Month: September 2024

By Harry Robertson and Wayne Cole

LONDON/SYDNEY (Reuters) -Share markets fell slightly on Monday as investors braced for a data-packed week culminating in a U.S. jobs report that could decide whether a rate cut expected this month will be regular or super-sized.

Survey data released on Saturday showed Chinese manufacturing activity sank to a six-month low in August, and data on Monday showed euro zone factories are also still struggling.

Wins for the populist parties in German state elections added a fresh layer of political uncertainty in European markets, while a holiday in the United States and Canada made for thin liquidity.

Europe’s STOXX 600 index fell 0.26%, after hitting a record high on Friday. Germany’s DAX and Britain’s FTSE 100 were down 0.11% and 0.1% respectively.

“European equities have opened on a weaker footing owing to weaker economic data from China,” said Aneeka Gupta, equity strategist at WisdomTree. “The industrials and consumer discretionary sector led the declines.”

The dollar index, which tracks the currency against six peers, was down very slightly at 101.73 after hitting a two-week high overnight. The U.S. currency climbed 0.5% against the yen to 146.95.

“We are seeing some natural caution at the beginning of a critical month for markets, with the Fed set to start its interest rate cutting cycle,” said Ben Laidler, head of equity strategy at Bradesco BBI.

“Markets made a dramatic recovery from the early August flash sell-off but now face seasonally by far the weakest performance month of the year.”

Chinese stocks lost 1.7%, led by losses in real estate after a survey showed home prices growth had slowed. Shares of New World Development, a major Hong Kong property developer, dived 14% after it estimated a net loss.

Futures for the U.S. S&P 500 index were down 0.14%, while those for the tech-laden Nasdaq 100 were 0.13% lower. U.S. stock markets will be closed for Labor Day on Monday and Treasuries were untraded.

“We’re always a bit cautious when we’re trading at all time highs and when earnings expectations continue to be fairly lofty in the U.S. in particular,” said said Carl Hammer, head of asset allocation at lender SEB.

The big event of the week will be the U.S. non-farm payrolls report on Friday, which is expected to show the economy added 165,000 jobs in August, up from 114,000 in July.

Traders currently think a September Federal Reserve rate cut is nailed on and see a 33% chance that it could be an outsized 50-basis point reduction, but that could shift on Friday.

The weak July jobs report helped spark a sell-off in global stocks at the start of August, although the S&P 500 has since rebounded to sit 0.4% off a record high.

Germany’s 10-year bond yield rose to its highest in a month at 2.338%, and was last up 4 basis points, in line with euro zone peers.

Pressure mounted on German Chancellor Olaf Scholz after the far-right Alternative for Germany (AfD) won its first regional election.

September has recently been a down month for stocks and bonds, analysts said, perhaps adding to the caution on Monday.

Deutsche Bank analysts said the S&P 500 and STOXX 600 have lost ground in each of the last four Septembers, while global bonds have fallen in the last seven.

Also important this week will be U.S. survey data, job openings figures, weekly jobless claims and the Fed’s beige book on current economic conditions.

Oil prices ticked up after falling in recent days. Brent crude rose 0.29% to $77.14 a barrel, down more than 5% from a week earlier.

Investing.com — “The sharp correction in stocks in July/early August was due to several factors, with the most important one being softer-than-expected economic growth data that culminated in a weak employment report on August 2”, said analysts at Morgan Stanley in a note. 

The upcoming release of the August jobs report on September 6 is expected to play a vital role in determining whether the market’s recent rebound can continue or if renewed worries about economic growth will lead to further downward pressure on stock valuations. 

Morgan Stanley analysts forecast that this report will significantly influence the market’s future trajectory.

The market downturn earlier this summer was primarily triggered by a series of disappointing economic indicators, culminating in a weak employment report on August 2. 

The most important factor was a 0.2 percentage point increase in the unemployment rate, which activated the Sahm Rule—a key recession indicator—and heightened fears of a potential hard landing for the economy. This spooked investors, leading to a broad-based sell-off in equities.

While some positive economic data, including better-than-expected jobless claims, retail sales, and the ISM non-manufacturing survey, have since emerged, the recovery in equity markets has been uneven. 

