My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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  • tim@emorningcoffee.com

Week ended Oct 7 2022

Bad news/good markets – good news/bad markets


“There was no evidence of mass layoffs, but hiring managers were in no rush to fill open positions — a shift in sentiment from the all-points bulletin for qualified candidates at most companies during the last two years.”ISM’s “Report on Business Roundup, September Manufacturing PMI”, Oct 3, 2022


[SKIP THE COMMENTARY AND GO STRAIGHT TO THE TABLES]


SUMMARY

The horrible month of September gave way to a flying start in October, as the first two days of the month (and final quarter) started with a bang – the S&P 500 was up 5.7% in just those two days. Perhaps this was short covering or just the signs of an oversold market although weak US economic data early in the week, including the ISM manufacturing report on Monday (see quote above) brought the narrative of a potential Fed pivot back to the forefront, cheering investors. However, the speeches and interviews being given by various Fed governors and regional presidents throughout the week remained right on script, as they reminded investors over and over again that inflation would be contained and that the cost would be some economic pain. Investors chose to ignore these messages, at least for the first two days of the week, although then reality seemed to creep back in as subsequent data releases showed ongoing US economic resiliency. The icing on the cake came Friday when a stronger-than-expected jobs report for September was released, sending US Treasury yields higher and stocks sharply lower as the week ended.


The good news is that in spite of Friday’s sell-off, equity markets ended in the green for the week (noting that Chinese equity markets were closed all week for Golden Week). The theme of bad economic news leading to hopes of a Fed pivot, which then spurs a rally in risk markets, seems so very flimsy to me. The Fed is likely to remain hawkish until its tighter monetary policies translate into significant progress in the fight against inflation. How investors can forget this from time to time is mystifying, especially since we are staring straight into the face of slowing corporate earnings and weakening credit profiles for companies. The good economic news on Friday with respect to the US jobs report was another reminder of how long the fight to tame inflation might last, although at the same time, it painted a picture of a strong US jobs market in spite of the various headwinds.


Across the pond in the UK, the dramatic move by the Bank of England to purchase long-dated Gilts seems to have settled markets for the time being, whilst Prime Minister Liz Truss has used this time to back off some of the tax cuts proposed by Kwasi Kwarteng. Still, the outlook remains rather bleak in old Blighty. Across the Channel, energy continues to be the focus on the continent with winter approaching, and all sorts of complications and uncertainties remain involving access to and cost of gas as the Ukraine–Russia war continues. Nevertheless, the ECB remains steadfast in its objective of curbing inflation, singing from the same hymn book as the Fed in its attempt to tamp down spiralling inflation. I suppose if there is any good news, it’s that the labour markets in the US, the UK and Europe remain relatively tight, giving the hawkish central banks in each economy some more leeway than otherwise as far as tightening monetary policy. Even so, I just can’t ignore all of the warning signs ahead:

  • ongoing and persistent high inflation in the US and most other developed economies,

  • Fed tightening via higher interest rates, quantitative tightening and increasingly hawkish rhetoric as it tries to rein in stubbornly high inflation,

  • bubble-like valuations in equities, real estate and other risk assets, which are slowly deflating but have room to go further,

  • higher mortgage rates in the US (and UK), which are starting to have a material effect on real estate transactions and prices,

  • a strengthening US Dollar which means the US is effectively exporting inflation, exacerbating issues especially in other Dollar-linked economies (and hurting US multinational companies),

  • the ongoing war in Ukraine which is contributing to supply-chain disruptions and high energy prices, and is heightening geopolitical risk across the board,

  • a slowing Chinese economy, the world’s second largest,

  • OPEC+ agreeing to curtail oil supply by 2m bbls/day (see here) in order to firm prices, further jeopardising global economic growth (and angering the Biden Administration), and

  • concerns about upcoming third quarter earnings which start in earnest in mid-October for S&P 500 companies; early indicators from some well-known US companies like FedEx, Apple, Nike and now AMD have been far from encouraging.

Of all of these issues, it is probably the last one that is bothering me the most. Second quarter earnings were mixed to say the least, but investors seemed to shake it off. Some of the same culprits that negatively impacted 2Q22 earnings are still around as we approach 3Q22 earnings – supply-chain disruptions, higher energy costs, wage inflation, strong dollar effecting international sales (and leading to a negative translation adjustments), higher interest rates, etc. There are all factors that will put pressure on operating margins and will be a drag on top-line growth. For my bullish readers, please explain to me how it is possible to be constructive at this point? I recognise that markets tend to look forward not backwards, but it seems to me that this confluence of negative factors ­– and especially upcoming earnings – does not suggest that risk markets should be experiencing wild up days like Monday and Tuesday.


