Confusion or Conviction?

Key Points
  • U.S. equity indexes have emerged out of their recent tight range, but persistent economic and trade uncertainties have not dissipated.

  • The economic picture is mixed, as manufacturing continues to weaken but the consumer/services segments remain strong.

  • The European Central Bank eased again, but there are doubts as to whether monetary policy is losing its effect and if a fiscal response is necessary.

Listen to the latest audio Schwab Market Perspective.

“We often confuse what we wish for with what is.”
― Neil Gaiman

Rally with conviction?

U.S. stocks have broken out of their recent trading range and moved closer to all-time highs as trade tensions have marginally subsided and the European Central Bank (ECB) has engaged in further easing. Despite this move, attitudes among investors have been less than enthusiastic as the Ned Davis Research Crowd Sentiment Poll (CSP) recently dipped into extreme pessimism territory and has rebounded only slightly into a zone that has historically been the best in terms of the S&P 500’s annualized performance (although past performance is no guarantee of future results). We remain cautious despite the recent move and still-supportive investor sentiment measures as trade news continues to dominate market behavior, and that is virtually impossible to predict. [See the details of our study in Chop, Chop, Chop: Stocks’ Choppy Behavior Around Trade News].

Attempting to trade around short-term news has proven to be a treacherous task; and though hope has emanated from anticipated trade talks in October and the delay of the October 1 tariffs (to October 15), a comprehensive deal remains elusive. Additionally, our colleague Mike Townsend has noted that, while the topic has garnered less attention than the trade dispute with China, the United States-Mexico-Canada Agreement (USMCA) still awaits Congressional approval. A failed ratification may increase trade tensions and sour investor attitudes. More broadly, sentiment around the world—particularly in response to Hong Kong’s abandonment of the “extradition bill” and another delay in Brexit—has also marginally improved. Yet, no major issues have been resolved and we believe there is heightened risk of volatility, keeping us in line with our theme of “be prepared.”

Mixed picture but weakness could be deepening

Google reported that search volume for “recession” recently hit highs last seen in 2009—when the U.S. was in a recession. Though recession chatter has persisted, overall economic data doesn’t show that one is imminent. Key, larger components of the economy—including services and the consumer—have held up well in light of trade uncertainty; while manufacturing has weakened further. The Institute for Supply Management’s (ISM) Manufacturing Index fell to 49.1 in August (below the 50 mark that separates expansion from contraction) and the forward-looking new orders component dropped even further to 47.2.

Manufacturing continues to weaken

ISM manuf. vs ISM Man new orders

The survey highlighted firms’ continued concerns related to trade uncertainty. Unsurprisingly, apprehension over the trade dispute between the United States and China has brought down planned and actual capital expenditures. Absent a comprehensive deal and reigniting of corporate animal spirits, it is difficult to envision a near-term rebound in these measures.

Capex is also suffering

Actual capex bar vs planned capex composite index

Manufacturing’s malaise has yet to spread to the larger services/consumer segments of the economy. Unlike manufacturing, services has strengthened of late, as the ISM Non-Manufacturing Index surprised to the upside in August, ticking up to 56.4. The labor market has also continued to show strength, as the four-week average for jobless claims recently moved down to 213k and the unemployment rate stayed at 3.7% in August (Department of Labor). Yet, last month’s addition of 130k jobs missed the 160k consensus; and revisions for the prior two months revealed a net loss of 20,000 jobs. Should payrolls start to weaken and jobless claims tick up, consumer confidence—as measured by The Conference Board—may start to weaken and catch down to The University of Michigan Consumer Sentiment Index. As you can see in the chart below, the two measures have maintained their divergence, with The Conference Board’s survey staying elevated. Important to note is the tendency for confidence to peak ahead of recessions, which is why cracks in the labor market and/or consumer are worth paying attention to.