Hello Gaugers.  Hope that you had a profitable week and are beginning to enjoy the late summer/early fall seasonal changes.  I know it is beginning to get much cooler at night, and daylight seems to be getting shorter.  If you are celebrating the Jewish New Year (as both the Schneiders and us are) we wish you Shana Tova u’metuka  (which translated means a good and sweet year).  We extend our gratefulness that you are in our lives.  We wish you a happy, healthy, and prosperous New Year.  Jewish people everywhere will be welcoming in the year 5784.

 

Uncertainty prevailed.

We have been operating in a volatile trading range since the end of July.  The rally from last (2022) had gotten overheated and was overdue for a pause and some profit taking.

From there we saw the typical 5% pullback for the overall market.  Many of the stocks that led the rally saw a bigger correction than that.

Much of the reason for the enhanced volatility and the trading range has been dictated by data.  Recall that the Fed Governors have been steadfastly commenting that their future decisions on potential further rate hikes would be “data dependent.”  The markets have become dependent on every headline or data point that comes out, which are often interpreted quite differently by economists, analysts, and talking heads.

The stock and bond markets have been directionless as it takes its immediate cues from the headline of the day.  So it bounces around, especially after earnings season, which was met with commentary (not earnings) that conveyed concern from many CEO’s about their future sales and revenue projections.  While more than 75% of companies reported better than expected earnings, some of it can clearly be attributed to rising prices and inflationary measures that companies have imposed to offset raw material increases and a huge rise in transportation and delivery costs.

 

A week full of data and then a rally, then a selloff.

This week, we received updated numbers on the Consumer Price Index (CPI) and the Producer Price Index (PPI), the latter being the favored indicator by the Federal Reserve.

The CPI came out on Wednesday.  The number showed the yearly Core Inflation rate continues to come down (4.3% versus 4.7%).  However, some investors did flinch at the tripling of the monthly non-core rate from 0.2% to 0.6%.  Surprisingly, the S&P 500 was up slightly on that headline day, but it was a risk-off session for small caps.  Smaller company stocks took most of the beating of the perceived sticky inflation. It is those size companies that are penalized by interest rates staying higher longer.

Thursday, the PPI report showed an even more explosive 0.7% month-over-month increase. This was the sharpest increase in 14 months, driven by a 10.5% jump in energy prices (more later).  That would put wholesale inflation on an 8% annualized path.

The CORE PPI number was much more subdued with a +2.2% year-over-year inflation pace, which is getting us ever closer to that 2% Fed target.  This led to the belief by investors that there would most likely not be another Fed hike this year.  See Producer Price Index chart below:

(Click on image to enlarge)

One would think that stocks would have cratered from that kind of data and a higher likelihood for the Fed to take further action, sooner.  But instead, the market had a big rally on Thursday, helped partly by retail sales.

 

Retail Sales

Retail sales increased by 0.6% month-over-month in August.  This was a big increase given the estimate was for 0.2%, and the previous month, considered good, was up 0.5%.  However, looking more closely at the retail sales number, one would see that a big surge was from sales at gas stations.  No surprise there.  See chart below:

(Click on image to enlarge)

However, once you adjust for inflation, the retail sales data is much less encouraging with notable pullbacks in volumes across most categories."  See chart below:

(Click on image to enlarge)

I read a great write up from Steve Reitmeister (Riety) on his takeaway of the effect of the CPI/PPI headlines to stocks.  It goes like this:

“Higher inflation means Fed raises rates higher which means increasing odds of a recession and STOCKS GO DOWN.”

 

So why a stock market rally on Thursday?

Surely investors could see the only reason for the rise in the PPI was a 1-month spike in Oil prices.  And most investors believe that these kinds of moves are very transient and not likely to last.  That is the very reason that the Fed likes to focus on CORE INFLATION figures, which removes the volatility in food & energy.

Today, investors place 97% odds of the Fed standing pat at their upcoming meeting on Wednesday, September 20^th.  However, it is still (and always was) the November meeting that was a more significant concern.

