It isn’t ever a good sign when markets become manic. August was quite volatile with five days out of 22 (23%) where the S&P 500 intra-day market swings exceeded 2%, and three days when the market closed down more than -2.5% from the prior day’s close. (We haven’t seen such price volatility since 2011!) While, so far, September has been less volatile, the market is still susceptible to tweets. For example, news about the resumption of trade talks with China set it on an uptrend the week after Labor Day, and markets also now hang on nearly every Jay Powell utterance, including the latest one indicating that the Fed doesn’t see a recession. (They NEVER EVER have; imagine market reaction if they said they saw one!)
Bonds Have More Fun
But, even after all of the bullish sentiment we’ve heard for the past 18 months, the S&P 500 closed Friday, September 6th only 3.6% higher than it was in late January 2018. Bonds, on the other hand, have had much better returns over that time period. For example, bonds of intermediate duration (6-7 years) returned nearly 10% over the same time frame.
Bonds Not Immune
Speaking of bonds, the fixed income market is also susceptible to volatility, with yields across the entire yield spectrum backing up nearly 20 basis points (0.2 percentage points) between September 5th, the day of the trade talk announcement, and September 9th (3 business days). That kind of movement is a three standard deviation event. Over the past year, we have seen a steady downward movement in interest rates. And they became more intense over the past couple of months. Negative yields in Europe make U.S. interest rates attractive.
The week after Labor Day saw some $72 billion of investment grade corporate debt come to market (a record) in the U.S. and about double that amount worldwide ($140 billion). With such a surge in supply, the price of the bonds naturally fell (i.e., their interest rates rose). But, as discussed below, the downward pressure on rates is likely not over.
Historically, September is the worst month of the year for the equity markets. But, this year, the first few days have been positive, with the S&P actually up nearly 1.8%. There was a good deal of positive news, especially on the political front:
The Employment Report- “Just Right!”
Friday’s potential market moving employment report turned out to be a yawner. It wasn’t strong enough to cause the Fed to hold the Fed Fund rate where it is, but not weak enough to cause Recession worries to upset markets. It appears, Goldilocks-like, to have been “not too hot, not too cold – just right!” Since the number seemed to satisfy everyone (+130k net new jobs), few looked beyond the headline, and even fewer seemed to care. As a result, markets see a 95% probability that the Fed eases the Fed Funds rate by 25 basis points at its September 17-18 meetings. Here is the quick and dirty that few have discussed:
- There was a 20k reduction in the number of net new jobs for July and June combined, and likely some in earlier months that BLS won’t discuss until next January;
- There were 34k net new government jobs, 25k of which were from census hiring;
- The Birth/Death model magically added 93k jobs (65k after seasonal adjustment). The Birth/Death model is a mathematical algorithm that plugs in a number for the small business sector because BLS does not survey that sector. At economic turning points, the use of the model distorts the actual surveyed results. There is some recognition of this at BLS as they recently reduced the number of net new jobs in 2018 by more than 500k. But they still use the algorithm. Just looking at the detail of the model for August, a number of these plugged-in jobs were in the retail sector (7k). This makes little sense since the counted number in the actual survey was an -11k reduction in retail employment;
- Transports, a key barometer of economic activity, showed significant job losses (trucking: -4.5k and railroads: -0.6k (railroad employment is down seven months in a row and employment has fallen -10.7k over that period). (Note: The transports deliver goods, a major component of the GDP.)
Adjusting for all of this indicates that the actually counted net new jobs in the private sector was less than 25k higher than that originally reported in July.
On the positive side, the Unemployment rate (U3) held steady at 3.7% despite a rise in the labor force participation rate (more people looking). Another positive was that wages rose +0.4% (and +0.5% for production and non-supervisory workers), and the workweek, itself, expanded +0.1 hours. Partially offsetting this was a reduction in overtime to a 28-month low, a fall in the voluntary quit rate (a sign of worker caution), and a rise in the U6 unemployment rate from 7.0% to 7.2%, as those working “part-time for economic reasons” (i.e., can’t find full time employment) rose a whopping 397k, up 10% for the month. In the Challenger Gray & Christmas Survey (an outplacement employment service company), job loss announcements (tech, transportation, RE, construction) were 39% higher than the same week in 2018.
All in, there was something in the report that fed every point of view. Not too hot, not too cold!
- The ISM Manufacturing index tanked to 49.1 in August (contraction) from 51.2 in July with the key sub-indexes of New Orders (47.2 vs. 50.8), Production (49.5 vs. 50.8), and Employment (47.4 vs. 51.7) all showing contraction. Given what we see in the rest of the world, especially the EU (German IP, for example, is down -4.2% vs. a year earlier), there is little doubt that manufacturing has already entered a recession;
- On the other hand, ISM’s Non-Manufacturing Index rose to 56.4 in August from 53.7, quite the increase. But, a closer look reveals that inventories rose to the highest levels in six years, a key reason for the index’s rise. Either businesses see growing future demand, or they were just stockpiling to beat tariff charges (which do you think?). In the report, backlogs fell, a signal of weakness ahead;
- Mortgage purchase applications continue to fall despite rapidly falling mortgage rates. This can’t be good for the housing sector. Refi applications, however, are way up. So, it is likely that consumption is being supported by the cash-out refis, like they were in the housing bubble (the home, once again, acting like an ATM). Maybe that is why auto sales jumped to 17.0 million units (SAAR) in August from 16.8 in July (could be discount pricing too);
- The University of Michigan’s August Consumer Sentiment Index also tanked to 89.8 (vs. July’s 98.4). One doesn’t normally see such big changes in these surveys. Overall, expectations fell 10.6 points and was negative for every sex, age, income region and education level, a very rare occurrence’
- Finally, both the Atlanta and New York Fed models now place Q3 GDP near 1.5%. That’s awfully close to stall speed!
The GDP in the EU for Q2 was lowered to +0.2% (Q/Q) from +0.4%. Economic slowdowns like this are key, because, beginning the week of September 9th, there will be a string of major central bank meetings, all of which are expected to show moves toward more monetary ease:
- September 12: The ECB has promised they will move significantly toward ease, with some analysts suggesting “helicopter money;”
- September 18: The Fed is expected to ease 25 basis points, especially given the latest jobs report. Some say this is too little, too late; and FOMC members are still divided over whether ease is actually needed. This division remains despite great protestations from the bond market where all market driven Treasury rates over the whole yield universe are significantly below Fed Funds -and yes, even after the expected 25 basis point reduction;
- September 19: The Bank of England is expected to augment its QE program, especially given the uncertainty surrounding Brexit;
- September 19: The Bank of Japan is certain to keep the pedal to the metal.
In the face of this expected onslaught of central bank easing, the yield curve is likely to resume its recent descent. At the same time, until the U.S. consumption numbers weaken, which appear likely given the business data, the idea that a recession is a significant possibility will continue to be a controversial topic.
Robert Barone, Ph.D. is a Georgetown educated economist. He is a financial advisor at Four Star Wealth Advisors. www.fourstarwealth.com. He is nationally known for his writings and Robert’s storied career includes his having served as a Professor of Finance, a community bank CEO, and a Director and Chairman of the Federal Home Loan Bank of San Francisco. Robert is currently a Director of CSAA Insurance Company (the AAA brand) where he chairs the Finance and Investment Committee. Robert is the co-portfolio manager of the UVA Unconstrained Medium-Term Fixed Income ETF (FFIU).