Investors uncertain as economic and earnings headwinds emerge

Thoughts

• Equity markets have entered a volatile zig-zag pattern, with increased scrutiny over the health of the economy and earnings environment balanced against the continued tendency to buy the dip. Volatility has been notable, with last Tuesday being the weakest session since May and Thursday the best day since July, but the S&P 500® Index finishing the week modestly higher. September is heading for the first losing month since January, which is consistent with the seasonal pattern that saw September as the worst month of the year since 1950.
• Interest rates have spiked following an FOMC meeting last week that paved the way for a shift in Fed policy. The 10-year Treasury yield surged to the highest level since June at 1.50% and the yield curve is at the steepest level in nearly three months. A curve steepening driven by higher long-term rates is referred to as a “bear steepener” because it often happens when inflation expectations pick up and investors anticipate Fed rate hikes. Credit spreads remain tight and liquidity is robust, so the overall market remains supportive. Fed Chair Powell testifies in front of Congress this week, with all eyes on hints at timing of the taper and Fed Funds rate hikes. Commodity prices are surging, with crude above $75 for the first time since 2014 and natural gas up 116% this year.
• Equity markets have been buoyed by stock buybacks and investors’ “buy-the-dip” instinct amid rising volatility. But both of those supports will be challenged over the next few weeks as we enter third quarter quiet periods and seeds of doubt continue to chip away at bulls’ confidence.

News

• A busy week for Washington D.C. awaits, as Congress faces the expiration of government spending authority Thursday. A short-term spending fix is expected to fail in the Senate due to a GOP filibuster, as they do not want it tied to the debt ceiling increase. A “clean” continuing resolution that funds the government but does not address the debt ceiling is likely to pass. House Speaker Pelosi is scheduling a vote on the $1.2 trillion infrastructure deal despite progressives’ push for it to be paired with the broader domestic spending bill. Democrats are confident they have the votes, but the price tag will need to come down from $3.5 trillion. The debt ceiling increase will likely be added to the reconciliation bill, but there are questions on if there is enough time.
• Supply chain issues continue to plague global shipping lanes, with worker shortages at ports forcing companies to work at two-thirds capacity. A record 62 container ships are waiting at L.A. and Long Beach, double the level from six weeks ago. Asian factories remain at limited output due to COVID-19 outbreaks, while China now faces power shortages that will further limit manufacturing and industrial activity. Apple and Tesla, for example, have halted production in some factories to comply with Beijing’s tighter consumption rules. Several chip makers have received notes to stop production, further complicating the global chip shortage.
• Expectations for economic growth are moderating with the third quarter in reaction to COVID-19 fears and the continued supply chain issues. The recovery in high frequency data points, including time away from home, has stalled, down roughly 5% from pre-pandemic levels. The Atlanta Fed’s GDPNow model projects third quarter growth at 3.7%, down from 6.1% in August and compared with 6.6% in the second quarter. Expectations for earnings growth are also moderating, with the consensus estimate for the third quarter ticking down in September for the first time this year.

What to Watch

• This week provides a broad view into the economy, including durable goods on Monday, consumer confidence on Tuesday, pending home sales on Wednesday, revised second-quarter GDP on Thursday, and PCE deflator, personal income and spending, and consumer sentiment on Friday. Volatility could remain elevated as institutional investors position around quarter-end.