Stocks posted modest gains across most regions as U.S. lawmakers appeared on track to temporarily avert hitting the nation’s debt ceiling. In the U.S., the S&P 500 climbed 0.8% while the NASDAQ eked out a 0.1% gain. Non-U.S. markets posted modest gains as well with both European and Emerging Market stocks adding 0.9%. Japanese stocks underperformed – pulling back 2.3%. The 10-year U.S. Treasury yield jumped 15 basis points from 1.46% to 1.61%.
The table has potentially been set for an awkward Thanksgiving dinner with Republicans and Democrats on the verge of pushing back the debt ceiling debate until December 3. As it stands now, Democrats will likely use the time to finalize the details on their social infrastructure bill and to close ranks in order to lift the debt ceiling and replace the continuing resolution being used to fund the federal government through December 3 with permanent funding. We are hopeful that the extra time will be used productively, but no immediate crisis may also mean no immediate action.
The September employment report was weaker-than-expected, but likely good enough to give the Federal Reserve the green light for announcing a tapering of their bond purchases at their November 3 meeting. . In our view, it would likely take a very weak 3Q 2021 real gross domestic product (GDP) print on October 28 to change their stance.
The Week in Review
Third quarter earnings season kicks off with Financials taking centerstage.
S&P 500 earnings-per-share (EPS) are expected to rise by about 28% year-on-year while Bank earnings are expected to rise by about 23% year-on-year. Investors will likely be watching bank earnings to see how rising interest rates may be impacting net interest margins. Technology earnings will also be watched closely with EPS expected to rise by about 28%. Investors will also be listening to company comments on rising input costs and whether companies have sufficient pricing power to pass on these rising costs to consumers or if the costs will cut into profit margins.
World leaders struck a landmark deal on a global minimum tax rate for multinational corporations.
The Organisation for Economic Cooperation and Development (OECD) announced that 136 countries and jurisdictions, including China, agreed to a deal that would ensure that big companies pay a minimum rate of 15%. The countries that joined the deal account for more than 90% of the global economy. The agreement will likely become law in 2022 and go into effect by 2023.
The Table Has Been Set
Investors were pleased to hear that Congress may have reached a short-term deal to lift the debt ceiling by $480 billion in order to allow the U.S. Treasury to maintain government operations until at least early December. Thus far, the extension has been approved by the Senate, but still awaits passage in the House with a vote possible on October 12. While likely to pass and provide a short-term reprieve, kicking the can down the road may still set the table for an awkward Thanksgiving dinner between Republicans and Democrats if Democrats do not make any additional progress on the debt ceiling or federal spending by then (a continuing resolution that is funding the federal government will expire on December 3). It is unclear to us whether the additional time will simply be used as more time for both parties to point fingers or if it will be used productively, but we strongly suspect that “no immediate crisis” may mean “no immediate action.” However, at the very least, the near-term risk of a government default appears likely to be temporarily averted and market volatility may begin to ease some after weeks of wild swings in the Dow Jones Industrial Average (see figure 1) and third quarter earnings season kicks off. Aside from giving Democrats more time to work out procedural details, the delay may also allow the Treasury Department more time to bolster “extraordinary measures” should the debt ceiling debate go unresolved by December 3. In theory, bolstering these measures could allow the Treasury to fund government operations into the first quarter of 2022, pushing the “hard” debt ceiling back significantly from the original date of October 18.
Did the September Jobs Report Set the Table for a Fed Taper?
We think it probably did. The September employment report came in weaker-than-expected with just 194,000 jobs being added during the month (versus a consensus estimate of 500,000 jobs). However, much of the weakness can be attributed to a sharp decline in state and local government employment with local government education employment falling by 144,000 and state government education falling by 17,000. According to the Labor Department, pandemic-related staffing fluctuations have distorted the normal seasonal hiring and layoff patterns. In fact, prior to seasonal adjustment, the sector added 718,000 jobs in September. Excluding government jobs, private payrolls rose by a much better 317,000 jobs (see figure 2).
