Markets in Holding Pattern as Several Uncertainties Come to a Head

For months now, investors have been sorting through a laundry list of uncertainties. That’s clouded the outlook and led to rather lethargic trading through summer and into fall. Today’s market environment echoes that of 2017, during which major indexes moved just a few fractions of a percent in either direction from one day to the next for an extended stretch. Volatility tends to diminish when investors lack conviction, and a brew of competing signals today has left markets somewhat rudderless. We think these concerns have been circulating and getting priced into markets for months now; they may finally be coming to a head, and markets are poised to move past them.

The economy has reopened and is growing at a healthy pace; that much is clear. However, here’s what’s clouding the view ahead. Inflation, the Federal Reserve, COVID-19, a potential government shutdown, and even a real estate developer in China are sources of worry right now.

Remember, volatility is a feature of markets, not a bug. We’re not going to be overly concerned if things get choppy in the months ahead, as a sizable pullback would likely be met with buyers, given the amount of cash sitting on the sidelines.

Amidst all this uncertainty, we find no reason to change our intermediate-term outlook, which we have spelled out in our commentaries for the past few quarters. That laundry list of uncertainty will be sorted out, and we remain confident that economic growth, here and abroad, will continue at an elevated pace. As some of the clouds lift, we believe investors will gain renewed confidence in the growth story, and that should pull markets along with it.

Now, to the week that was and the week ahead.

WALL STREET WRAP

Thumbs Up for the Fed: The Federal Reserve’s policy meeting last week was highly anticipated (will it taper?), but there were few surprises once Fed Chairman Jerome Powell left the podium Wednesday. The Fed will keep interest rates near zero and continue its $120 billion in monthly asset purchases (quantitative easing), though “a moderation in the pace of asset purchases may soon be warranted.” We think “soon” will be at the Fed’s November meeting, when it will probably reduce purchases at a pace of $15 billion per month.

A notable shift was the Fed’s forecast for an interest rate hike. Nine of the 18 Fed officials now project a rate hike in late 2022, up from seven officials in June. Keep in mind, the Fed’s so-called “dot plot” is just a forecast and is not set in stone. All told, conditions will remain very accommodative well into next year, which is exactly what we expected.

Services, Manufacturing Growth Slows: The rate of expansion in the U.S. manufacturing and services sectors slowed in September, according to IHS Markit data. A resurgence in coronavirus cases is largely to blame, particularly in the services sector. Again, we emphasize that caseloads are near where they were last year, but the economic disruption is far less severe and localized to a few sectors. We’ve adapted to life with the virus, which is why the tangible impact on growth is more muted today. Overall, major leading economic indicators still indicate healthy growth today and going forward.

The flash manufacturing index PMI dipped to a five-month low — 60.5 in September, down from 61.1 the month prior. The services side of the index hit a 14-month low of 54.4 in September, down from 55.1 in August. Keep in mind, any read above 50 is indicative of expansion, so growth continues onward. Further, both reads may be at multi-month lows but remain near the higher end of the index’s long-term range going back to 2010.

Demand and backlogs in the manufacturing sector remain high by historical standards, while concern about COVID-19 is the primary reason growth decelerated on the services side of the economy. Private sector optimism in September remained strong, as businesses grew confident with hopes of improved demand and diminished supply chain constraints.

A similar story is playing out abroad, as the flash Eurozone PMI fell to 56.1 in September from 59 in August, a five-month low. The underlying factors for growth deceleration are much the same as here in the U.S.: rising input costs (at a 21-year high), supply chain constraints and concerns about the Delta variant.

A Quick Housing Market Survey: Last week, we got several data points on housing, and it’s all good from our view. The National Association of Homebuilders Index rose to 76 in September, up from 75 in August; building permits rose to 1.73 million in August from 1.63 million in July; and housing starts rose to 1.62 million in August, up from 1.55 million in July. Existing home sales pulled back slightly to 5.88 million in August compared to 6 million in July, and new home sales rose to 740,000 in August from 729,000 in July. Home prices and material costs remain elevated, but the market remains generally healthy.

THE WEEK AHEAD

What We’re Watching This Week: Today’s durable goods and core capital goods orders will provide some insight into how businesses are investing in their operations amid elevated backlogs and tight labor conditions. Consumer confidence for September will be released Tuesday, and we’ll see how the Delta variant, rising costs and potential product shortages are affecting the broader outlook going into the key holiday months. We’ll also dig into the ISM manufacturing index, namely the prices paid component, to see how inflation is faring.

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