Many indices have rallied back near all-time highs, yet the bond market, the yen, and commodities suggest lingering caution among investors. Furthermore, equity market “internals,” such as the performance of cyclical versus defensive stocks, have not rebounded significantly, indicating a cautious market sentiment.

Morgan Stanley analysts say that the August jobs report will be a critical test for the market’s recovery. “A stronger-than-expected payroll number and lower unemployment rate would likely provide markets with greater confidence that growth risks have subsided, paving the way for equity valuations to remain elevated and a potential catch-up in some other markets/stocks that have lagged,” the analysts said.

Conversely, another weak jobs report, particularly if it shows a further rise in the unemployment rate, could reignite fears of a hard landing and put renewed pressure on equity valuations. 

Morgan Stanley’s economists are forecasting a non-farm payroll increase of 185,000 jobs and a decrease in the unemployment rate to 4.2%, which aligns with market consensus. However, they caution that the stakes are high, given the market’s current valuation levels.

Morgan Stanley flags the challenge for equity investors in the current environment. The S&P 500 is trading at 21 times earnings, which places it in the top decile of its historical valuation range. This is based on consensus earnings per share (EPS) growth estimates of 11% for this year and 15% for next year—well above the longer-term average of 7%. 

Given these elevated valuations and high earnings expectations, Morgan Stanley sees limited upside at the index level over the next 6-12 months, particularly in a soft-landing scenario, which is their base case.

The market’s current valuation levels make it vulnerable to a downturn in case of a hard landing.  The upcoming labor report is crucial as it could either strengthen or weaken the current market sentiment.

Morgan Stanley also notes that the Bloomberg Economic Surprise Index, which tracks the degree to which economic data exceeds or falls short of expectations, has not yet reversed its downward trend that began in April.

 Additionally, cyclical stocks continue to underperform relative to defensive stocks, further suggesting that growth concerns remain prevalent.

Unlike previous corrections in 2022 and early 2023, where inflation was the primary risk, the current market dynamics are driven by growth worries. 

This shift supports the idea that, until there is clearer evidence of improving economic growth, investors should favor high-quality defensive stocks in their portfolios.

Analysts believe that AI stocks have been a major force in the U.S. market, but recent disappointing earnings have caused a decline in many of these stocks.

While Morgan Stanley doesn’t think the AI trend is over, they suggest investors might be looking for a new market theme that can attract a lot of investment.

In this context, the analysts advise against rotating into small-cap or other cheap cyclical stocks that have underperformed in recent years. They argue that in a late-cycle, soft-landing scenario where the Federal Reserve is cutting rates, these areas of the market typically do not perform well.

Morgan Stanley flags that the bond market has already expected some of the Federal Reserve’s potential interest rate cuts. With back-end rates falling by more than 100bp over the past 10 months, making borrowing cheaper for things like mortgages. Despite this, sectors highly sensitive to interest rates, such as housing, car purchases, and credit card spending, haven’t seen a boost yet.

This lack of response from the cyclical parts of the equity market further supports the analysts’ cautious outlook. Unless the Fed cuts rates more than the market is currently expecting, the economy strengthens, or additional policy stimulus is introduced, Morgan Stanley expects minimal returns at the index level over the next 6-12 months.

Investing.com — All eyes are on the monthly jobs report at the end of the week, as investors look forward to this month’s Federal Reserve meeting and a potential rate cut. The quarterly earnings season is drawing to a close, and has been stronger than possible. Elsewhere, politics in Germany looks more fractured after state elections over the weekend. 

1. Payrolls to guide Fed easing plans

The week’s key economic data release will be Friday’s August jobs report, as investors look for more clues about how aggressively the U.S. Federal Reserve will ease monetary policy later this month.

Fed Chair Jerome Powell has flagged it is time to start reducing interest rates, and many in the markets expect the process to begin with a 25-basis point cut at the Sept. 17-18 meeting.

However, any signs of a dramatic weakening in the labor market could revive fears over the prospect of a recession that roiled markets in late July-early August, potentially leading to a more aggressive reduction.

A result in line with forecasts of a gain of 164,000 in nonfarm payrolls and a  4.2% unemployment rate would likely see the chance of 50 basis points recede completely, though it would take an extraordinarily strong report to make markets give up on 25 basis points.

