Market Turmoil Offers Economic Insight

The recent stock market decline reveals a lot about the economy.

Until the last few weeks, the lagging sectors in the stock market were the interest-rate-sensitive sectors. Joining them were low-quality companies, including those with the weakest balance sheets. Home builder stocks were some of the worst performers during that period, followed by utilities and other high-dividend stocks.

But the market indexes continued to increase. The conclusion from those trends was that the Fed was tightening the money supply, but not enough to significantly reduce growth. Stocks of companies that are the most sensitive to tighter money declined while those sensitive to economic growth continued to do well.

There was a change beginning in late September.

Leading the stock market indexes down were the economically sensitive sectors that had been lifting the indexes higher. Stocks that fell significantly were growth stocks, especially technology, consumer cyclical and health care.

Some of the stocks that did poorly earlier in the year continued to decline as the market downturn broadened. These included home builders and basic materials companies. But others that were laggards earlier in the year, especially utilities and consumer staples, improved. Utilities and consumer staples are defensive stocks, and their recovery indicates investors are concerned about economic growth.

Another change we’ve seen in the markets is the relative performances of U.S. stocks and international stocks. Through much of 2018, U.S. stocks were almost alone in generating positive returns.

But the recent market decline has been broad-based. U.S. stocks, and the few foreign stocks that did well earlier in the year, joined the global downturn.

It is notable that many of the stocks that led the U.S. indexes higher earlier in the year are among the biggest losers since Oct. 1. These include Amazon, Netflix, Google and Mastercard. NVIDIA (NVDA) was the hottest stock the last few years, rising from $30 to almost $300 since 2015. In the last 16 trading days, NVDA declined 32%.

All of these changes are indications that investors believe economic growth in the United States is going to slow. Growth already slowed outside the United States. But investors now anticipate that higher interest rates, trade conflicts and the fading power of 2017’s tax cuts will reduce growth.

A few stocks hammer this point home. Caterpillar (CAT) lost 7.6% on Tuesday and, at one point during the day, was down 10%. 3M (MMM) lost 4.4% on Tuesday. Other global manufacturers also saw similar declines.

These companies and others reported that they faced strong headwinds from the stronger dollar, higher tariffs and slower growth in China. Higher commodity prices also are stifling profit growth.

While markets are anticipating lower growth, they aren’t yet signaling a recession. We’ve had sharp declines at different times in this bull market that began in 2009. Each time, the economy continued to grow and stocks recovered.

The difference this time is the Fed seems determined to keep raising interest rates. In the past, the Fed was protective of stock prices. When stocks stumbled, the Fed provided more monetary stimulus. This time, investors have to be concerned that the Fed might raise rates too much and push the economy into a recession.

The Data

Growth increased in the last month, according to the PMI Composite Flash Index. The composite index increased to 54.8 from 53.4. The manufacturing sector increased to 55.9 from 55.6. Services jumped to 54.7 from 52.9.

Manufacturing activity continues to increase in the Philadelphia area, according to the Philadelphia Fed Manufacturing Business Outlook. The index declined a little to 22.2 from 22.9. New orders decreased a bit while current shipments increased.

But the Richmond Fed Manufacturing Index tumbled. After hitting a record high of 29 last month, it declined to 15. Both shipments and new orders declined significantly. The Richmond Fed Index is believed to be the regional survey most sensitive to trade policy, because three major ports are included in its survey. Its decline indicates that trade conflicts are hurting the manufacturing sector. Hurricane Florence also is believed to have had a negative influence on the survey.

The Kansas City Fed Manufacturing Index also declined to 8 from 13. That’s the fourth straight month of declines for the index. Its recent high was 29, reached in May.

Reflecting the mixed manufacturing surveys, durable goods orders had mixed results again this month. The headline number was strong, with a 0.8% increase in orders. But much of that was in transportation, especially defense aircraft. After excluding transportation, orders increased only 0.1%. And the important core capital goods, which is a measure of business investment in new equipment, declined 0.1%.

The Leading Economic Index from The Conference Board continues to indicate there is no recession in sight. The index increased 0.5% to 111.8. This indicates strong growth, but at a little bit slower rate than in recent months. The Conference Board says this indicates growth could exceed 3.5% in the second half of 2018 but is likely to slow in 2019.

The housing market continues to slow in the face of rising interest rates. Existing home sales, as reported by NAR, declined 3.4% for the month and now are down 4.1% over 12 months. The number of existing homes sold is at its lowest level since November 2015.

New home sales also tumbled in September. They declined 5.5% from August and are down 13.2% over 12 months. Also, sales for the three previous months were revised lower. These numbers were well below expectations and are a fresh indication of weakness in the new home market.

Home prices increased 0.3% for the month, according to the FHFA House Price Index. Prices are up 6.1% over 12 months, which is the lowest reading since January 2017.

Some good news in housing is that pending home sales increased 0.5% for the latest month. That compares to a 1.9% decline last month. Over 12 months, pending sales are down 1.0%.

New unemployment claims decreased by 5,000 last week to 210,000. But that was offset by a 5,000 increase in claims this week. The number of new claims and insured unemployed remain near the lowest levels since 1969.

The Markets

The S&P 500 declined 5.39% for the week ended with Wednesday’s close, which gives it an 8.83% loss over four weeks. The Dow Jones Industrial Average lost 4.35% for the week. The Russell 2000 fell 7.60%. The All-Country World Index gave up 5.12%. Emerging market equities dropped 4.91%.

Long-term treasuries rose 0.68% for the week. Investment-grade bonds returned 0.04%, while Treasury Inflation-Protected Securities (TIPS) added 0.14%. High-yield bonds declined 0.90%.

On the currency front, the dollar rose 0.94%.

Energy-based commodities lost 3.47% for the week. Broader-based commodities fell 2.72% but gold rose 0.77%.

Bob’s News & Updates

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