Ameriprise Financial : Reads on Economic Activity Paint a Mixed Picture

Reads on Economic Activity Paint a Mixed Picture

10/9/2023

Anthony Saglimbene, Chief Market Strategist, Ameriprise Financial

Major U.S. stock averages opened the fourth quarter mixed. Crosscurrents across backward-looking data on economic activity as well as employment trends played heavily into stock reactions last week, leaving investors trying to figure out the Federal Reserve's next policy move. The S&P 500 Index finished the week up +0.5% (breaking a four-week losing streak), while strength across Big Tech helped the NASDAQ Composite gain +1.6%. However, the Dow Jones Industrials Average ended the week down 0.3%, while the Russell 2000 Index shed 2.2%. The Russell 2000 Index, in particular, posted its fourth weekly decline in five and has now given up nearly all its year-to-date gains on a total return basis.

On the sector front, Communication Services (+3.2%) led stocks higher last week, while Information Technology (+2.9%) also helped growth-based indexes outperform value-based indexes. Notably, Energy (-5.4 %) ended the week down sharply, as West Texas Intermediate (WTI) oil lost nearly 9.0%, logging its largest weekly decline since March. WTI has come under recent stress as global recession worries grow and U.S. gasoline inventories build (a sign of weakening demand) - despite OPEC+ continuing to keep oil production tight. Over the weekend, the terrorist group Hamas unleashed coordinated, unprovoked attacks against Israel on a multipronged front that surprised the world and has killed over 1,000 people. Israel has now declared war on Hamas, with the weekend's events quickly undermining a U.S.-brokered normalization strategy between Israel and Saudi Arabia and complicating stability in the Middle East.

Across fixed income last week, swirling concerns about future Fed policy, growing U.S. Federal debt levels, continued deficit spending, and a dysfunctional Congress all contributed to lifting yields on the longer end of the curve. For example, the 30-year U.S. Treasury yield hit 5.0% for the first time since 2007, while the 10-year U.S. Treasury yield hit a fresh post-2006 high, ending the week at 4.78%. Lastly, the U.S. Dollar Index recorded a slight decline last week, breaking an eleven-week streak of gains. And Gold dropped roughly 1.0%, hitting levels last seen in March.

Path for Fed policy remains clouded

Incoming economic data continued to cloud the path for Fed policy last week, but Friday's nonfarm payrolls report offered some clues.September ISM reports showed mixed trends of activity across the economy last month. For instance, manufacturing activity in September came in higher than expected (though it remained in contraction) and showed prices paid (a form of inflation) slowing more than economists forecast. The headline ISM manufacturing figure hit its highest reading since November, and employment moved back into expansion territory. In our view, these are positive signs that manufacturing activity in the U.S. is beginning to recover from its long slump. However, services activity has been providing the jet fuel for outsized U.S. economic growth over the last several quarters, and here, trends are weakening. September ISM services activity remained in expansion but came in a tick lower than expected and below August levels. The new orders component of the measure dropped more than expected, though employment trends and outlooks remained relatively optimistic. Bottom line: Recent reads on economic activity point to a mixed picture that clouds Fed policy, in our view.

Jobs report shows a soft-landing scenario remains in play

Moving to the employment front, before the September nonfarm payrolls report was released, the August Job Openings and Labor Turnover Survey (JOLTS) showed 9.6 million available jobs, more than the 8.9 million expected and up from the 8.9 million open jobs in July. Here, the general market view is that the Fed wants to see available jobs come down, which would help slow employment growth without materially increasing the unemployment rate. While the JOLTS report is heavily backward-looking and can bounce around month-to-month, available jobs in the U.S. have trended lower over the last year, which is what the Fed wants to see. However, September ADP private payrolls unexpectedly dropped to +89,000, well below consensus forecasts and the August level of +177,000. Headline private payrolls came in at their lowest levels since January 2021. Notably, pay gains in the ADP report for employees staying in their current job dropped for the twelfth straight month, while pay gains for those moving to another job eased. Bottom line: Mixed JOLTs and ADP reports had investors on edge heading into last Friday's September nonfarm payrolls report.

So, how did the closely watched jobs report come in? September nonfarm payrolls grew by a stunning +336,000 jobs, well ahead of the +163,000 jobs expected. The unemployment rate held steady near a historical low of 3.8%. July and August jobs were revised higher by +119,000, while the prime-age employment-to-population ratio in September stood at 80.8%, remaining above pre-pandemic levels. At first blush, such blistering job strength would immediately cause stocks to sink, as investors assume the Fed would likely need to raise rates further to cool the job market. And when stocks opened for trading on Friday, sink lower is exactly what they did. However, as markets digested the information as the trading day developed, the focus turned to the average hourly earnings component of the report (a read on inflation), which came in cooler than expected and below August levels. On a year-over-year basis, average hourly earnings growth ticked down to 4.2% last month, its lowest reading since June 2021. Here, while the jobs market is growing strongly and unemployment remains low, wage inflation is ticking lower. One way to look at the job market today is to see more workers entering the market over recent months and quarters (i.e., the supply of labor increasing) while demand for labor normalizes, helping keep wage inflation pressures in check. If it can last, that's a pretty good setup for economic growth, overall activity, and corporate profits. Yet, we believe a relentless backup in interest rates, the delayed effects of constrictive monetary policies, and lingering questions about the profit outlook complicate the investment environment heading into year-end.

