In today's FSI First Word Note, we discuss why we remain constructive on the market for September despite Tuesday's minor selloff in equities and rise in November hike odds. Manheim release this week and CPI/PPI next week are the key events to watch. Bottoming of ISM PMI strengths the case of Industrials.
Please click below to view our Macro Minute (Duration: 7:31).
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Investors are generally cautious on equities for September, and the weakness seen Tuesday will undoubtedly strengthen those concerns. The S&P 500 fell 19 points, or -0.4%, but it felt worse because this decline saw a rise in yields (US 10-yr +8bp) and rise in oil (+1.3% to $87) and the VIX also inched up barely to a still low 14. But our base case remains that we see stocks higher in September, driven by what we expect to be softer inflation data (used cars, CPI) along with further evidence of softening labor (revised -355k this year). And collectively, this would change the consensus view on future rate hikes, which in turn is supportive of equities.
* Fed Governor Chris Waller was interviewed on CNBC yesterday and he noted that while last week was "hell of good data" supporting a September pause, he also noted that he didn't think "one more hike would necessarily throw the economy into a recession if we do feel we needed to do one." That latter comment could be a reason the odds of a November hike jumped to 41.4% yesterday, up +930bp. And this possibly also pressured longer term rates as the US 10-yr yield moved to 4.264% (up 8bp). These are conditional statements, and not necessarily arguing that a November hike is necessary. But it does show where the Fed perspective sits, and many remain unconvinced the economy has softened sufficiently.
* Another headwind for stocks over the past few days is the rise in oil prices. WTI crude has risen almost $10 to $87 in just the past seven sessions and the highest levels since November 2022. The Saudi production cuts is the driver and this time, the US does not really have excess reserves to release from the SPR (strategic petroleum reserve) and thus, investors are naturally wary of these moves.
* To us, the bigger story this month is we expect the core inflation trajectory to come in softer than consensus, and this to lead to the market and the Fed repricing the future path of rate hikes. The most notable being we believe the Fed will not hike in September and not in November. Currently, Fed funds sees 6.8% and 41.4% probability of hikes in Sept./Nov., respectively.
* The two data points in the coming weeks are the following:
-- 9/8 9am ET: Manheim used car prices <- we expect this to be another soft report
-- 9/13 8:30am ET: August CPI <- expect core CPI below consensus of +0.20% MoM
* Headline inflation will certainly see a boost from the higher oil prices, and this is a predictable outcome. This does not necessarily feed into core CPI and core PCE (Fed's preferred measure) but will certainly catch the attention of the public and in a way, will be something the Fed has to consider. But the more important drivers of inflation, core that is, going forward are housing and used cars.
* As our pie chart below highlights, housing and auto-related (new and used cars) account for 57% of the core CPI basket. And the next two biggest weights after that are Healthcare (9%) and Education and Communication Services (8%). The latter two are not really sensitive to monetary policy, so it is really housing and autos that matter the most. And as we have written about extensively, both are set to be reducing materially core CPI over the next few months.
* It is fair for someone to say that weaker jobs and softening inflation are consistent with both a hard landing and a soft landing (our view). And the Fed study by former Fed Vice Chair Alan Blinder shows that most tightening cycles end in soft landings. What leads to a recession is a subsequent shock. In 2008 it was the GFC. In this cycle, there have been multiple shocks already:
-- Oil surge in 2022 from Russia-Ukraine war
-- Credit shock from SVB failing in March 2023
-- 27% stock market fall in 2022
* So, the equity market and economy have already endured these shocks. In fact, in early 2022, we saw two consecutive quarters of negative GDP. In a sense, if someone is expecting a recession in the near future, it means there would need to be another shock ahead. There are possible candidates:
-- resumption of student loan payments
-- UAW strike possible
-- possible US gov't shutdown
But these seem to be less seismic compared to prior shocks.
BOTTOM LINE: September not off to a great start, but key fundamental data points are later this week
But while equity markets are nervous, and we know that September seasonals are not great, in our view, this is also "dead space" until we get key incoming macro data points. We discussed those above. And ultimately, the key is our expectation that consensus inflation expectations are on a path to course correct lower.
* Mark Newton, Head of Technical Strategy at Fundstrat, is still watching for signs of a low in early September. And this remains his view. And the possibility that we see weakness in the first 1-2 weeks before reversing.
* This would be consistent with timing of the August CPI and PPI releases, which is next week.
* In the near term, we would want to see US yields decline and that along with Fed fund probabilities declining are the most consequential. While rising oil is not welcome, it is certainly not the economy killer nor equity killer or even inflation creator that it was last year.
* As for sectors, we will talk about this later this week, but we still lean towards Cyclicals. Our top sectors remain:
-- Technology/FAANG
-- Industrials <- PMIs do look like they bottomed
-- Energy
* On this latter point, the latest ISM was released last Friday 9/1 and came in at 47.6, three consecutive months of improvement. This could be scored as a sign of a bottom. And this bodes well for industrial stocks ( XLI) :
-- since 1950, when PMIs <47 and improving
-- win-ratio for Industrials next 12 months is +95%
-- median gain +22%
* So this means the fundamental case for Industrials is strengthening as we move into YE.
Source: Twitter.com
Source: Twitter.com