MARKETS THIS WEEK

If that commentary didn’t wind you up enough, take a look at the summary table below if you can bear it.

Friday was such a poor day for US equities that it is hard to believe that we were in the green for the week, which shows just how strong equities were on Monday and Tuesday. Intermediate and longer-maturity US Treasuries rallied through mid-week, and then gave it all back plus some, as yields headed higher across the curve. Oil was also very active on the week. The surprise announcement of a decrease of 2m bbls of oil/day by OPEC+ starting in November shocked markets and pushed the price of WTI crude back above $90/bbl (+16.5% WoW). The US Dollar was slightly stronger on the week, a recurring theme unfortunately. Corporate bonds improved on the week, with spread compression in investment grade and high yield occurring, more likely an effect of higher underlying yields than optimism around the asset class. High yield bonds (and loans) in particular remain under the microscope as central banks raise interest rates.


KEY DRIVERS AND WHAT MATTERED THIS WEEK

US ISM manufacturing and services data for September


The Institute for Supply Management (ISM) released its September manufacturing PMI report on Monday (here), indicating that US manufacturing firms were the least robust in their outlook since May 2020. Sub-indictors for employment and new orders were both below 50 (suggesting contraction), and this bad economic news triggered a rally in bonds and equities as investors believed it signalled a sooner-than-anticipated easing by the Federal Reserve. September services PMI, released Wednesday (here), painted a more robust picture of the servicing sector (than manufacturing), with all sub-components beating consensus expectations. The data suggests that whilst US manufacturing might be slowing gradually, the US services sector remains strong. This news led to a more muted response from investors, halting the two day rally as investors backed off the “Fed will pivot” narrative and reality set back in.


US jobless report


The Bureau of Labor Statistics jobs report for September was released on Friday (here), which was better than expected. New nonfarm payroll employment increased by 263,000 in September (vs consensus expectations of 250,000) and was down from the August figure of 317,000 new jobs. Unemployment fell to 3.5% (vs consensus expectations of flat), the lowest in 50 years and a slight decrease from the August figure of 3.7%. Investors interpreted this to mean overall that the US jobs market remains robust, so the Fed – as stated over and over throughout the week by various Fed officials – will stay the course in terms of its objective of reducing inflation.


US earnings: AMD warns, Levi beats


AMD released preliminary 3Q22 revenues (here) on Thursday, indicating that sales would be around $1 bln lower than it had expected for the quarter. Similar to warnings from Intel and Nvidia, the cause of slower-than-expected sales of PC chips is waning demand for PCs as demand continues to come off its pandemic highs. The shares got hammered in the after-market and the following day, down nearly 8% WoW. Levi Strauss released its earnings for the 3Q22 ended Aug 29, 2022 (here), which were a beat on the top and bottom lines, even though 3Q22 EPS was down from 3Q21 EPS. The company re-affirmed its full-year guidance although it did mention issues with supply-chains, a common theme today. The stock was down 2.7% WoW, with the faltering market on Friday dragging shares lower. These early indicators provide a mixed picture of 3Q22 earnings, which kick-off at the end of the coming week.


WHAT’S NEXT?


Below are some of the key data releases and other financial events that matter for the weeks ahead.

  • S&P 500 earnings – most initial focus to be on banks which begin reporting 3Q22 earnings on Friday, Oct 14th(JPM, MS, WFS, CITI) (BoA on Oct 17th and GS on Oct 18th)

  • Mid-term elections are approaching in the US, slated for Nov 8th. According to The Economist, at this point Democrats are expected to keep their majority in the Senate but lose their majority in the House. In total, all 435 seats in the House of Representatives are open, 35 seats (of 100) in the Senate will be contested, and 36 state governorships will be decided.

  • Most of the economic data that matters this week in the US will be towards the end of the week, including the much-watched CPI for September to be released Thursday (Oct 13) before the market opens. Consensus is 8.1% (down from 8.3% in August), and core 6.5% (up from 6.3% in August). We also get retail sales data and the Michigan consumer sentiment index on Friday. The minutes from the last FOMC meeting will be released Wednesday. In the UK, unemployment data for August will be the focus, with the release on Tuesday. Consensus expectations are that unemployment for the UK will remain flat at 3.6% in August.

  • Upcoming central bank meetings (and last one of year):

  • ECB – Oct 27th (next and Dec 15th)

  • Federal Reserve – Nov 1-2 (next Dec 13-14)

  • Bank of England – Nov 3rd (next Dec 15th)

  • Bank of Japan – Oct 27-28 (next Dec 19-20)

THE TABLES

Global equities


US equities


US Treasuries


Corporate bonds (credit)



Safe haven and other assets


_________________


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