Investors should watch for margin pressures as labor negotiations heat up

Thoughts

• The unusual period of calm continues for the equity market, with the S&P 500® Index falling for the fourth time in six weeks, but no week with a move of greater than 3% since March. Since late June, the S&P 500 has seen six winning and six losing streaks as investors are confused about the forward direction of the economy, settling the S&P 500 into a trading range. The “good news is bad news” theme in the market continues, with the Citigroup Economic Surprise Index again over 60, suggesting economic data continues to handily beat estimates. This has not supported equities, in fact, the correlation between economic beats and equities is at the most negative level on record. A wave of data is on the way, including CPI this week, an FOMC meeting next week, and earnings next month.
• While markets have been sluggish since the peak at the end of July, indications are that the pause is a period of consolidation following an impressive year-to-date rally rather than the beginning of a new bear market.  Investors are not acting emotionally, with the VIX below 15 for the past two weeks, and the MOVE Index (the measure of bond market volatility) is approaching the lowest level in 18 months. Other measures of risk and sentiment have settled as well, with credit at tight levels, CNN’s Fear & Greed Index is neutral at 51, and the put/call ratio not reflecting elevated nervousness.
• Labor negotiations are being closely watched by investors, but their focus should be less on the disruption from strikes and more on how these new contracts could significantly increase labor costs, putting significant pressure on margins. Watch for this to be a developing cloud heading into 2024.

News

• Investor concerns about the sustainability of consumer spending are beginning to grow, highlighted by Bloomberg’s latest Markets Live Pulse survey, showing 21% expecting a decline in the fourth quarter and 56% expecting a decline in early 2024. This would be the first negative reading since early in the pandemic. This is despite real wages being positive for three months following a decline for more than two years. The excess savings that consumers accumulated through the early stages of the pandemic (through lack of spending ability and direct checks from the government) will be exhausted this quarter and student loan payments resume in October. Delinquency rates on credit cards and autos are already rising due to stressed budgets from inflation and higher interest rates. This week’s reading on retail sales will be the next data point. Interestingly, while investors’ outlook for consumers continue to deteriorate, JPMorgan data showed that the odds of a recession have fallen to the lowest level since April 2022. The S&P 500 is assigning just 22% odds to recession, down from 98% in October while the market for junk bonds sees a 9% chance.
• The relative lack of economic data has focused investor attention on the looming FOMC meeting that is scheduled for September 20. The Fed Futures curve currently embeds a virtually 100% chance of no move at that meeting and a nearly 50% chance of one additional hike in November. There are roughly four cuts priced in for 2024 beginning in the Spring, though that is unlikely without a substantial decline in economic activity, as Fed officials have stressed patience and a commitment to a 2% inflation goal. New York President Williams said that policy is “in a good place,” relying on upcoming data releases to guide policy. Dallas President is in favor of a “skip” in September, “but skipping does not imply stopping.”
• Labor issues are a growing hurdle for companies, with the UAW threatening to strike unless a contract is settled by next Thursday. The two sides are far apart, with the union asking for a 40+% increase in hourly pay, a 32-hour work week, a return of the traditional pensions, and other items. GM and Ford recently made offers of pay hikes in the low to mid-teens. This comes at a time when a Chevron LNG plant in Australia is shut for a strike and Hollywood actors and writers continue their strike. In total, if 150,000 auto workers strike, the 450,000 total stoppages would be the highest level since 2018 and second highest since 1988 despite continued decreases in union membership. Last month, UPS reached a deal with their 340,000 workers with significant pay increases bringing the average pay and benefits for a full-time driver to $170,000. Cost and availability of labor placed pressure on margins and earnings, and this is likely to continue as real wages have recently turned positive.

What to Watch

• Inflation data will be in focus this week, with CPI on Wednesday and PPI on Thursday. Other notable data include the NFIB Small Business Index on Tuesday, retail sales on Thursday, and industrial production on Friday. There will also be close attention paid to rates ahead of the FOMC meeting of September 20.