer savings rate, at 9.4 percent in August, remains near the top of its 30-year average trend (a low of 2.1 percent was reached in July 2005). All told, consumers are in great shape, but the big question is whether supply chains and businesses can rise to meet healthy demand in the months ahead. Keep in mind, even if supply chains do struggle, that may simply push demand further out in time rather than eliminate it altogether (consumers will still buy a product even if they need to wait).
Business Spending Remains Strong: Capital goods orders and shipments, a proxy for business investment, rose solidly in August. Orders rose 0.5 percent, and shipments climbed 0.7 percent in August from the month prior. New orders shot up 16.4 percent on a year-on-year basis and are now 18 percent above pre-pandemic levels.
Sure, there are price pressures for businesses and consumers, but this has been accompanied by strong growth. This is a key point. A strong U.S. economy is providing a firm foundation for companies to invest in technology and improve the productivity of their workers. If the economy were faltering, businesses would be far more hesitant to spend on capital goods. Over time, these investments will help put downward pressure on prices (see below) as productivity rises to meet demand.
Key Inflation Hits Multi-Decade High, but We’re Not Sweating It: The core personal consumption expenditures price index, which excludes food and energy costs, rose 0.3 percent in August and 3.6 percent year-over-year — the highest since May 1991. Core PCE is the Federal Reserve’s preferred inflation gauge, and Fed Chairman Jerome Powell said the bank is targeting a long-term inflation rate of around 2 percent (though it may go higher for some time). Jammed supply chains, rising material costs, and tight labor markets paired with strong demand are all pulling prices higher.
“It’s also frustrating to see the bottlenecks and supply chain problems not getting better — in fact, at the margins, apparently getting a little bit worse,” Powell said during an event hosted by the European Central Bank. “We see that continuing into next year, probably, and holding up inflation longer than we had thought.”
While inflation may be stickier than the Fed originally expected, we remain steadfast in our view that this is a transient phenomenon. There’s still plenty of slack left in the economy, which basically means there’s excess productive capacity to meet demand. Supply chains are going to catch up. However, there are many forces that impact pricing, so pinpointing exactly when prices will balance is tough for any forecaster. Keep in mind, inflation isn’t a function of time, it is a function of economic fundamentals. And from that view, there’s little evidence to indicate our current bout with rising prices is something that’ll endure.
Manufacturing Sector Stalls in China, Services Accelerate: The Chinese manufacturing sector shrank in September as restrictions on electricity use and input costs applied the brakes on businesses. The manufacturing Purchasing Manager’s Index fell to 49.6 in September versus 50.1 in August (a read over 50 indicates growth), according to China’s National Bureau of Statistics. Sectors that consume a lot of energy, such as metal and oil products, were an outsize drag on the sector.
Meantime, the non-manufacturing component bounced back to growth in September, rising to 53.2 from 47.5 in August. Activity in the rails, air transport, hospitality, catering and environmental services all recovered following a spike in COVID-19 cases in August that hamstrung many of these sectors.
Improvement in the U.S.: It was a different story for U.S.-based manufacturers in September, as the ISM Manufacturing PMI reached 61.1, up from 59.9 in August. That growth comes amid challenges we’ve been seeing for a few months. Demand remains strong, and new orders accelerated, but we didn’t see much pricing relief.
“All segments of the manufacturing economy are impacted by record-long raw materials lead times, continued shortages of critical materials, rising commodities prices and difficulties in transporting products,” said Timothy R. Fiore, chairman of the ISM. Finding enough qualified workers also remains a formidable challenge.
The week ahead
What We’re Watching: This week we’ll pore through the ISM services PMI for September. August’s read marked the 15th consecutive month of growth in the sector, and that’s poised to continue. We’ll also get another read on unemployment, though jobless claims have hovered near pandemic lows for a few weeks now. Unemployment remains a key metric, as it is the Fed’s primary policy barometer (in addition to inflation and markets). Recall, the Fed signaled it intends to begin tapering its $120 billion in asset purchases in the “near future,” and the labor market weighs heavily on that timeline.
We expect the debt ceiling to remain at the forefront of fiscal policy discussions, as lawmakers are deciding whether to raise (or suspend) the debt ceiling. Treasury Secretary Janet Yellen warned Congress last week that failing to reach a decision by an Oct. 18 deadline could have significant negative consequences for the economy — markets, thus far, have largely been unfazed. Lastly, we’ll look to the eurozone, as industrial production and retail sales from the region are due this week.
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