Importantly, even with August and September payrolls coming in weaker-than-expected, monthly job gains have averaged 561,000 per month in 2021. That is a very solid recovery pace with the unemployment rate falling to 4.8% in the latest report. There are also signs that the more modest pace in hiring seems to be more of a result of worker shortages than a lack of demand with job openings in the U.S. still near a record high. In fact, there is currently 2.8 million more job openings than there are unemployed (see figure 3). While a positive dynamic, this could continue to put upward pressure on wages in pandemic-distorted sectors of the labor market. A prime example is the leisure and hospitality sector where wages are now up 10.8% year-on-year as the demand for workers outstrips the supply (see figure 4). Transportation and warehousing wages are also up 6.0% year-on-year and education and health services wages are up 5.8% year-on-year.
This likely bolsters the Fed’s case that sufficient progress has been made within the U.S. labor market to move forward with a tapering of its bond purchases. An announcement seems highly likely to occur at the November 2-3 Federal Open Market Committee (FOMC) meeting; however, we would encourage investors to keep an eye on third-quarter growth with the widely-followed Atlanta Fed’s GDPNowcast tracking at just 1.3% currently (see figure 5).
Such a low rate of growth seems out of step with the type of growth that national business surveys like the ISM manufacturing and services indices are pointing to, but with third quarter real gross domestic product (GDP) set to be released on October 28 the report could be yet another hurdle for the Fed to overcome before making their official announcement. Though it is encouraging that there are plenty of signs that suggest that the recent slowing in growth is a result of supply chain issues and not a slowing in demand. The National Federation of Independent Business’ Small Business Economic Trends report supports this with just 4.0% of small businesses saying that poor sales are their single most important problem (see figure 6). Quality of labor remains a much larger issue with a record high 28.0% saying it is their biggest problem. Unsurprisingly, the cost of labor is also becoming a larger problem as the shortage of qualified workers persists (see figure 7). Assuming supply chains issues eventually ease, this should lead to a stronger fourth quarter real GDP print.
What Does a Less Accommodative Fed Mean for Markets?
Despite the prospect for near-term volatility as investors look for clarity, if we use the 2013 “taper tantrum” as a playbook, the U.S. stock market held up quite well over the longer-term – returning an average of 12.2% over the next four years as the economy continued grow while the Fed stopped expanding its balance sheet and eventually went on to raise interest rates nine times between the end of 2015 and the end of 2018 (see figure 8). Returns were indeed negative in 2018, but we would argue that rising U.S. – China trade tensions likely played a crucial role. As figure 9 shows, on average, the S&P 500 returned an additional 35.6% over the next two years following the first Fed rate hike in a monetary policy tightening cycle before experiencing a 20% plus bear market. With the first Fed rate hike unlikely to occur before the end of 2022, history suggests that a bear market remains some ways off.
|First Rate Hike||S&P 500 Index||S&P 500 Peak Date||S&P 500 Index||S&P 500 % Move
From Hike to High
|Number of Months
from Hike to High
|Average:||average percent change for S&P 500 from hike to high across all given records in this table is 35.6||average percent change for number of months from hike to high across all given records in this table is 25|
|Median:||median percent change for S&P 500 from hike to high across all given records in this table is 36.5||median percent change for number of months from hike to high across all given records in this table is 22|
|Index||Weekly Chg (%)change in percent||YTD (%)year to date change in percent||12 Months (%)12 month change in percent||Div. Yield (%)division yield in percent|
|Instrument||Weekly Chg (%)change in percent||YTD (%)year to date in percent||12 Months (%)12 month change in percent||Level|
|10-Year Treasury Yield (%)||15 bps||69.8 bps||82 bps||1.61%|
|Index||Weekly Chg (%)change in percent||YTD (%)year to date in percent||12 Months (%)||Div. Yield (%)division yield in percent|
The Week Ahead
|10/12||6:00||NFIBNational Federation of Independent Business Small Business Optimism||September||99.5||100.1|
|10/12||10:00||JOLTSJob Openings and Labor Turnover Survey Job Openings||August||10950k thousand||10934k thousand|
|10/13||8:30||CPIConsumer Price Index YoY year on year||September||5.3%||5.3%|
|10/13||8:30||CPIConsumer Price Index Ex Food and Energy YoY year on year||September||4.0%||4.0%|
|10/13||14:00||FOMC federal open market committee Meeting Minutes||9/22/2021|
|10/15||8:30||Retail Sales Advance MoMMonth over Month||September||-0.2%||0.7%|
|10/15||8:30||Retail Sales Excluding Auto and Gas||September||0.5%||2.0%|
|10/15||10:00||U of Mich.University of Michigan Sentiment||October P||73.5||72.8|