Bottom line: Stocks finished last Friday higher, as the major takeaway from the nonfarm payrolls report is that a soft-landing scenario remains in play. A strong job market, with low levels of unemployment and wage inflation coming down over time, is, by definition, the economic landing the Fed is trying to stick. Investors quickly assumed the lower levels of wage inflation in the jobs report could prompt the Fed to remain on hold at its November 1 policy decision. Following the nonfarm payrolls report, investors now assume there is a roughly 27% chance the Fed will hike its fed funds rate next month by 25 basis points, up from 18% a week ago, according to the CME FedWatch Tool. Notably, roughly 58% of the market believes the fed funds rate will end this year at its current range of 5.25% - 5.50%. Expect these odds to jump around this week as reads on September inflation, particularly core measures, are released.

The week ahead

After Kevin McCarthy became the first House Speaker in U.S. history to be ejected from his role last week for putting a bipartisan bill on the floor (which was passed into law) and keeps the government open until November 17, House Republicans this week will begin the process to elect a new House Speaker. Simply, we believe the obvious dysfunction across the House GOP at the moment increases the likelihood of a government shutdown in mid-November. This could inject a degree of background uncertainty and volatility into markets this month as reads on inflation, economic activity, Fed dynamics, and Q3 earnings reports take center stage.

Speaking of inflation, the September Consumer Price Index (CPI) will be released on Thursday. FactSet estimates see headline consumer inflation moderating lower on both a month-over-month and year-over-year basis. Headline CPI is expected to have grown by +3.6% year-over-year last month and down from the +3.7% pace in August. September core inflation is also seen declining to +4.1% year-over-year versus +4.3% in the prior month. Along with reads on producer price inflation on Wednesday, further signs of easing price pressures could increase the odds the Fed holds policy steady next month. Conversely, hotter-than-expected inflation trends would likely increase the odds the Fed would hike rates on November 1, which could put additional weight on stock prices this week.

Importantly, the Q3 earnings season kicks off this week, with PepsiCo, Domino's Pizza, Walgreens Boots Alliance, Delta Airlines, JPMorgan Chase, and several other large financial companies providing a view into prior quarter results. According to FactSet estimates, analysts expect overall Q3'23 S&P 500 earnings per share (EPS) to come in flat year-over-year on revenue growth of roughly +2.0%. Bottom line: The upcoming earnings season, which is always critical to helping form the corporate fundamental picture for investors, takes on added significance this go around as recession risks remain elevated. Although we anticipate S&P 500 companies to modestly hurdle over Q3 profit expectations, particularly as economic activity during the quarter was solid, outlooks could play a much heavier role in shaping stock prices over the coming weeks.

Finally, ongoing developments in the Middle East, Wednesday's release of the September FOMC meeting minutes, Friday's preliminary look at October Michigan Sentiment, and numerous Fed speeches during the week will capture investor's attention.

These figures are shown for illustrative purposes only and are not guaranteed. They do not reflect taxes or investment/product fees or expenses, which would reduce the figures shown here. An index is a statistical composite that is not managed. It is not possible to invest directly in an index. Past performance is not a guarantee of future results.

Important Disclosures
Sources: FactSet and Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.

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The fund's investments may not keep pace with inflation, which may result in losses.

Past performance is not a guarantee of future results.

An index is a statistical composite that is not managed. It is not possible to invest directly in an index.

Definitions of individual indices and sectors mentioned in this article are available on our website at ameriprise.com/legal/disclosures in the Additional Ameriprise research disclosures section.

The Standard & Poor's 500 Index (S&P 500^® Index), an unmanaged index of common stocks, is frequently used as a general measure of market performance. The index reflects reinvestment of all distributions and changes in market prices but excludes brokerage commissions or other fees.

The NASDAQ composite index measures all NASDAQ domestic and international based common type stocks listed on the Nasdaq Stock Market.

The Dow Jones Industrial Average (DJIA) is an index containing stocks of 30 Large-Cap corporations in the United States. The index is owned and maintained by Dow Jones & Company.

The US Dollar Index (USDX) indicates the general international value of the USD. The USDX does this by averaging the exchange rates between the USD and major world currencies. This is computed by using rates supplied by approximately 500 banks.

The Institute for Supply Management (ISM) manufacturing index is a national manufacturing index based on a survey of purchasing executives at roughly 300 industrial companies. It is an index of the prevailing direction of economic trends in the manufacturing and service sectors.

The ISM Services PMI (formerly the Non-Manufacturing NMI) is compiled and issued by the Institute of Supply Management (ISM) based on survey data. The ISM services report contains the economic activity of more than 15 industries, measuring employment, prices, and inventory levels; above 50 indicating growth, while below 50 indicating contraction.

JOLTS report is a monthly survey of U.S. job vacancies, hiring, and job separations released by the Bureau of Labor Statistics of the U.S. Department of Labor.

The CME FedWatch Tool analyzes the probability of FOMC rate moves for upcoming meetings. Using 30-Day Fed Fund futures pricing data, which have long been relied upon to express the market's views on the likelihood of changes in U.S. monetary policy, the tool visualizes both current and historical probabilities of various FOMC rate change outcomes for a given meeting date. The tool also shows the Fed's "Dot Plot," which reflects FOMC members' expectations for the Fed target rate over time.

The Consumer Price Index (CPI) is an inflation indicator that measures the change in the total cost of a fixed basket of products and services, including housing, electricity, food, and transportation. The CPI is published monthly by the Commerce Department and is also commonly referred to as the cost-of-living index.

The ADP National Employment Report is a monthly report of economic data that tracks nonfarm private employment in the U.S.

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