Sightline Weekly Market Update: Views from Three Fed Governors on What Lies Ahead
Positive earnings surprises inflated investor sentiment, propelling the S&P 500 Index, the Dow Jones, and the S&P MidCap 400 to record highs. Real estate, utilities, and healthcare stocks led the charge in the S&P 500 with energy stocks taking a breather after recent leadership.
The S&P400, the MidCap 400 jumped 1.77% reaching new highs followed by the S&P 500 gaining 1.64%, TSX increasing 1.49%, Nasdaq advancing 1.29%, with the Russell 2000 gaining 1.13%. Over the past several weeks, investors were sensitive to inflationary pressures, supply chain disruptions and labor markets. This week inflationary worries were overshadowed by companies reporting above-expectation Q3 earnings and revenues.
According to FactSet, to date, 23% of the S&P 500 companies have reported EPS results with 84% beating expectations, exceeding the five-year average of 76%. In aggregate, companies are beating the estimates by 13.4%, which is also above the five-year average, with 75% of the reporting companies recording revenues above estimates in aggregate of 2.2%, also above the five-year average of 1.4%. The energy and financial sectors were the largest contributors to the increase over the last month.1
In other economic data, on Monday, the Federal Reserve reported industrial production declined by 1.3% in September. Manufacturing output decreased by 0.7%, with auto production dropping 7.2% caused by shortages of semiconductors. Other factory output fell by 0.3% with utilities falling 3.6% as the cooling season eased and mining production fell by 2.3%. Even with the September decrease, total industrial production rose 4.3% in the third quarter. Capacity utilization for the industrial sector came in at 75.2%, lower than the long-run average (1972-2020) average by 4.4%. 2
The Census Bureau reported last Tuesday that September housing starts declined by 1.6% to a seasonally adjusted rate of 1.56 million over August. Permits for new house construction dropped from August by 7.7% to an annual rate of 1.59 million. The main driver of the monthly drop in permits was due to a 21% decrease in multifamily housing permitting. In comparison, single-family permits dropped by 1%. One of the factors contributing to the decline is likely the shortages of supplies and labor as well as a softening of demand as inventory levels tighten.3
Last Friday, the HIS Markit Flash US Composite PMI reported the economy is accelerating, with the survey of business leaders in the service sectors, like banks and retailers, rebounding to 58.2 from 54.9 in September. A similar survey of manufacturing showed a decline to 59.2 from 60.7, but still elevated. The common theme to reach full capacity continues to be the shortages of supplies and labor. 4 The Department of Labor Initial jobless claims reported a decrease of 6,000 to 290,000 compared to the previous week. Continuing claims also decreased to 3,279,036 for all programs, a drop of 369,992 from the previous week. 5
During the week, there were three Fed governors who spoke at various conferences stating their respective views on the economic outlook. Fed Governor Christopher Walker in a speech to the Stanford Institute for Economic Policy Research offered three points. First, he thought the significant slowing of GDP in the third quarter of this year would rebound in the first half of next year. Second, he believes the progress in the dual mandate of inflation and employment should result in tapering of asset purchases sooner rather than later. Third, Walker commented that “the next several months are critical for assessing whether the high inflation numbers we have seen are transitory” and if the data remains elevated for the rest of the year, he suggested a more aggressive policy response than just tapering may well be warranted in 2022. 6
On Wednesday Fed Governor Randal Quarles spoke at the 2021 Milken Institute Global Conference. With strong economic conditions forecast to continue into 2022, his focus was turning from employment to inflation and whether it is transitory. One of his concerns was how disrupted supply is forcing inflation much higher than forecast, but still believed as others at the Fed inflation is expected to decline toward the 2% target over the next year.7
On Friday, Fed Chairman Powell spoke at the Bank of International Settlements, indicating that the employment target is the last remaining requirement for raising interest rates. The first two were, inflation rising above 2% and the second, inflation needed to remain elevated above 2% for a period. With strong labor growth continuing into next year, the last hurdle would be met in his opinion. He went on to say if bottlenecks persist, pushing inflation higher, the Fed will act to tighten monetary policy. He further indicated it was time to taper with the buying ending in the middle of next year.8
Government policies are the largest single contributor to the current inflationary environment and are not likely to change any time soon. Monetary policy is only one tool, and what started as a response to a health crisis has created roadblocks that must be navigated on the road to economic recovery.
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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