The early summer pickup in economic activity appears to have waned throughout September with softness in the housing market the primary culprit.
As the third quarter comes to a close, the US economy appears to be crawling along at a subpar, albeit positive, rate of growth.
It’s likely the Federal Reserve took this into consideration in deciding to hold off raising interest rates at their September meeting. Currently, the futures market is pricing in just a 17% chance for a rate hike in November and a 57% chance for a quarter-point hike in December.
We continue to think December is the likely month for the FOMC to take the Fed Funds rate back above 50 bps as employment remains near it’s lower bound while inflation, particularly wage inflation appears to be picking up.
As mentioned above, housing is showing signs of weakening despite the paucity of newly built homes in many parts of the country.
The latest reading on Pending Home Sales showed a decline of -2.2% YoY while Housing Starts fell -5.8% MoM and Building Permits came in -0.4% lower than the prior month.
Despite spectacular summer weather in many parts of the country, Existing Home Sales declined -0.9% in August while New Home Sales fell -7.6% MoM.
This weakness is contributing to some of the pullback we’ve seen in the Materials and Consumer spaces over the summer. With an Unemployment Rate of +4.9%, any further gains will likely come at the expense of employee wages, which are already starting to tick higher.
Average Hourly Earnings were up +0.1% MoM in August and are up +2.4% YoY, contributing to some of the decline in corporate profit margins that we’ve seen in 2016.
Unit Labor Costs for the 2nd quarter rose +4.3%, nearly double economist’s estimates for a rise of +2.1%. The latest JOLTS number (Job Openings and Labor Turnover Survey) came in at a 10+ year higher, indicating a growing demand for labor.
With the limits of monetary policy having been reached, it will be up to Congress to enact sufficient fiscal stimulus to take the US economy higher and GDP growth back over 3.0%. Both candidates for President have announced intentions for large scale infrastructure spending, which is sorely needed here in the US.
Let’s all hope that whichever candidates prevails remains true to their word, instead of offering us all another empty promise
Domestic Equity
U.S. equities were mixed on the month, as investors grappled with global interest rates, muddling domestic and international economic growth, and the uncertainties surrounding the U.S. presidential election next month. Large-Cap stocks, as measured by the S&P 500, rose +0.02% during the month.
Small-Caps outperformed both Large- and Mid-Caps by +62 bps and +128 bps, respectively.
Small-Caps, which have returned +7.2% during the quarter, continue to outperform their larger counterparts. Growth stocks, as measured by the S&P 500/Citi Growth Index, returned +0.4%, bringing the year to date performance of the index to +9.36%. Value stocks reversed last month’s trend, underperforming Growth stocks by -77 bps.
Although Value has underperformed Growth over the last quarter, Value remains in leadership on the year by almost 300 bps of outperformance.
Most domestic equities look expensive compared to their historical averages, especially with the S&P 500 trading at 20.4x trailing earnings compared to its 10-year average of 16.6x. Growth stocks appear to be the most expensive compared to averages, trading at 23.4x trailing earnings while its 10-year average of only 17.4x.
From a sector standpoint, Energy and Information Technology led the pack, returning +3.08% and +2.44% on the month, respectively.
Energy companies benefited from the sharp increase in oil prices from the end of August, as OPEC stated it would cut its oil output to between 32.5 million barrels per day and 33.0 million barrels per day from upwards of 33.5 million barrels per day.
The Tech sector was the best performing sector over the past quarter, returning +12.86%, and outperforming the S&P 500 by over 900 bps.
Information Technology’s 21% weight in the S&P 500 helped keep the index positive in the month. While Financials are the second best performer on the quarter, the sector lagged all others this month, falling -2.72%.
Headlines, such as Wells Fargo’s fraudulent opening of accounts and the postponement of an interest rate hike both hurt the sector’s performance.
Defensive sectors, such as Consumer Staples, Utilities, and Telecoms, lost much of the allure they had in the beginning of the year, with the sectors falling -2.63%, -5.91%, and -5.60% QoQ.