Week of Oct 3, 2022

The release of employment data was the highlight of this week. With the unemployment rate at 3.5% and 263,000 new jobs added during September 2022, the US economy shows resiliency and strength. This data point supports the case of a 75 bps rate hike by the Fed in the November FOMC meeting. As a result, the markets declined immediately after the data was released.
See the details below.

Economic Calendar

Indicator	Result	Period	Impact/Significance Discussion
ISM PMI (Institute for Supply Management)	50.9	Sep 2022	The September result was lower than the market expectation of 52.2 as well as lower than Aug 2022 figure at 52.8. The lower amount indicates a slowdown in the economy. Usually, the slowdown in PMI will translate into a slowdown in indicators such as CPI or PCE with a few months lag. That being said, note that we cannot only rely on one data point.
Manufactured Goods - New Orders (US Census Bureau)	No Change	Aug 2022	The revised figures for August and July were published, showing that on a month-over-month basis the July new orders fell by -0.1% and they were unchanged in Aug 2022 This indicator precedes other indicators such as consumer spending, etc, as it basically shows the activity at the source (manufacturing facilities)
ADP National Employment Report ( ADP )	208,000 increase	Sep 2022	US non-farm employment is tracked by ADP showed an addition of 208,000 new jobs, with the year-over-year pay for job-stayers increased by 7.8%, while it increased by 15.7% for job changers This is one data point, but it is significant as it shows the resiliency of the job market. The increase in wages is also significant because the ideal of 'wage-price spiral' is the top concern for the Fed. To clarify this point, the Fed wants to curb inflation by controlling the wage increases because as wages increase, the consumers will maintain the level of spending while the higher wages drive the price up (and so on, creating a vicious cycle.)
Unemployment Insurance (jobless) Weekly Claims (Department of Labor)	219,000 (An increase of 29,000)	Week ending Oct 1, 2022	The increase indicates the cooling down of the labor markets. However, this is only one data point. Note that due to the impact of hurricane Ian, we expect jobless claims to go up in the coming weeks and therefore, this indicator will lose its value as a tracking tool, unless if we exclude the irregularity. Also, note that the figures are seasonally adjusted by the Department of Labor (DOL)
Employment Status (Bureau of Labor Statistics)	Jobs: 263,000 increase Unemployment: 3.5%	Sep 2022	Non-farm employment increased by 263,000 (expectation was 250,000) with an unemployment rate of 3.5%. There have been significant job gains in healthcare as well as leisure and hospitality. Unemployment was down from August (3.7%) by 0.2% and is not at July levels (3.5%). In addition to job gains, the other contributor to lower unemployment was 0.1% reduction in the participation rate (from 62.4% in August to 62.3% in September.) Overall, low unemployment is good news for the economy but in the context of high inflation and the Fed's determination to reduce inflation by targeting employment, it might be bad news for stock markets. After this release, it appears that the market is convinced that the Fed will increase rates by 75 bps in their November meeting. Note that among all indicators released this week, this last indicator (employment status) was the most significant one.

Market Movements

This week started on a positive note with S&P 500 index growing significantly on Monday and Tuesday. However, the rally was short-lived in light of disappointing economic data and revisions made to the forward guidance of companies. We did expect a short-lived rally two weeks ago prior to the Fed’s decision on rates. However, it didn’t materialize until this week. As the prices were falling, we bought some stocks as we were expecting this bounce back. However, the profits we made were meager because we were not able to time the market well (as it is not expected anyways, but we ran this as an experience and we will post the results under the portfolio section).

The large movement on Friday was definitely linked to the employment report by BLS (see above). The prices were relatively unchanged with very low volume in the pre-market session on Friday morning. As soon as the BLS released its report at 8:30 AM, the market started to slide.

During the week, OPEC+ had a meeting in which they cut production by 2 million barrels. Note that this is on paper and the real cut is close to 800,000 barrels. Basically what it means is that some of the countries had not been able to produce up to their quota (on paper) so the cut basically is scaling back some of those unfilled quotas. This news, of course, resulted in an increase in the prices of energy stocks.

Also, if you look at our post from last week, gasoline reserve levels are reducing while crude oil levels are increasing. This has to do with the limited refinery capacity in the US and around the world. So, even if oil production is increased, it might not directly impact the price of gasoline. It seems that there is no immediate plan to increase refining capacity. This is important if you want to formulate investing strategy and invest in downstream companies. See our post on energy for details.

Two factors can make the price of energy spike again: 1) harsh winter, and 2) damage to oil facilities in the gulf of Mexico due to hurricane. The latter could be specifically impactful. Considering this is important in formulating an investment strategy, such as investing in companies that have less presence in the areas that are prone to natural disasters.

In terms of emerging markets, Brazil and Chile received special attention last week with investors taking long positions in both economies.

What to expect next?

Next week, the CPI for the month of September will be released. This month is specifically important because it’s almost 6 months since the first rate hike and this is sufficient time to pass in order to see the impact of the monetary policy on the economy. We expect that this one data point impact the markets on the day it’s released. Interestingly enough, the Fed pays more attention to PCE (Personal Consumption Expenditure) than CPI, but given that both metrics intend to measure the same underlying factor, a movement in one should be in line with the movement in the other.

Below is the S&P 500 chart with a regression line starting from November 2021 up to Oct 7, 2022. We expect this downward trend to continue for the following reasons:

1) The impact of the monetary policy manifests itself with a 6 to 18 months delay and we’re reaching a point where we should see the impact. Note that the impact is priced in up to a certain degree but we don’t know how much. It is believed that it’s not fully priced in because of the narrative of “Fed being forced to pivot when faced with the prospect of a crisis”.

2) The Fed is engaged in Quantitative Tightening (“QT”), the impact of which is not well-known. Hypothetically, it should accentuate the impact of monetary policy tightening. It seems like the market participants have not fully factored in the impact of the QT.

3) As the dollar becomes stronger, food crises and geopolitical tensions are posing more serious threats, and ongoing inflation, something will go wrong in an economy that will have a ripple effect on global markets. We don’t know what that is, but it seems that the ingredients are in place, waiting for a catalyst. We were actually close to one after the UK government announced its plans for the tax cuts. However, the actions of the UK central bank and later on the adjustment to the plan by the government stopped the fallout. We got out unscathed this time, but this might not be the case next time.

Below is the zoom-out of the chart above.

Source: Yahoo Finance