Summary
Economic data for the week was highlighted by a weather-suppressed but otherwise decent employment report, strong results from other labor metrics such as private employment and claims, and mixed manufacturing results.
Equity markets in both the U.S. and overseas experienced a negative week as interest rates ticked sharply higher. As expected, fixed income was similarly affected across the board. Commodities, however, ticked higher due to stronger agricultural and energy prices.
Economic Notes
(-) The ISM manufacturing index for September fell by -1.5 points to 59.8, just below expectations of a round 60.0 reading. Under the hood of the report, results were mixed as production and employment each rose slightly, while new orders, inventories, prices paid and supplier deliveries declined by a few points. All areas continue to run in expansionary (over 50) territory, and point to strong underlying conditions. However, on an anecdotal level, survey respondents continued to note an âoverwhelming concernâ over trade policy, notably about how reciprocal tariffs imposed by China will impact manufacturing conditions going forward.
(+) The ISM non-manufacturing index for September, on the other hand, rose +3.1 points to 61.6, reaching a new high for this cycle, the second-highest reading in the surveyâs 21-year history, and surpassing expectations calling for a level of 58.0. The key components of business activity, new orders, employment, supplier deliveries and prices paid all rose by several points. Like the manufacturing survey, concerns over trade policy and tariffs surfaced in survey responses, although the relationship with services is more nuanced than with the manufacturing sector.
(-) Construction spending rose +0.1% in August, lagging expectations calling for a +0.4% increase. July numbers were also revised up by a few tenths of a percent. Private construction declined in non-residential by a few tenths and residential, by nearly a percent. Public residential and non-residential construction each rose by +2%.
(0) The final trade balance report for August increased -$3.2 bil. to -$53.2 bil., which was slightly tighter than the -$53.6 bil. expected. Exports fell by -0.8%, due to a -12% drop in petroleum exports; imports rose +0.6%, due to results from the âgoodsâ category outside of petroleum.
(+) The ADP employment report for September showed a gain of +230k jobsâsurpassing the +184k expected by consensus. Services jobs were up by +184k, with professional/business services and healthcare leading the way. Goods-producing jobs rose by +46k, led by a +34k gain in constructionâthe strongest number in that segment since early in the yearâwhile manufacturing came in at a less stellar +7k. Overall, this metric continues to point to strong underlying job growth, in keeping with other robust labor data.
(+) Initial jobless claims for the Sep. 22 ending week fell -7k to 207k, below the 215k claims expected in consensus estimates. Continuing claims for the Sep. 15 week fell by -13k to 1,650k, below the 1,665k forecast. Following a short post-hurricane rise the prior week, claims fell by several thousand in NC, as would be expected, although claims levels overall remain high for affected states in that region. Aside from that weather anomaly, claims nationwide remain at the lowest levels for the cycle thus far.
(-) The governmentâs employment situation report for September came in a bit weaker than expected, but this was less of a surprise due to extreme weather in the Southeastern U.S. over the survey period. All-in-all, considering the positive revisions for prior months, the report was seen as relatively decent, which helped solidify the case for continued Fed tightening and caused a rise in bond yields.
Nonfarm payrolls rose by +134k, a result far less than the +185k expected and smaller than the +201k average monthly gain over the last twelve months. Results appeared to be at least a bit affected by hurricane activity in the Carolinas during the month, with the reported category of weather-related non-work coming in at an elevated level of at least 50k. Otherwise, gains were led by professional/business services by +54k, health care by +26k, transportation/warehousing by +24k and construction by +23k, while leisure/hospitality and retail each lost close to -20k jobs. Payrolls for the prior two months were revised up significantlyâby +18k for July +69k for August.
The unemployment rate fell by a significant -0.2% to 3.7%âa tenth below expectations and the lowest level in 48 years. This was a robust result considering that the labor force participation rate was unchanged at 62.7%. Interestingly, the U-6 underemployment rate actually ticked up a tenth of a percent to 7.5%. The household employment portion of the survey showed a decent gain of 420k. The average workweek was unchanged at 34.5, while average hourly earnings rose by +0.3% over the month to $27.24. Year-over-year, wage gains have grown to +2.8%.
Market Notes
| Period ending 10/5/2018 | 1 Week (%) | YTD (%) |
| DJIA | 0.00 | 8.83 |
| S&P 500 | -0.95 | 9.52 |
| Russell 2000 | -3.78 | 7.29 |
| MSCI-EAFE | -2.34 | -3.74 |
| MSCI-EM | -4.50 | -13.61 |
| BlmbgBarcl U.S. Aggregate | -0.94 | -2.53 |
| U.S. Treasury Yields | 3 Mo. | 2 Yr. | 5 Yr. | 10 Yr. | 30 Yr. |
| 12/31/2017 | 1.39 | 1.89 | 2.20 | 2.40 | 2.74 |
| 9/28/2018 | 2.19 | 2.81 | 2.94 | 3.05 | 3.19 |
| 10/5/2018 | 2.23 | 2.88 | 3.07 | 3.23 | 3.40 |
U.S. stocks lost ground for the week on net, with large caps holding up better than small by a significant margin. Agreement on a draft North American trade treaty replacement for NAFTA, known as USMCA, buoyed stocks early in the week but this positivity was later hampered after comments from the Fed surrounding the strength of the economy pushed interest rates higherâpunishing fixed income and equities. From a sector standpoint, energy and utilities both gained nearly +2%âthe latter being a bit of surprise due to interest rates rising, despite a preference for defensive stocksâfollowed by financials, which benefitted from the higher rates. On the other hand, consumer cyclicals and technology each fell sharply. In the case of consumer cyclicals, sentiment toward Amazonâitself a quarter of that sector following the recent reshufflingâdue to the decision to raise employee wages to $15/hour and rumors of substantial Chinese hacking activities.
