Market Recap

Posted on November 1, 2019 by Gemmer Asset

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Economic Recap – Faint Hints of a Trough

 

A number of key economic reports this week:

 

Decent Growth in Q3

 

The advance estimate for Q3 GDP came in at 1.9%, a modest dip from 2.0% in Q2, but well ahead of expectations of 1.6%.

 

 

Manufacturing Recession Continues

 

The ISM manufacturing index increased for the first time since March but remains in contraction mode. To early to call a bottom in the manufacturing sector, but this is starting to look like the last two manufacturing downturns that didn’t lead to an economy wide recession.

 

 

Job Growth Persists

 

Friday’s payrolls report was solid. Non-farm payrolls rose by 128,000 in October, down from 180,000 in September (which was revised upwards from an initial read of 136,000). Forecasts were for just 89,000 job additions due to the drag from the GM strike. The unemployment rate ticked up as expected to 3.6% from 3.5% and wage growth stayed the same.

 

 

Inflation is Muted

 

Nothing on the inflation front to raise any eyebrows. The September core PCE grew at an annual pace of 1.67% while the headline number (including food and energy) was up just 1.33% year-over-year. Both are well below the Fed’s target of 2%.

 

 

Summary

 

What does it all mean?

 

– Growth outside manufacturing is plodding along just fine.

 

– There’s a chance we’ve seen the worst of the manufacturing recession.

 

– If so, broad economic growth should plod along in 2020 as well.

 

– Underlying job growth is sufficient to keep the consumer in the game.

 

– And inflation is low enough that we are unlikely to see the central bank on the warpath in 2020.

 

Of course, the turn in manufacturing hinges on the path of the trade talks. And who knows??? Not going to comment until somebody actually signs something!!

 

The Long Pause

 

The Fed met Tuesday and Wednesday and surprised no one with a quarter point cut in rates. This was the third cut of the year that has brought the Fed Funds rate down from 2.25-2.50% to 1.50%-1.75%.

 

The message from the statement and the press conference points to a long pause:

 

– They argued that the underlying economy is in decent shape and doesn’t need any more rate cuts. Chairman Powell pointed out that a preliminary US-China trade deal and lower risk of a no-deal Brexit had the potential to increase business confidence.

 

– Powell also pointed out that the central bank would need to see a sustained and significant uptick in price pressures before considering future rate hikes. To quote the Chairman from his press conference:

 

“We just touched 2% core inflation to pick one measure. Just touched it for a few months and then we’ve fallen back…So I think we would need to see a really significant move up in inflation that’s persistent before we would consider raising rates to address inflation concerns.”

 

Summary

 

This is probably the biggest takeaway from the meeting. In 2017 and 2018 the Fed tried to be proactive to get ahead of a possible inflation upswing. They aren’t going to do that this time. They want to see inflation actually increase ‘significantly’ before hiking rates. If we had to bet this won’t be the case until well after the election.

 

Earnings Surprises

 

It’s never the data itself – it’s how the data compares to expectations. This is clearly evident in earnings this cycle.

 

Going into Q3 earnings season expectations were bombed out – analysts thought the numbers would be down roughly 5% year-over-year. As it turns out they are going to be less bad. And less bad is good!!

 

About two-thirds of companies have reported so far and as you can see below, over 70% of firms have beat estimates, well above the average of the last twenty years.

 

 

Now this doesn’t mean the numbers are good. Q3 earnings growth will probably be down 1% to 2% year-over-year. But the key is they are better than most thought. As you can see below, the estimate for Q4 is fractionally negative with an upturn coming in Q1 and Q2 next year.

 

 

The Flight to Safety Trade in 2019

 

So what are people doing with their money in a year when both stocks and bonds are up? Apparently shoveling it into money market accounts and bond funds. US equity funds saw net outflows of $173 billion in the past 12 months, according to Goldman. Bond and cash funds saw inflows of $259 billion and $592 billion, respectively. The 12-month flow gap from stocks to bonds and cash is the biggest since 2008.

 

 

Investors are selling stocks because they are obviously worried about the economy and the political backdrop. It will be fascinating to see what happens next year if economic risk dampens down at the same time the political noise ramps up.

 

Have a good weekend.

 

 

 

 

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