What's the downside?
Unloved sectors may be setting up nicely.
Was on Bloomberg TV and radio this week. You probably didn’t catch it. The last week of August marks the unofficial end of summer and no one was around. Makes for very thin trading, so you probably shouldn’t overanalyze the market. Since Chair Powell keeps chanting his “2 means 2” mantra, he should love this week’s data (more below). As goes inflation and jobs, so goes the Fed, and both served up welcome surprises. With the Atlanta Fed tracking Q3 GDP at 5.6%, any signs of slowing growth are stock and bond friendly. Indeed, both markets rallied this week, paring the S&P 500’s August losses and accelerating the 10-year Treasury yield’s pullback after hitting its highest level since 2007. Tepid volumes the unofficial final week of summer almost certainly helped the equity market overtake its 50-day moving average, with 100% advancers in S&P technology names. Fundstrat thinks it’s enough to call the recent correction over. We’ll see. Again, probably shouldn’t overanalyze August.
Lots of discussion about consumers drawing down savings and stretching themselves on credit, particularly at the lower ends of the income spectrum. Dollar General and Dollar Tree took hits on warnings about their outlook, and student loan repayments begin later this month. But Renaissance Macro research shows the correlation between y/y changes in real consumption and real aggregate weekly payrolls is running about twice its historical average, a sign that incomes—not savings—are driving spending. With inflation moderating, and used vehicles and shelter prices easing, real incomes should continue to pick up. Tracktherecovery.org, a real-time website often cited during the reopening phase after the pandemic, shows entertainment and recreation spending up 30% since January 2020, vs. respective increases of 15% and 13% on groceries and transportation, another indicator discretionary spending is doing fine. Spending on goods also is rebounding (more below), more fuel for factories on thinning inventories due for a rebuild. It’s true households are dipping into savings, roughly to the tune of $80 billion a month, Bank of America estimates. But at the pace, it says it still will take six to seven more months to deplete the excess savings from all the Covid relief. While it expects consumers will spend more on back-to-school shopping this year, the National Retail Federation said it doesn’t necessarily mean more borrowing. It says 50% of college and 53% of K-12 BTS shoppers plan to use debit cards this year vs. 41% and 45% last year. As savings draw down and student loan lenders start knocking, the end of Easy Street may be coming into view for the consumer.
With the anniversary of last year’s October lows looming, the tape remains very selective. Over the last 11 months, Strategas Research says the S&P at no point has seen more than 80% of issues above their 200-day average. That’s very rare this far into a rally. The current reading is just above 50%. The early innings of a new advance tend to be a rising tide, and that just hasn’t been the case. Only one sector, Energy, has seen all its constituents above their 50-day average and 90% above their 200-day average, and it was the only sector with equal and cap-weighted gains in August. That said, S&P earnings revisions have turned noticeably higher, with the past month seeing the highest percentage of upward adjustments since November 2021. Sectors with the most notable upticks: Energy, Health Care and Financials. These are among the cheapest sectors of the market, along with Communication Services and Consumer Staples. In fact, these defensive sectors are all trading below their forward P/Es relative to the S&P going back 30 years, according to Goldman Sachs. With recession on the backburner, the Fed on potentially a long pause and Powell chanting “2 means 2,” rates will eventually bite. Defensive sectors are unloved, for sure. But at 30-year relative lows, what’s your downside?
Positives
- Fed friendly August job growth surprised slightly but downward revisions to the two prior months put the 3-month average monthly gain at just 150k, another sign the labor market is normalizing. Other signs: July job openings at their lowest level since March 2021, a quits rate back to pre-pandemic levels, and August job cuts and continuing jobless claims at post-pandemic expansion highs
- Fed friendly July headline and core PCE inflation were in line with consensus, with the core rate marking its smallest back-to-back increase since late 2020. The 3-month annualized rates for both also declined, further suggesting inflationary pressures are weakening. And with unemployment rising on a big gain in workforce entrants, average hourly earnings growth in August fell to a 19-month low.
- The consumer reigns supreme Real consumption surged 0.6% in July, lifting the 3-month annualized rate of change to a solid 2.8% annualized. On a headline basis, spending rose a stronger-than-expected 0.8% m/m, with goods spending up 0.9%, topping June’s 0.7% burst.
Negatives
- Manufacturing may be making a bottom Final August ISM and PMI manufacturing reads were revised higher but still below a breakeven 50. The Chicago PMI also remained contractionary but improved to a high for the year, while the Dallas Fed PMI beat consensus with its slowest contraction in 5 months. With goods spending up 3.3% over the past year, the continued contraction in nonfarm inventories (trimming GDP growth half a point per quarter over the same period) looks unsustainable.
- Housing may be making a bottom Even though the estimated average monthly mortgage payment made a new high of $2,700, according to Strategas calculations, mortgage purchase applications inched up in the past week. Also, July pending sales rose nearly 1%, vs. expectations for a decline, while home prices decelerated more than expected, according to Case Shiller and FHFA.
- Consumers (and voters) don’t like high gasoline prices They jumped to $3.83 a gallon, a high for the year, and AAA says the run-up prompted some to pare Labor Day travel. Higher gas prices were among factors cited in August’s plunge in Conference Board consumer confidence to its lowest level since May.
What else
Don’t fear September At least, not this year, according to Fundstrat. In six of seven instances since 1950, when the S&P has risen 15% or more year-to-date but was down in August, as was the case this year, it experienced a median gain of 3.3% in September, historically the market’s worst month.
Capex tailwinds Manufacturing construction is surging—driven almost entirely by semiconductor and battery investments spawned by the CHIPS and Inflation Reduction Acts—and should remain elevated through 2024. Also, AI capital spending expectations for each of the next three years jumped from 3-4% at the start of 2023 to +16% in August.
September historically has marked the unofficial start to the election year About 40% of U.S. recessions since the 1850s began during a presidential election year or the first half of the following year. Also, stocks tend to perform better when a sitting president runs for reelection—unless the incumbent loses. That’s a worst-case scenario for stocks.