Earnings will be coming in over the next few weeks for Q3, with expectations remaining high on a year-over-year basisâfalling in the range of +19% year-over-year growth, per FactSet. This is actually a few percent lower than was initially forecast a few months ago, and below the +25% growth levels from Q1 and Q2 of this year. A portion of this decline is due to a higher starting point, but also from negative company guidance. Revenue growth is expected to come in at a rate of +7%, while the forward P/E for the S&P stands at 16.7âa bit above its long-term average, but not as extreme as some may have expected.
Foreign stocks also lost ground during the week due to bond yields in the U.S. and elsewhere rising, as well as continued contention in Europe over Italyâs government budget deficit. Japanese stocks also fell as the IMF expressed concern over pressures in achieving ample enough economic growth. The preliminary budget deficit in Italy of -2.4% (which has now supposedly improved to -2.1% for 2020) caused turmoil in European stock and bond markets the week prior, with negative sentiment continuing. This is most directly due to possible bond downgrades that could occur for Italy due to higher debt levels than are believed to be sustainable, as well as fundamentally due to the Eurozone limitation on deficits larger than -3% and, more importantly in this case, debt of more than 60% of GDPâper the original Maastricht Treaty of 1992. The current budget could lead Italy down a difficult trajectory of debt far beyond this level, which pits populist politics into a more difficult position, of either scaling back to appease broader EU leadership, or stoke the flames of anti-EU rhetoric, which again brings up the possibility of Italy rejecting euro membership (although this is still considered to be a less likely scenario at this point). An Italian departure could certainly prove to traumatic to European and global markets, but could well be more disastrous to Italy itself, likely resulting in a sharply negative currency adjustment, downgrade in credit rating and sharply higher interest rates.
Emerging market equities fared the worst, with strength in Brazil as the election season winds down and the right-wing populist reform candidate showing strength, but India substantially weaker due to rising oil prices (being an oil importer) as well as perceived trouble with several non-bank financial firmsâwhere a key firm defaulted and required government intervention. Turkey again struggled, as inflation accelerated to a 25% pace, which, on top of an already-weak currency, may require additional interest rate increases to help stabilize fundamentals. This could be thought of as a Paul Volcker-like response to inflation in the early 1980s in the U.S., albeit without the luxury of a global safe haven currency and consistently supportive political establishment.
Bonds were the big news item of the week, with 10-year treasury yield reaching its highest level in seven years at just under 3.25%. Key catalysts for the jump included Fed Chairman Powellâs comments concerning strength in underlying economic conditions (described as âremarkably positiveâ, with the current expansion continuing for âquite some time, effectively indefinitelyâ), continued strength in labor market and manufacturing metrics, as well as perhaps technical bond market factors, including sales from momentum traders as yields increased. As of late, even the more âdovishâ members of the FOMC, who had been advocating a slower path of rate increases, have been jumping on board for the current path of additional hikes over the next year, where further hikes are now seen as a higher probability. Notably, comments from Powell and others on the committee about a possible willingness to let fed funds rates drift up âbeyond neutralâ has added uncertainty to the recent economist focus on the neutral rate alone (called r-star) being the end point for this stage of monetary policy.
Due the higher rates, U.S. bonds experienced their worst week in some time, with treasuries and both high yield and investment-grade corporates losing nearly a percent. Floating rate bank loans were the only fixed income sector to gain a small amount of ground during the week. A stronger dollar and higher rates both punished foreign debt by over a percent in both developed and emerging markets, in USD and local currencies.
Real estate fell by several percent on the week, in both the U.S. and abroad, in keeping with a typical response to higher interest rates. Residential/apartment REITs fared slightly better, while lodging/resorts fared worst for the week.
Commodities gained ground during the week, with all segments higher, led by agriculture and energy (mostly in the natural gas segment). Crude oil gained during the week before falling back to end at just over $74/barrel, a net increase of +1.5%. Oil pricing continues to be driven in large part by concern over the anticipated supply reduction from Iran as additional sanctions are imposed next month.
Sources: Ryan M. Long, CFA, FocusPoint Solutions, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Citigroup, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Marketfield Asset Management, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, PIMCO, Standard & Poorâs, StockCharts.com, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wall Street Journal, The Washington Post. Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends. Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.
The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness. All information and opinions expressed are subject to change without notice. Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product. FocusPoint Solutions, Inc. is a registered investment advisor.
Notes key:Â (+) positive/encouraging development, (0) neutral/inconclusive/no net effect, (-) negative/discouraging development.