Today, thanks to the numbers from this week’s CPI and PPI the odds investors have now placed on a Fed rate hike in November is approximately 36%.  Let’s get back to Reity’s analysis:

“Lower inflation means the Fed STOPS raising rates which means they may soon lower rates which decreases the odds of a recession and STOCKS GO UP!”

These simple concepts probably explain Thursday’s rally.  However, reality set in on Friday when the market continued to sell off from another day of uncertainty.  That may be due in part to rising interest rates yet again and the price of oil staying above $90 per barrel, something we discussed in detail in last week’s Market Outlook. (along with news of an impending strike which we cover below). If you have not had a chance to read it, you can click here to go back and read a copy.

The risk of recession, according to most large banks and investment houses, remains low.  Goldman Sachs has decreased their odds of a recession to only 15%.  Most of the firms see little right now that could lead to a recession and are mostly recommending to investors to stay invested as they see more stock market upside ahead.

We at MarketGauge accepted long ago that August and September are usually unpleasant for investors, and it seems that 2023 is following that exact same script.  Look for more volatility in the days and weeks ahead.  And make sure you read the current seasonal strategy (at the end of this Outlook) that provides possible relief later this month. 

 

As we entered the weekend, more economic turbulence!

While the CPI and PPI reported above tells you the US is still on a bumpy road to fully taming inflation, the economy this weekend is encountering two new challenges.  A potential government shutdown and an unprecedented strike against all three of the legacy Detroit automakers. 

A government shutdown would harm any consumer confidence and possibly put an immediate stop to the economic positive growth we are still enjoying (GDP expected to be above 3% for this quarter).

The UAW (United Auto Workers) strike against Ford, General Motors and Stellantis could do more damage to the economy.  Workers are demanding job security and better wages (and a 32-hour work week).  The walkout comes amid a resurgence of labor activism in the US after decades of decline.  Most of the unionized workers in the US are emboldened by a tight labor market, inflation, and risks they took on during the COVID pandemic.

GM Chief Executive Officer Mary Barra, however, said the strike could be resolved “very quickly”.  A prolonged action by the UAW could ripple across the economy and, more importantly, complicate the Fed Chair Jerome Powell’s bid for a soft landing.

According to Bloomberg, a 10-day UAW strike would reduce US GDP by $5.8 billion. The auto industry currently accounts for 3% of the US GDP. A strike longer than a few days would send many Midwest states into a recession.

Though Labor is having their “moment” and workers want pay that keeps up spending power, the UAW strike comes with a catch, Liam Denning writes in Bloomberg Opinion Saturday, “a rapid uptake of electrified vehicles demands cheap cars and eventually, a less labor-intensive industry.”  I suspect this is a prevalent motivation of the leadership at the UAW as they try and navigate this strike.

46% of US auto production is set to go offline as a result of the UAW strike. Currently, there are about 30 days of inventory at most car dealers’ lots.  If this strike should go on for any prolonged period, it will significantly harm consumer confidence and likely hike up used car prices quickly.  That would not be a good outcome for bringing down inflation anytime soon.

 

The nagging case of higher oil prices.

Just last month, prices at the pump drove inflation up faster than at any other time in a year. The consumer-price index, as referenced above, showed that prices rose 0.6% in August, with more than half of that blamed on gasoline prices that hit 10-month highs.

Oil prices are driven by both demand and supply. Global demand hit all-time highs in August. And supply remains constrained by voluntary production cuts from Saudi Arabia, OPEC, and their allies.

That’s a no-doubt-about-it path to higher prices. Not surprisingly, crude oil has jumped 8% in the last month to hit nearly $90 a barrel.  See chart below:

You don’t have to be a hedge-fund manager or a Wall Street quant to know that energy stocks are surging in kind.

The broad XLE Energy Select Sector SPDR (XLE) ETF – which includes companies from the oil industry, gas and consumable fuels, and energy equipment and services – has surged more than 20% in less than four months. That’s three times the 6% gain in the S&P 500 during that same time frame.

XLE’s largest holding is Exxon Mobil (XOM). The $465 billion oil giant constitutes more than one-fifth of the entire fund. Its massive size helped push XLE higher, but it’s up only 13.5% when the overall fund has gained 20%.

 

Business Conditions.