Ahead of Friday’s report there are other updates on the health of the labor market, starting with Wednesday’s Jolts job openings report, which also contains data on layoffs. ADP data on private sector hiring will be released on Thursday, along with the weekly report on initial jobless claims.

2. Futures slightly lower on Labor Day

Wall Street is closed Monday, with Americans enjoying the Labor Day public holiday, and activity is likely to be limited ahead of the release of key labor market data at the end of the week.

By 04:05 ET (08:05 GMT), the Dow futures contract was 90 points, or 0.2%, lower, S&P 500 futures dropped 15 points, or 0.3%, and Nasdaq 100 futures fell by 75 points, or 0.4%.

The main indices have bounced back to near-record highs after an early August swoon on expectations that the Federal Reserve is on the cusp of monetary policy easing for the first time in years.

Investors expect a 25 basis point cut at the Sept. 17-18 meeting, but further signs of the labor market weakness at the end of the week [see above] could increase expectations of a larger cut.

Futures are 100% priced for a cut of 25 basis points in September, and imply a 33% probability of 50 basis points. They also have 100 basis points of cuts priced in by December, and 120 basis points for 2025.

Also important this week will be the ISM surveys, JOLTS job openings and ADP employment, trade and the Fed’s Beige Book, while speeches from the likes of Fed Governor Christopher Waller and NY Fed President John Williams will also be widely digested.

3. S&P 500 sees strong earnings growth in Q2

The second-quarter earnings season is largely over, with only seven S&P 500 companies yet to report. 

So far, the S&P 500 index has reported a 13% earnings growth rate in the quarter, according to financial data firm LSEG, the strongest earnings growth since Q4 2021.

Leading the way, the tech, financials and health-care sectors all saw earnings growth of more than 20%, with only two sectors — materials and real estate — reporting earnings contraction.

The index has also seen a rotation, with a broadening rally offering an encouraging signal to investors worried about concentration in technology shares. 

A total of 61% of stocks in the S&P 500 outperformed the index in the past month, compared to 14% outperforming over the past year, Charles Schwab (NYSE:SCHW) data showed.

Meanwhile, the so-called Magnificent Seven group of tech giants have underperformed the other 493 stocks in the S&P 500 by 14 percentage points since the release of a weaker-than-expected U.S. inflation report on July 11, according to an analysis by BofA Global Research. 

4. Complicated German politics 

German state elections have complicated the political landscape in the eurozone’s dominant country.

Alternative for Germany (AfD) became the first far-right party to win a state legislature election in Germany since World War Two with its result in Thuringia, as well as coming a close second in Saxony.

“The results for the AfD in Saxony and Thuringia are worrying,” German Chancellor Olaf Scholz said in a statement to Reuters. “Our country cannot and must not get used to this. The AfD is damaging Germany. It is weakening the economy, dividing society and ruining our country’s reputation.”

With a year to go until Germany’s national election, these results could result in infighting amongst Scholz’s three-party coalition, given the apparent popularity of AfD’s anti-NATO, anti-immigration and Russia-friendly stance.

The German government’s faltering authority could also complicate European policy when the bloc’s other major power, France, is still struggling to form a government after snap elections in June and July.

5. Crude falls after weak Chinese data

Crude prices fell Monday, extending recent losses on concerns of sluggish demand growth in China as well as expectations for higher OPEC+ production.

By 04:05 ET, the U.S. crude futures (WTI) dropped 0.3% to $73.33 a barrel, while the Brent contract fell 0.3% to $76.68 a barrel.

An official survey showed on Saturday that Chinese manufacturing activity sank to a six-month low in August, following on from a weak performance in the second quarter, raising concerns about future consumption at the world’s biggest crude importer. 

Both Brent and WTI posted losses last week, adding to two consecutive weaker months as these demand concerns have outweighed recent disruptions in Libyan oil supply and tensions in the oil-rich Middle East.

Investors are also looking ahead to planned oil output hikes from members of the Organization of Petroleum Exporting Countries and allies, known as OPEC+, next month.

Eight OPEC+ members are scheduled to boost output by 180,000 barrels per day in October, as part of a plan to begin unwinding its output cuts.

Investing.com — As per analysts at Citi Research, the U.S. job market remains strong, even as the overall economy shows signs of slowing down.

