Key Points

  • After August’s all-time highs followed by a stall, stocks were once again jolted into action by mixed messages from the Federal Reserve (Fed). We continue to believe the bull market is intact but near term risks are elevated.
  • Economic data continues to have a groundhog day quality to it—perking up some before then pulling back again. The attendant movement between tighter and looser financial conditions has caused the Fed to also ping pong between dovish and hawkish rhetoric.
  • The Fed isn’t the only game in town and other global central banks have added to uncertainty, with many catalysts this fall potentially adding to the monetary mashup.

Complacency no more

Some complacency had set in along with the low-volatility summer rally, but Fed policy uncertainty yet again shook the market out of its slumber. The S&P 500 didn’t decline more than 1% for 52 consecutive trading sessions, before last Friday’s 2.5% decline (for more see Liz Ann’s article Is That All). Volatility spiked in the ensuing week, largely fueled by a renewed uncertainty regarding global central bank policy, rising U.S. and global bond yields, and exacerbated by valuation concerns.

We remain relatively optimistic that the long bull market in stocks can continue, but have been consistent in our view that risks for a pick-up in volatility and more frequent pullbacks remain elevated. As a result, we maintain our neutral view on U.S. equities and urge investors to remain vigilant and stick to their long-term asset allocations—using volatility to tactically rebalance around strategic allocations.

Frustration building?

Patience can be difficult in this environment where we seem to be on an economic version of the classic movie “Groundhog Day.” Economic data appeared to be perking up in June and July, with better readings on durable goods orders, housing data, industrial production, and railcar loadings according to ISI Evercore Research. And while the economy still appears to be growing, the recent round of data has thrown some cold water on the hopes for a sustainable uptick in growth. The recent soft patch has become a pattern—with dips in growth having been experienced in every year since the recession ended over seven years ago. Manufacturing continues to struggle with the Institute for Supply Management’s (ISM) Manufacturing Index moving back into territory depicting contraction (below 50) at 49.4. Even more disappointing was the sharp drop in the new orders component (a key leading indicator) from 56.9 to 49.1. We believe that this weakness was exaggerated by the “August” effect when worldwide activity seemed to come to a standstill, but the trend bears close scrutiny. Also discouraging was the ISM Non-Manufacturing (services) Index falling by a larger-than-expected 4.1 points, although still on the expansion side of 50, while the new order component also fell precipitously.

Manufacturing still appears to be spinning its wheels

Source: FactSet, Institute for Supply Management. As of Sept. 13, 2016.

While the service side also seemed to hit a speed bump

Source: FactSet, Institute for Supply Management. As of Sept. 13, 2016.

The labor market still looks healthy, but the rate of improvement appears to be slowing. This should be expected as a tighter labor market means there are fewer qualified workers to fill open positions—which according to the July JOLTS report (Job Openings and Labor Turnover Survey) hit a record high. The tighter labor market has yet to generate a sustainable improvement in wage growth, with average hourly earnings (AHE) declining in August to 2.4% from 2.6% year-over-year. However, the mix shift of workers entering and exiting the workforce may be biasing this growth rate down. That is why an alternate measure of wage growth put out by the Atlanta Fed (via its “Wage Tracker”)—accounting for mix shift calculation problems—shows wage growth of a full percentage point higher than AHE.

There was also recently some very good news on the personal income front. This week the U.S. Census reported that median incomes rose from $53,718 to $56,516—the largest arithmetic and percentage increase in the history of the data back to 1967. While real median incomes are still below their 2007 peak of $57,423, the spiking income growth is being driven most by the bottom two deciles of the income distribution, which is good news in terms of income inequality.