Market Recap
Stocks were about unchanged last week despite a bevy of macro and company-specific data stirring up day-to-day volatility. The S&P 500 was higher by 0.5% while the Nasdaq finished narrowly in the red. Small caps struggled again, ending at their lowest weekly settle since October of last year. At the sector level, Energy, Utilities, and Real Estate outperformed – the latter two groups have endured steep selling pressure over the preceding months.
A rally in the bond market, despite hotter-than-expected inflation data, helped yield-sensitive areas. Likewise, a drop in real yields (the TIPS ETF rose 1.5%, its strongest week dating back to November 2022) and mounting geopolitical uncertainty were beneficial factors for gold. The yellow metal had its best week since early 2023, rising more than 5%, and surged into the close on Friday. The broader commodity complex jumped, too. Oil enjoyed its biggest single-session advance since March as the conflict in Israel continues.
The Look Ahead
Following a strong September jobs report and last week’s iffy PPI and CPI data, investors will pay close attention to consumer spending trends. The Census Bureau releases its Advance Retail Sales report for September on Tuesday morning. The expectation is for a spending slowdown as the consensus estimate stands at +0.3% on the headline –0.1% for the Core Control group. Light numbers will surely wipe away any chance of a November rate hike while a hot data set would increase the chance of another policy rate increase. Also before the bell on Tuesday, Industrial Production for last month will offer a glimpse of the demand situation at the manufacturing level.
A slew of housing data then hits the tape from later in the day on Tuesday through Friday’s Existing Home Sales report. We continue to be on the lookout for any shifts in jobless claims, which remain low. That report, along with the Philly Fed regional survey crosses the wires on Thursday. Finally, traders expect an 18th straight negative print on the Conference Board’s Leading Economic Index (LEI) report on Friday at 10 a.m. ET. It is another busy week of Fed Speak, as well. The Beige Book comes out Wednesday afternoon and five FOMC voting members have confirmed speaking engagements, including Chair Powell Thursday at noon ET.
Economic Data on Tap: Retail Sales, Industrial Production, Housing Reports, LEI
Earnings Reports This Week
It’s not all about the macro, though. The third quarter earnings season heats up with a host of big-name S&P 500 companies issuing profit reports. A steeply rising dollar, higher interest rates, and more elevated energy and labor costs were no doubt headwinds for corporate America but results so far have come in decent. Key companies reporting include Tesla (TSLA), Taiwan Semi (TSM), Johnson & Johnson (JNJ), Procter & Gamble (PG), Bank of America (BAC), Netflix (NFLX), and American Express (AXP).
Earnings Season Broadens Out
Topic of the Week: Too Warm?
September inflation data came in last week. It was met with trepidation by investors as both Wednesday’s PPI figures and Thursday’s CPI data were not what the soft-landing crowd hoped for. Last month’s wholesale price rise registered +0.5%, hotter than the +0.3% expectation, while the core was also above estimates.
Stock market futures wobbled after the 8:30 a.m. ET report, but more volatility struck the following morning care of CPI data. It wasn’t an awful set of numbers, but headline CPI was a tick higher than forecasts on the year-on-year print as well as the monthly gauge. Importantly, the Core Services ex-Shelter component rose at an uncomfortably high clip, +0.61%, or above 7% on an annualized basis. On an annual basis, September CPI rose 3.7% and Core CPI increased 4.1%, the lowest in two years.
Robust Inflation to Close Out Q3
Fed Watch
Did the probability of a Fed rate hike at the November meeting (just two weeks away) jump? Nope. Investors, and surely the FOMC, recognize that the Shelter components within the CPI report are badly lagged. High-frequency housing and rent price indicators suggest much softer price increases in that key part of the CPI data.
Some alternate measures of inflation using real-time shelter metrics assert true inflation is closer to the Fed’s 2% target. Still, wage growth remains robust, and that will likely keep CPI and the Core Personal Expenditure (PCE) above where Powell and the rest of the FOMC want them as the election year approaches.
Scant Chance of a November Rate Hike
Another Weak Treasury Auction
Ironically, it wasn’t the all-important monthly inflation reports that brought about volatility in the stock and bond markets. Later in the day on Thursday, poor demand at the 1 p.m. ET Treasury auction immediately sent yields higher and equities tumbling. We usually do not see such dramatic responses to what are normally rather routine and non-newsworthy security sales.
Naturally, the 30-year bond was the culprit. Dealers were forced to take 18% of the supply as market participants were unwilling to step up to the plate – the normal dealer share is near 11%. The rate on the ‘long bond’ soared 12 basis points to 4.86% after what had been a trend lower across the yield curve going back to shortly after the jobs report the previous Friday morning.
Who Will the Buyers Be?
Jitters persist regarding how the US government will pay for its rapidly growing debt burden given extreme annual deficit figures – all this during a period of economic growth.