There are plenty of negative charts and data points we could show you, but we thought we would concentrate on some of the positive signs that are leading many analysts and economists (Goldman Sachs) to lower their chances of the US entering a recession anytime soon.  Let’s explore a couple of these:

Empire State Manufacturing. The index topped expectations for a modest improvement and flipped back into positive territory. The 6-month ahead outlook increased to the highest level since March 2022.  See chart below:

New businesses vs. bankruptcies. "Business applications remain high (34k, vs. 25k average in 2019), and commercial bankruptcies remain low (2.3k, vs. 3.3k on average in 2019)." See chart below:

Institutional investors are increasingly bullish according to the State Street confidence indicator. "US Equity institutional investors are no longer underweight as soft-landing expectations rise."  See chart below:

Equity fund flows. Equity funds saw their "biggest weekly inflow ($25.3bn) since Mar'22, as confidence in soft landing consensus grows." This is further proof that individual investors are feeling more positive. See chart below:

Once again the inflows were dominated by Retail investors (which hasn’t seen an outflow since April), while institutional fund assets rose for the 3rd straight week.

It is worth taking a deeper look into investment sentiment, both for professionals and individuals.  Given the above Inflation statistics, higher interest rates, and new yearly highs on the price of Oil, how are investors feeling about the stock market?  Let’s look at investor sentiment below.

Active managers exposure. The NAAIM (National Association of Active Investment Managers) Exposure Index increased to 57.9 from 49.7.  This is a healthy increase and,for September, unexpected. See chart below:

AAII sentiment. (The American Association of Individual Investors) "Bullish: Below average for the fourth time in five weeks. Neutral: At highest level since May 18. Bearish: Below average for the second consecutive week."  See chart below:

 

How are folks (households) investing their money?

"US households currently allocate 43% of their total financial assets to equities, which is elevated."   Households are invested close to other recent times when they were quite bullish with 50% of their household assets allocated to equities. See chart below:

Investor allocations. "Regardless of what people say or what you hear in the news, overall people are fairly bullish on equities."

AAII=American Association of Individual Investors
ICI= Investment Company Institute
Fed FoF= Fed’s Flow of Funds

The positive sentiment shown above, is why many analysts believe that when you have a positive first half of the year, especially after a previous negative year (2022), an investor is more likely to experience continued gains for the remainder of the year.  See explanation and chart below:

Seasonality setup. And finally, “since 1900, 123 years of data (1900-2022), the average Q4 return for SPX when Q1-Q3 exceeds>10% going into Q4, is +4.6%. SPX is up ~16% YTD.”

(Click on image to enlarge)

 

Sell Rosh Hashanah and Buy Yom Kippur

We started this week’s Market Outlook by acknowledging the Jewish Holidays which began Friday at sundown.  Long ago someone shared with me the Jewish Holiday trade and our friend Jeff Hirsch (from Stock Traders Almanac) reacquainted me with it this past week.

The thesis is that folks sell positions on or before Rosh Hashanah (Sept. 16^th), the first day of this holiday season (called the Days of Awe) to rid themselves of financial commitments and then return to the market after Yom Kippur (Sept. 25^th), the Day of Atonement.  It is no coincidence that this coincides with the seasonal September/October weakness.

The period after Yom Kippur and up until Passover (typically sometime in mid-March to mid-April, April 23^rd in  2024) is usually a positive one.

According to Stock Trader’s Almanac, the stock market has been tracking the 4-year cycle Presidential/Election cycle and seasonal trends to a T this year.  This should make a great entry for the Q4 pre-election year rally.

See the historical track record for the “Sell Rosh Hashanah and Buy Yom Kippur” along with the “Buy Yom Kippur to Passover” trades below:

(Click on image to enlarge)

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Thanks for reading.  We hope you have a good and productive week ahead.  Stay safe and stay calm in any market volatility.  Remember what my wise mother (92 years young) says:  “this too shall pass”.

We now turn it over to Keith and his team and the all-important Big View bullets and Keith’s video presentation on the health and condition of the markets.

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More By This Author:

Could Higher Oil Prices Throw The U.S. Into A Recession?
What Might September Hold For The Markets?
The Inflation Fighters: Will They Keep Raising Rates Or Pause?