Solitude

It was the worst week for the markets since the 2023 banking crisis as investors worried about the outlook for growth. September is often a difficult month anyway, but this year featured the poorest start to September since 1953 (!). Market participation is more broadly based than you’d expect to see in a market top, so the volatility witnessed lately may augur further rotation away from mega cap growth and into value. The selloff may be due to further unwinding of the yen carry trade. Commodities have struggled mightily of late as well, with oil falling nearly 4% on Tuesday and down 20% since early July. Is the recessionary pricing in bonds and commodities a red flag about growth or just a big market participant getting squeezed? Yardeni argues for the latter. There are causes for optimism. In presidential election years, the S&P 500 usually experiences a pullback in September and October and then rebounds afterwards. The equity put-call ratio closed during the week at about 1.0, a sign of panic that suggests the year’s lows are already in – even if gains only come after the election is settled. Also, the S&P 500 advances versus declines reached a new high in August, a sign that the highs for the year are not yet in place. As for the path ahead – five of the last six rate-cutting cycles have begun with a 50-basis-point cut. Of the seven cycles since 1984, four came amid recession while three were soft landings. Incidentally, mid-caps have been the best performers in the first 12 months after the Fed starts to cut rates. One concern: the dollar has been weak lately, which means that recent losses were especially painful to foreign investors, who hold 17% of the US equity market.

Hiring has slowed, but layoffs are still modest. It has been harder to get a job over the last couple of years because job openings have been declining, perhaps a fallout of labor hoarding. For now, at least, the rising unemployment rate is in large part a matter of an increase in labor supply, likely due to recent years’ surges in immigration. And while productivity growth has been robust, up 2.7% y/y, that may be a bumpy road ahead, as Boomers retire and recent immigrants temporarily face language, housing and other barriers to success. The latest jobs report neither proved nor disproved that a recession is in the cards; activity would have to deteriorate rapidly to indicate a downturn. If unemployment does not spike, the Fed is likely to move more slowly. The next two or three quarters could be critical in that regard, which all depends on earnings. The bear case is top line growth under pressure going forward, as the biggest four-year increase in revenues since the late 1960s ends (the downside of falling inflation). This could drive firms to slash labor and other costs in a bid to maintain profit margins. This dynamic would be compounded if high rates and higher debt balances force consumers to pull back on their borrowing. And yet workers 25-54 are employed at an 80.9% rate, near a record. All good, but while real wages are up 1.5% over the past year, consumer spending has risen 2.7% over that period. How long can this keep going on?

The biggest risk for inflation may be one-party rule in January, since neither party on its own has given any sign of fiscal discipline. The betting markets have Harris and Trump roughly even. Polling guru Nate Silver still puts Trump’s chances at 60%. Given the states with Senate elections this year, it looks at present that the upper chamber will flip Republican, with Montana and West Virginia likely GOP pickups. Unlike the White House and Congress, the Fed is not on the ballot this November. Cuts from the central bank should help the economy grow faster, but that comes with a lag and the risk that inflation reignites. Thanks in part to rising productivity, unit labor costs are up just 0.3% y/y, the lowest since 2013. The CPI report (more below) didn’t interrupt the expectation for a September cut, though many now expect 25 basis points rather than 50, as inflation was just a little hotter than expected. A big piece of that, however, had to do with owners' equivalent rent (OER), a quirky (and weirdly sticky!) statistic of questionable relevance given the big retreat in residential lease prices in recent months. (OER serves as an estimate of what a homeowner would have to pay to rent an equivalent dwelling.) A recent paper from MIT Sloan pointed out that federal spending was the single biggest factor behind the inflation of recent years. If you’re wondering why inflation has been so slow to depart the scene, consider that even now the federal government is due to increase spending 5.8% y/y. Feeling angst? This vociferous lady is just back from my first ever 7-day silent retreat. Invisible, I thought I’d be lonely. Rather, solitude! And ready to get back on that roller coaster!

Positives

• Prices rise a bit but not a lot The August core CPI came in slightly above expectations, rising 0.28% m/m versus 0.2% consensus. The surprise came mainly from airlines, lodging and OER. The first two are seasonal and not especially a concern. OER should (eventually) be okay since real-time rents have been benign. Headline PPI rose 0.2% m/m; ex-food and energy, PPI rose 0.3% m/m. 
• Consumers’ mood brightens The University of Michigan’s consumer sentiment index rose to 69 from 67.9 last month. Inflation expectations diverged, with the one-year measure falling to 2.7% even as the 5-10 year measure increased from 3.0% to 3.1%.
• Not overstretched The last two years or so have seen the largest tightening in the senior loan officer survey of credit standards outside of a recession. Now that standards have been tightened, banks appear ready to start easing. It’s positive for the economy, going forward, that we’ve had strong growth without excessive credit.

Negatives

• Small business woes The NFIB’s small business optimism index dropped 2.5 points in August to 91.2 against expectations that the index would be unchanged at 93.6. For the 32nd month in a row, the index remained below the long-term average of 98. The frequency of reports of positive profit trends came in at -37%, the worst since March 2010 (!). That said, firms with job openings increased to 40%.
• The consumer’s debt burden grows Consumer credit outstanding gained $25.5 billion (versus $10.4 billion expected) to a total of $5.09 trillion in July, the Federal Reserve reported. Revolving credit picked up $10.6 billion, while non-revolving credit rose by $14.8 billion, the most in more than a year.
• Does this imply global recession or something else? China is struggling mightily: real estate sales and prices have been falling for three years now, while stocks are down 58% since 2021. Weak growth in China is hurting the global demand for oil, weighing on bond yields and the dollar. Oil production in the US has been strong, though, even as global consumption falls.

What Else

So, who will win? The misery index, a calculation deriving from the stagflation-plagued 1970s, adds together the rates of unemployment and of inflation. This index has predicted all but one of the last 16 elections, and currently is in Harris’ favor. Strategas calculates that a misery index below 7.35% favors the incumbent, if indeed that is what she is. Right now, it’s below 7%.

Harris, the incumbent? When the S&P 500 rallies over the three months leading into Election Day, the incumbent party has won 12 out of 15 times. The incumbents have lost eight of the nine times that the index has been down over that period. Election Day is November 5; the S&P opened at 5,250 on August 6 …

Looking good, Kamala, however … Trump lost all of his debates against Clinton in 2016 and yet won victory that November. This year, Harris won the debate by acclamation yet it’s not clear she successfully addressed concerns about the Biden economic record or where she stands on the issues. For now, the election is too close for investors to bet significantly on the outcome.