The Treasury Department is currently issuing hefty amounts of long-term bonds for funding, but more short-term paper may be put to the market over the coming weeks and beyond. That would seem to put upward pressure on yields considering that Japan is loosening its yield curve controls and China has become less of a demand source. In all, this year is on track to be the second biggest year of net Treasury issuance, behind just 2020. A result is a surge in interest expenses for the federal government – soon to top $1 trillion annually.
More Government Spending, High Deficits, Increased Treasury Bill, Note, and Bond Selling
Hamas Attacks on Israel: What It Means for Markets
We all know the macro factors that could continue to drive up interest rates. Helping to cool the trend of higher yields, however, could be further geopolitical upheaval. The terrorist attacks on Israel are ongoing, and fears of a broader war are very real. Such a situation could bring about a temporary “flight to safety” in which investors sell risky assets, like stocks, in exchange for safe havens such as US government bonds and the dollar. History shows, though, that war efforts can ultimately be inflationary due to increased military spending and commodity price increases.
War Risks
Policy Implications
It’s too soon to tell if the fighting in the Middle East will be a major factor for the Fed to weigh, but price action to close out last week was concerning. WTI crude oil rose nearly 6% on Friday for its second-best session in the last year. We mentioned the move in gold earlier, too.
Investors were clearly anxious going into the weekend, and stocks gave back a chunk of their gains for the week from midday Thursday through the closing bell Friday. The dollar, meanwhile, jumped during the back half of the week, continuing its impressive rise from under 100 on the US Dollar Index to above 106.
US Dollar Index: Near Year-to-Date Highs Amid Heightened Tensions Overseas, Rising Treasury Yields
Frightening Narratives, But Pay Attention to Sentiment and Price Action
A lot of scary headlines and narratives playing out, right? Spooky, and very ‘October-y,’ indeed. Not surprisingly, we see several sentiment gauges turning softer. Last week, the September NFIB Small Business Optimism Index took a leg lower while BofA’s Bull/Bear indicator dropped to 2.2 from 2.6 - the weakest since April this year. Poor stock market breadth and large outflows from both high yield and emerging market bonds are bearish signals. But high negativity may be just the fuel to get a seasonal rally underway.
All Aboard the Bullish-Seasonal Train?
Stocks, domestic and foreign, tend to rally from mid-October through year-end. Moreover, when the S&P 500 is higher by 10% or more through September, Q4 tends to be even better. Seasonality is just one factor to consider, but markets love climbing walls of worry. Considering that Commodity Trading Advisors (CTAs) are heavily short equity futures at the moment, that’s further fuel for a significant rally on any positive macro headlines.
“Pleasure” at the Pump
There is some good news out there, though. Retail gas prices have fallen to near $3.50 - a fresh three-month low as the cheaper winter blend of gasoline now makes up the prompt-month contract of RBOB gasoline futures. Furthermore, oil’s jump from the low $80s to not far from $90 has not caused wholesale gas to rally very much.
RBOB near $2.25 implies a national pump price average of about $3.20 in a few weeks. That may effectively be like a stimulus to the American consumer as holiday spending is already underway. The 30-cent decline for a gallon of regular unleaded has come about just recently – so quickly that the September University of Michigan Consumer Sentiment Survey didn’t incorporate the lower prices.
Dissecting the September UMich Data
The survey released last Friday revealed that Americans are more downbeat about the state of the economy. The headline number plummeted from above 68.0 to just 63.0, while economists expected 67.1, and the expectations sub-component cratered from 66.0 to 60.7. Markets paid particular attention to how respondents viewed the inflation outlook. At 3.8%, one-year inflation expectations rose to their highest level since May as the five- and 10-year rates increased back above 3%.
Take it all with a grain of salt, however, since gas prices alone tend to drive how people feel about inflation and the economy writ large. Revised data could come in tamer and more sanguine while the October report to be issued next month will probably improve thanks to declining gasoline prices.
University of Michigan September Survey: Consumers See Higher Inflation Ahead
Higher Oil Prices = More US Energy Profits
Finally, rising energy prices are not entirely a terrible thing. Notice in the chart below that the United States just registered its highest crude oil output in history. Bigger costs for oil and natural gas no doubt pinch consumers’ wallets, but they also line the pockets of small and large Energy-sector firms.
Shareholders are also rewarded with bigger dividends and stock buybacks. In fact, the total shareholder yield within the Energy sector is now above 7%. The group trades with a forward price-to-earnings multiple near 11, under its 5-year average of 15.6, according to FactSet. Energy equities can be a decent hedge against inflation over the long haul and whenever tech stocks fall out of relative favor.
US Crude Oil Production Hits a Record High
The Bottom Line
Healthy jobs gains in September and last week’s PPI and CPI prints all suggest that Fed policymakers must keep an open mind to another rate hike, but geopolitical concerns and already-rising Treasury yields will probably keep the Fed on pause two weeks from now. Retail Sales data this week will offer more insight into the state of the consumer, and economists expect a spending slowdown. Key earnings reports as well as developments in Israel will also move markets.