As we approach the upcoming Federal Open Market Committee (FOMC) meeting in September, Citi expects that the Federal Reserve will initiate a rate-cutting cycle, with a potential reduction of 50 basis points (bps) as early as this month. 

This decision is expected to be driven by the latest employment data, which, while showing some signs of moderation, still point to robust job growth.

Citi analysts highlight that despite the broader economic headwinds, job growth in the U.S. remains relatively solid. For August, Citi forecasts a modest increase of 125,000 in nonfarm payrolls, a slight uptick from July’s figure of 114,000. 

The unemployment rate is expected to hold steady at 4.3%, although there is a possibility it could round down to 4.2%. This sustained job growth suggests that the labor market is not softening as quickly as some may have feared​.

The Federal Reserve’s response to the August jobs report will be critical. Citi Research expects the Fed to cut interest rates by 50bps at the upcoming September meeting if the jobs report aligns with their expectations of 125,000 payrolls growth and a 4.3% unemployment rate. 

This rate cut would be justified by the perceived downside risks to the labor market, particularly if job growth falls below 175,000 and the unemployment rate remains elevated.

The broader economic environment adds further context to the Fed’s anticipated actions. Consumer spending has remained strong, with a 0.5% month-on-month increase in July, driven in part by robust motor vehicle consumption. 

“But the savings rate at just 2.9% is unlikely to be sustained with unemployment rising. When the savings rate rises, spending will need to slow,” the analysts said. Core PCE inflation was recorded at 0.16% month-on-month, reinforcing expectations for a rate cut as inflation pressures continue to ease.

Citi Research analysts suggest that a 50bps cut in September could be the beginning of a series of rate reductions by the Fed, with additional cuts likely at subsequent meetings depending on economic data, particularly from the labor market. 

“Chair Powell sounded not only open to a larger-sized cut but also to laying the groundwork for one at Jackson Hole by saying there is “ample room” to reduce policy rates,” the analysts said. 

Investing.com — The Federal Reserve, led by Chairman Jerome Powell, is set to decide on September 18th whether to lower interest rates. 

The central bank has hinted that the U.S. economy might achieve a “soft landing,” meaning inflation will decrease without causing a severe economic slowdown. 

However, analysts at BCA Research in a note dated Monday question this optimism, arguing that the economy is still facing challenges.

“Investor sentiment is highly positive, with little cash on the sidelines, and US equities trading at 21x (very optimistic) forward earnings expectations,” the analysts said. This bullish outlook reflects confidence in the Fed’s ability to manage the economy without causing a recession. 

Both individual and institutional investors are fully invested in the equity markets, leaving minimal cash on the sidelines. As per analysts at BCA, such extreme optimism is often followed by market corrections, particularly if economic conditions begin to deteriorate.

Historically, stock markets have often seen a decline after the Federal Reserve’s first rate cut in a cycle. This pattern has been observed in past instances, such as in 2001 and 2007. 

An exception was 1995, when the Fed successfully cut rates without causing a recession. However, today’s economic conditions are markedly different from those of the mid-1990s. 

Unemployment is on the rise, and the job market is showing signs of weakness. This is supported by the Sahm rule, which was triggered last month, suggesting a potential recession is looming.

Analysts at BCA paint a bleak picture of the labor market. Job creation has plummeted by over a million in the last two years, and revised nonfarm payroll data reveals that job growth has been exaggerated. 

Although unemployment claims haven’t skyrocketed, the overall trend indicates a weakening labor market. This decline raises concerns about the long-term viability of the economic expansion and the Fed’s ability to achieve a gradual slowdown.

Even if the Fed proceeds with rate cuts as anticipated, monetary policy will remain restrictive for some time. BCA analysts warn that the benefits of easier monetary policy may not materialize quickly enough to avert a downturn.

The lag between rate cuts and their impact on the economy, which typically spans about 12 months, means that the economy could still face significant challenges even after the Fed begins to ease policy​.

BCA Research suggests investors to be cautious with their portfolios due to current economic risks. They recommend holding fewer stocks and bonds, preferring government bonds as a safer bet in case of a recession. 

Within stocks, they favor defensive sectors like consumer staples, healthcare, and utilities, which are less likely to be affected by a downturn. While they slightly prefer U.S. stocks, they warn that tech stocks could drop in value if the economy gets worse.