Rates spiked higher yet again, leading to another risk-off day and week. The 10-year Treasury interest rate peaked in mid-June at 3.48% before falling to 2.53% in August. This helped propel a solid run for stocks, led by growth and a Nasdaq return of 24%. Since then, interest rates have spiked higher and stocks resumed their downtrend. Fed speeches noting a strong emphasis on a slowing economy are clear indicators that inflation must be beaten, even if it means more people being unemployed and lower (negative?) GDP. That is not a recipe for cyclical stocks. Inflation must continue to show signs of decelerating if there is any chance the Fed can slow their aggressive actions.
Defensive sectors held their own with fractional gains in Utilities, Consumer Staples and Healthcare sectors. The brunt of selling occurred in Energy, Basic Material and Technology sectors which all dropped more than 3% in yesterday’s session before recouping some losses in the final hours of trading. One may want to hide in defensive stocks during bear markets, but valuations are becoming an issue. Successful investing requires patience and fair entry points, not when stocks are priced 20% above historical valuation means (From the Daily Shot):
Some other relevant news items:
China – Zero Covid and Geopolitics
In yet another sign that this Covid hangover will be with us for a while, China shut down a major electronics and auto component industrial metropolis yesterday. Chengdu, with a population of 21 million people, saw positive Covid cases jump from 8 to 144 over the past few days. Residents in this city, equal to the size of Illinois and Pennsylvania combined, are now locked in their homes. One person can leave a household after a negative test for grocery shopping. All businesses except supermarkets, hospitals and pharmacies are closed. If you saw the videos, it was utter chaos in the markets there yesterday. Shenzhen, another major electronics hub, could be next on the list as Covid cases are rising.
There are numerous other portions of China also closed which will continue to impact the supply of critical technology components still in short supply. On a positive note, we have plenty of TV’s, laptops, toilet paper, apparel and outdoor furniture. The supply shocks are limited to select areas, however many of them are critical, especially for auto manufacturers who still cannot produce enough cars anywhere near 2019 levels.
In other equally concerning China-related news, the U.S. is pressing forward on restricting critical infrastructure availability to the country. This is a clear escalation and a more aggressive approach in hampering China’s Artificial Intelligence capabilities and their expansion of military tech. Nvidia and Advanced Micro Devices confirmed the curbing of sales for numerous, industry leading- and cutting-edge AI chips in China. This could get expanded further, with many negative implications for the semiconductor food chain going forward. Nvidia and AMD closed down 9% and 4%, respectively. Nvidia has lost $100B in market capitalization this week. Stocks in Asia were also taken to the woodshed yesterday.
Jobs, Jobs, Jobs:
The all-important employment and wage inflation report is due out prior to this being written. Expectations are for another 290k jobs added and an unemployment rate holding steady at 3.5%. Equally relevant for inflation watchers will be the average hourly earnings increase, with consensus estimates for a 0.3% rise, or ~4%+ annual wage growth. This will be one of those reports where good news (more jobs, more wage gains) will be taken as a negative and vice versa.
ADP revamped their private employment survey metrics in hopes of having a more precise estimate of true employment. Their release on Wednesday showed a gain of 132k jobs, about half of expectations and a far cry from last month’s 270k job gains. Their economist, Nela Richardson, noted “Our data suggests a recent shift toward a more conservative pace of hiring, possibly as companies try to decipher the economy’s conflicting signals. We could be at an inflection point, from super-charged job gains to something more normal.” This is music to the Fed’s ears. They have a clear focus that inflation cannot be tamed when jobs and raises are so easy to get. Higher interest rates will slow down growth and corporate job postings, but will not help on the available worker supply issues.
A declining labor force is out of anyone’s control at this point. There will be no massive rush of immigration calculations. Excess Covid deaths, aging Baby Boomers and flush savings accounts (people are more apt to retire early if they have the funds) have taken upwards of 2 million workers out of the labor force. Combine this with supply chain snarls and an increased demand for goods and services, and companies become forced to pay up for talent when demand increases. This does not get fixed overnight, but if inflation is to be squashed a bad report on employment satisfies some of the Fed’s goal. Inflation will not get back to ~2% if wages are rising 5%+ and jobs are plentiful. Today’s trading environment will rely upon the 8:30AM release. Throw in a low- volume Friday before a long weekend, and wonky things can happen. Do not let one day’s worth of trading change your long-term thinking.
Third Quarter Earnings (Warning Season):
Not only does September bring an end to the Summer season, it is also the start of the last month in the quarter. Many investor conferences occur as vacations end. So far, this is bringing forth many profit warnings relative to expectations detailed just a month ago. Earnings warnings have run the gamut from sector to sector, but have a general theme: a slowdown is already upon us and CEOs are becoming less confident and more cautious. In certain segments, recessionary conditions are prevalent. For every “demand > supply” industry such as autos, there are numerous others where supplies are too high: apparel, consumer electronics, home good, etc. Pricing power is dropping for many. The question is how much demand destruction does the Fed want to create before recognizing it went too far in creating a spiraling recession? History would say that odds are not in favor of a soft landing, especially considering the rhetoric from Fed officials since their Jackson Hole meeting. Although tightening monetary conditions will impact demand, the Fed cannot control the supply of semiconductor chips, or end China’s lockdowns, defeat Vladimir Putin, drill oil or create more housing supply. Higher interest rates can only do so much.
We are now six days away from the official start of the NFL season. After marrying a woman who bleeds Eagles green (we named our boxers Reggie White and Jerome Brown), tailgating is a built-in family tradition. For those prepping, it will be a lot more expensive this year!
From The Daily Shot:
Keanu Reeves turns 58 today, and Salma Hayek is 56. Steelers legend Terry Bradshaw is now 74. Cirque du Soleil fans will be happy to know that its co-founder Guy Laliberte turns 63 today.
James Vogt, 610-260-2214