Equities finished lower for the third straight week, despite a rally on Friday, with the S&P 500 falling 0.30% for the week. Technology, health care and consumer staples were the strongest-performing sectors, while energy, financials and industrials were the weakest. Growth concerns dominated the headlines for the week, following a 10-year low for the September ISM manufacturing index and a three-year low for the ISM non-manufacturing index. The September employment report that highlighted a relatively solid labor market provided some reprieve on Friday.
Weekly top themes
1. The ISM manufacturing index surprised substantially on the downside for September, falling 1.3 points to 47.8 and marking its lowest level since June 2009. The index has now fallen steadily in each of the past six months. However, September’s reading diverged somewhat from other important manufacturing indicators this month, giving the economy some hope.
2. The ISM non-manufacturing index was lower than expected, falling from 56.4 to 52.6 in September to its lowest level in three years.
3. The 136,000 new jobs created last month were slightly below expectations, but the July and August payroll figures were revised upward substantially. Notably, the unemployment rate fell to 3.5%, the lowest since 1969. Labor costs remain historically tame, with average hourly earnings up 2.9% year-over-year versus August’s increase of 3.2%, which should keep inflation in check.
4. Housing demand in the U.S. has accelerated meaningfully, spurred by the substantial decline in mortgage rates, which reached a three-year low. The U.S. economy has never entered a recession with housing market activity on an improving trajectory.
5. We still don’t think a recession is imminent. Mediocre growth is the safest bet, thanks to solid consumer spending and enormous fiscal and monetary stimulus. But a perfect storm of negativity looms with the ongoing GM strike, continued trade uncertainty, higher energy prices, the threat of a European recession, a messy Brexit and more.
6. Global manufacturing PMIs weakened to their lowest levels since post credit crisis, led by further weakness in the U.S. ISM and European PMI. While monetary easing is gaining momentum, its effects are still being countered by lingering trade uncertainty. As a result, we expect global growth to remain weak, with monetary easing helping to drive a modest recovery beyond current measures.
7. Markets will be focused on upcoming high-level trade talks between U.S. and China. Despite a recent decrease in tensions, there is no reported progress on resolving key structural issues around removing existing tariffs. For now, the best-case scenario seems to be an interim deal that would revolve around China’s increased purchases of U.S. agricultural products in exchange for a delay in a tariff rate increase.
Lack of positive economic data and progress on trade weigh on stocks
Better economic data and meaningful progress on trade negotiations are needed for stocks to move sustainably higher. Until that happens, risk assets could be under pressure. Global financial conditions have eased significantly over the last several months, thanks in part to the dovish pivot by most central banks.
Whether weakness in the manufacturing sector will spread to the much larger services sector is still in question, but deceleration in service-sector activity has been limited thus far. This is a key difference from the 2001-2002 and 2008-2009 periods, when service sector activity collapsed in lock step with manufacturing activity.
The depressed manufacturing and trade activity may improve modestly, supporting risk assets. Yet the political landscape has become more problematic, especially following the start of a presidential impeachment inquiry by the U.S. House of Representatives. Next year’s U.S. elections already represented a risk to markets because of the uncertain outcome and the sharply contrasting policy objectives of the two parties.
The economic toll from the U.S./China trade war is still rising, with other trade tensions escalating. A possible hard Brexit, unrest in Hong Kong and the recent attacks on Saudi oil facilities reinforce the threat of significant negative political shocks. Until recently, key equity benchmarks, including the S &P 500, had been resilient despite disappointing earnings.
We retain our moderately upbeat outlook for the global economy, but heightened uncertainty mitigates our current appetite for risk. We do not rule out another move higher for equities and other pro-growth assets, but don’t we see it becoming sustainable. Accordingly, we maintain our neutral stance on equities.
Robert Doll is chief equity strategist and senior portfolio manager at Nuveen.