Issue 101: Last Week’s Risk-Off

This Week’s Highlights

• How to read last week’s equity selloff
  It was a dismal week for those long US stocks, with recession fears leading all three major indices lower—including shares in most sectors, as well as small-cap stocks. Friday’s jobs data from the BLS didn’t help, indicating a continued cooling in new private payrolls.
• Parsing August’s report on US PMI
  Data out on Tuesday from the Institute of Supply Management in the form of its well-known Purchasing Managers Index (PMI) showed US services holding up, manufacturing continuing to struggle, and manufacturers’ prices paid inching up as shipping costs climb.
• Hard landing sentiment hits energy
  Energy commodities proved to be just as bad as equities last week, with oil traders seeming to bake in the same fears of a global downturn. Amidst such gloom, neither OPEC+ members’ talk of production cuts nor a surprising decline in inventories could bail crude out.

The CIO’s Take:

• We try to keep an even keel amidst alternating waves of greed and fear, with the latter definitely prevailing over last week’s stock trading. It’s understandable that data on a cooling US economy have stoked investors’ fears, though we see such concerns as overblown, with liquidity conditions improving and a recession unlikely at present.
• It wasn’t just mixed jobs data prompting bears to panic last week. August PMI showed manufacturing remains in the doldrums, while input prices are back on the rise: stagflationary trends. Such data didn’t scare us; rather we see the stage increasingly set for a 25-bps September cut, a quarter-point short of what some doves still expect.
• We are overweight commodities in our models partly because we expect a likely soft landing would lead to a rally in things like energy and industrial metals. Concerns demand could turn down have worked against that trade, though last week’s data on August-end crude inventories suggests to us supply is tighter than some might appreciate.

Last Week’s Risk-Off

Equities had a bad week
Last Friday, a day on which the S&P 500 fell by 1.7% and the NASDAQ slumped 2.6%, capped off the worst week of the year for US stocks, seeing those markets off by 4.3% and 5.8%, respectively, since trading reopened after the Labor Day break. In fact, US equities put in their worst performance last week since January 2022. Nvidia’s Tuesday loss didn’t help matters: the chipmaker’s 9.5% single-day decline translated to a drop in market cap of $279 billion, marking the largest-ever daily decrease in a company’s size. So, what was to blame for equity markets’ woes?

Many sectors, small caps hit
The broad-based nature of declines offers a clue, because it wasn’t just semiconductor stocks falling; tech stocks in the S&P 500 dropped by just over 7%, but Energy stocks were down 5.6%, Industrials lost 4.3%, and Consumer Discretionary stocks were off by 2.8% for the week. Small-cap stocks saw similarly dismal performance, with the Russell 2000 Index slipping 5.7%. Seeing stocks with exposure across the economy on the retreat underscores investor’s concern that September cuts by the Fed are already too late and the US is headed for a hard landing.

Recession fears are rising
In our last edition of Perspectives, we commented on macro data pouring in as we approach the final FOMC meeting of the third quarter, with plenty for traders to parse in the past week. Looking at the data, it’s easy to see why hard-landing bears might have their way. Back in August, we looked at the so-called ‘Sahm Rule’, an indicator based on unemployment sounding the recession alarm. But it’s not just unemployment: a composite of many leading indicators tracked by the Conference Board, in decline since 2022 (see below), is down to levels not seen since COVID hit in 2020.

There’s a glass-half-full take on the data above: while July marked a fifth consecutive monthly fall in the Leading Indicators Index—after February’s positive reading stopped a two-year streak in declines—the six-month annual growth rate has actually improved (i.e., become less negative) to the point the Conference Board no longer sees data as signaling an impending recession.

BLS data spooked markets
Investors will nevertheless reserve the right to sweat developments in each component leading indicator, accounting for some of the volatility witnessed in recent weeks. One item underlying the Conference Board’s composite, for example, is S&P 500 performance, which has clearly taken an unfortunate turn of late. Another is US jobless claims. Last Friday brought a new reading on that component, with the final week of August clocking in at 227K unemployment claims, slightly better than the consensus estimate of 230K and a seven-week low for the stat.

