Chris Versace is CIO of Tematica Research. This article is from the firm’s Sept. 12 Monday Morning Kickoff newsletter.
Before we took our Labor Day siesta last week, we mentioned September tends to be one of the worst months for the stock market. After trending sideways for pretty much most of August and the first few days of September, we were proven prescient, with several items hitting last week that raised “caution ahead” flags. Those events also renewed Fed talk about the next interest rate move, and that on the back of those flags, much like a dog on the 4th of July, the market was spooked, sending all the major indices into retreat mode — the Dow down 394.46 points, the Nasdaq down 2.5%, and our preferred market benchmark, the Standard & Poor’s 500, down 2.45%.
The “caution ahead” flags included the back-to-back weak August ISM Manufacturing and Employment Reports, which were followed this week by the August ISM nonmanufacturing Index (better known as the service sector) falling to 51.4 in August from 55.5 in July — the lowest level since early February 2010 and the biggest monthly drop since November 2008. Looking at the combined ISM reports, August fell to 51.2 from 55.1 in July marking the lowest reading since January 2010 and the largest monthly drop since November 2008.
What this tells us is the forecasted rebound in the economy is not shaping up quite as expected.
While you might think the market was spooked following the North Korea’s latest nuclear bomb test, which is indeed pretty unnerving, it was Federal Reserve Bank of Boston President Eric Rosengren who rocked the market last Friday. During a speech, Rosengren said that “a reasonable case can be made” for tightening interest rates to avoid overheating the economy. Given the August data received thus far, we’re inclined to think Rosengren is either still jet-lagged from his recent trip to China last month where he made similar comments, or he hasn’t had time to digest the latest data. In our view, Rosengren’s comments likely mean additional weight will be put on this week’s August PPI and CPI readings.
Keep in mind, Rosengren’s comments came after the Fed’s latest Beige Book was published during the middle of last week. The Beige Book is based on data compiled on or before August 29th and its findings revealed that most of the 12 districts reported “fairly modest” wage pressures that are expected to remain as such over the coming months. Overall, price increases were subdued and consumer spending was little changed.
Uncertainty surrounding the outcome of the presidential election appears to be increasing caution around expansion plans, with only modest expectations for sales and construction activity in the coming months. While not exactly a measure of the market, to say the least, we found it telling that the word “flat” was used 56 times in the August report, versus 36 times in the last Beige Book this past July. Where can you get that kind of analysis?
Our key takeaway was the Beige Book gave little indication that we are likely to see what others have been predicting as a dramatic surge in growth during the second half of 2016, something we’ve been quite openly skeptical of, given the lack of identifiable catalysts for such a move. The follow through on that thought is prospects for a pronounced pickup earnings from the S&P 500 companies in the December quarter is likely to underwhelm, relative to current expectations.
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