D.C. Drama

It was announced that there were early results of an oral antiviral (a pill) that reduced the risk of COVID hospitalizations and deaths by about 50%.

This includes all versions of COVID, including Delta. While we already have vaccines, yet another type of therapeutic is an encouraging signal that the worst of COVID may be past us and on its way to become something akin to influenza.

The ISM manufacturing index rose in September.

As we suggested might happen based on the surge in regional Fed surveys, the national ISM manufacturing reading rose from 59.9 in August to 61.1 in September. New orders, which are a leading economic indicator, remained elevated at 66.7. The employment component rose slightly. Supplier delivery times slowed further, which supports the notion that supply chain issues are constraining economic growth as a shortage of truck drivers and containers impacts delivery times. If supply chain issues are not resolved and demand shows no signs of moderating, then inflationary pressures may stay elevated longer- than-originally anticipated.

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The drama continues in Washington with Congress still negotiating the bipartisan infrastructure bills and needing to raise the debt ceiling by mid-to-late October. However, Congress did successfully pass a bill to fund the federal government through December 3rd, which at least removed the risk of an imminent government shutdown.

As it stands now, House Speaker Nancy Pelosi has moved the non-binding date to vote from September 27 to October 31 as she attempts to gather sufficient support to ensure the passage of both infrastructure bills (a “physical” infrastructure bill and a “social” infrastructure bill). Importantly, this new date seems to imply that the debt ceiling will need to be handled separately with lawmakers' attention likely to shift solely to the debt ceiling this week. Citi Research’s U.S. economics team believes that Democrats will likely use party line reconciliation to increase the debt ceiling but will need at least one week of procedural time to pull it together. If Democrats do not appear to be on track towards raising the debt ceiling via reconciliation by later this week, markets may become more concerned about the quickly approaching October 18 deadline to lift the debt ceiling. With the White House and Congress having acted 98 times since the end of World War II to modify the debt ceiling, we believe that history heavily suggests that a deal can still be reached, but tail risks appear to be rising.

In terms of the infrastructure bills, further negotiations are needed with Senator Manchin declaring that he is comfortable with a price tag of $1.5 trillion while some progressive Democrats are arguing for a much higher price tag. One solution being discussed is to limit the number of years for which some programs run. Doing so might allow progressives to accomplish their immediate goals with the hope that a future Congress will maintain the programs while limiting the topline price tag to something in between Senator Manchin’s $1.5 trillion and $2.1 trillion (a number reportedly being used in the ongoing discussions). This may help to ensure passage, but we think it’s important to note that the October 31 deadline is a “soft” deadline and the passage of the bills could easily be pushed towards the end of the year if necessary. As a historical reference, 21 of 25 past budget reconciliation bills (or 85%) have went on to be signed by the President.

Third Quarter 2021 Earnings Season Kicks Off

Third-quarter 2021 earnings season is starting with S&P 500 earnings-per-share (EPS) expected to rise about 28% year-on-year. If accurate, that would be a sharp drop from the massive 96% jump in second quarter earnings (which were compared against the previous year when the economy was in lockdown). However, it would still mark a strong quarter. Interestingly, earnings for both Growth- and Value-companies are expected to rise by about 28% this quarter. The reason this is interesting is because Value-company earnings are starting to normalize after surging 187% in the second quarter. This can be seen in the 2022 consensus estimates as well with Growth-company EPS expected to rise by 5% while Value-company EPS are expected to rise by just 0.2%. While Value stocks may be getting a bid once again as interest rates rise and Growth (specifically technology) stocks sell-off as a result, this dynamic may change heading into 2022 (see figure 1).

This bar chart shows the S&P 500 Consensus Earnings-Per-Share Estimate Year-over-Year in percent from Q3 2021 to Q4 2022. Growth-companies may experience better and more stable earnings growth than Value-companies in the year ahead.

As Citi Global Wealth’s Chief Investment Strategist Steven Wieting pointed out is this week’s CIO Strategy Bulletin | Looking Through the Market Noise to 2022, the outperformance of traditional cyclical shares may not last beyond the next quarter or so as the earnings power shifts back to higher quality, larger-cap firms with less cyclical exposure. Over the next couple of years, Citi Global Wealth believes that S&P 500 EPS could grow by an annual rate of 7%-8% even if a higher corporate tax rate shaves off 2%-3% from topline earnings.

Will the September Jobs Report Be a Green Light for Tapering?

Fed Chair Powell expressed quite clearly at the September Federal Open Market Committee (FOMC) meeting that he does not need to see a blowout September employment report to feel confident that sufficient progress has been made in the labor market for the Fed to move forward with a tapering of bond purchases. On October 8, investors will receive that report with the consensus looking for the economy to add 488,000 jobs during the month. Though we think it’s worth noting that the range between the high estimate (750,000 jobs) and low estimate (zero jobs) is quite wide...potentially setting the stage for a surprise. Citi Research is expecting an above-consensus of 560,000 jobs to be added. We believe that a report that falls in line with the consensus is likely more than enough for the Fed to feel confident with a tapering announcement at its November 3 FOMC meeting. While a failure to lift the debt ceiling could potentially change this, we think it is far from the base case as we expect the debt ceiling to be lifted ahead of the October 18 deadline.

A Tribute to a Lost Colleague

Citi’s Chief U.S. Equity Strategist Tobias Levkovich unfortunately passed away last week. A larger-than-life personality, Tobias taught many of his colleagues a great deal about financial markets over his lengthy and storied career here at Citi. However, it wasn’t his market wisdom that will be missed the most. It was his ability to make others laugh and to humanize an often-dull subject. His behavior served as a constant reminder that building lasting relationships is often more important than building lasting wealth. Remembering that everything we do is about people first and money second is just one thing that Tobias taught me, and I thank him for that. He will be sorely missed by many.

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