How loose is the labor market?
Friday’s jobs report turns out to perfectly illustrate the kind of mixed data that’s caused investors frustration, as the somewhat positive jobless claims contrasted with a drop in job openings and August growth in private payrolls marking the weakest tally since January 2021. Our take—which jibes with the Conference Board chart above—is that there are signs of weakness in the US economy, but we’re coming off a very high base. That’s why we’re more sanguine on the prospects for a soft landing and expect the Fed feels similarly.

August ISM Data

Concern over Manufacturing PMI
Jobs data wasn’t the only thing throwing investors for a loop last week. Another component of the Conference Board’s Leading Indicators index, Institute of Supply Management (ISM) data on manufacturers’ new orders, came out for the month of August last Tuesday, showing a decline to 44.6 from July’s reading of 47.4, its third straight drop. Output also fell, with production declining from 45.9 to 44.8, marking its lowest level since May 2020, when the pandemic was in full swing. The overall ISM Manufacturing PMI came in at 47.2 for August, its fifth month in contraction (see below).

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Services sector looks brighter
Manufacturing has been weak since late 2022, with only this year’s March reading exceeding 50. But going back to the theme of mixed data, it’s worth noting that manufacturing represents only around one-tenth of the US economy, while services, by far a much bigger contributor, have been doing much better. That was the case in August, which saw a modest rise in the ISM Services PMI from 51.4 to 51.5, indicating some growth. On the services side, new orders also rose from 52.4 to 53. Even services employment rose in August, coming in at 50.2.

PMI impact on monetary policy?
From the Fed’s perspective, weak manufacturing would definitely suggest rate cuts, though one of the most consequential sub-indices for central bank policy could be ‘prices paid’, which gives an indication as to how inflation might be moving in coming months. Manufacturers’ prices paid rose from 52.9 in July to 54 in August, while prices paid within the services sector increased from 57 to 57.3. Part of the former increase could be higher freight rates. Overall, we see all of this data as again consistent with a measured quarter-point cut from the Fed this month.

Checking In On Energy

Oil’s been taking a beating
We alluded to a drop in energy stocks last week, but commodity prices in the sector have been on the decline for some time now, likewise reflecting concerns that a soft landing won’t materialize and global energy demand will significantly soften. Even before last Friday’s jobs report, Brent crude was off almost 8% for the week, but the market’s pessimistic take on nonfarm payrolls sent oil priced down another 2%. Poor macro data out of China is obviously another major headwind on the demand side, and there has been no relief on that front in recent weeks.

Considering the supply side
On the other hand, demand is only part of what determines prices. What about energy supply? One of the things we’ve pointed to time and again is the part producers play in supporting oil prices through supply cuts. Along those lines, as prices have slumped, recent conversation among countries in the OPEC+ group has centered on halting or even reversing pre-planned October and November production hikes. The muted impact of these developments suggests to us negative sentiment around hard landing fears is dominant in traders’ minds at the moment.

Surprise inventory drawdown
More data on supply, inventory data released last week by two industry groups, pointed in the same direction as OPEC+ chatter. On Wednesday, the American Petroleum Institute reported that US crude inventories fell by 7.4 million barrels in the last week of August, exceeding forecasts of a 1 million barrel decline. The US Energy Information Administration (EIA) said on Thursday that it estimated inventories fell by 6.9 million barrels, way more than the 1.1 million barrels analysts had expected, continuing a trend of draws on oil stocks (see below).

Given our view that a soft landing is more likely than not, it won’t surprise readers that we are relatively bullish on energy—one of the reasons we’ve kept a healthy exposure to commodities in our models. The fact that major oil producing states intervene to manage supply and stabilize prices provides a potential backstop.