Capital markets perspective: Agree to disagree

Capital markets perspective: Agree to disagree


Agree to disagree.

Last week’s most important economic data should’ve been the so-called PMI releases for the services sector of the U.S. economy. As a reminder, “PMI” stands for “purchasing managers’ index” – a series of monthly surveys of business executives designed to tease out how business leaders feel about the future and how they’re positioning their firms for whatever might lie ahead. Survey-takers ask all sorts of questions like “are your customers ordering more stuff from you, or less?” and “how much are you paying for the things you need to conduct your business?” or “how much are you charging your customers in return?” As such, the PMIs have gained a reputation as both insightful and forward-looking; if I were given access to only one type of economic indicator to do my job, I’d pick the PMI surveys.

Two of the most famous and well-respected PMI surveys are conducted and disseminated by Standard & Poor’s Global[1] and the Institute of Supply Management[2]. Both surveys have clear similarities in how they’re designed and interpreted by markets, and they tend to move more or less in the same direction most of the time. But there are times when they seem to disagree, at least on the margin. Last week was one of those times.

Here’s the deal: the reason last week’s services PMIs were potentially so interesting is that the manufacturing version of both surveys suggest the nation’s factories have been facing contraction nearly a year, but the services versions have been significantly more upbeat. Because the services side of the U.S. economy is so much larger, any self-respecting economist still stubbornly clinging to a prediction of near-term recession is absolutely begging for the services PMIs to cool alongside manufacturing so as to avoid having to backtrack against that call (and eat a significant amount of crow in the process...)

S&P’s version complied with that bearish outlook, drifting very close to neutral and continuing a downward trajectory that, at least to the naked eye, makes it look almost inevitable that services will soon join manufacturing below the line separating growth from contraction. The ISM’s version, however, was not so compliant: their version zigged while S&P’s zagged, with ISM data beating analyst’s expectations and suggesting the services sector even moved a little deeper into growth territory.

Now… the differences weren’t massive, and it’s possible to find data inside both surveys hinting at a pending reconciliation of those seemingly contradictory views (for example, the ISM version contained evidence that work backlogs among service providers shrank significantly despite its generally more upbeat tone, while the more bearishly-tinged S&P version grudgingly admitted that export orders had increased.) But in some ways, the disparity between these two very similar surveys simply highlights the rift that has grown between the “doom-and-gloom” crowd who see recession as always lurking just around the corner, and the “this-time-is-different” partisans who insist that the Fed can successfully engineer the rarest of rare feats for a central bank: a soft landing amid the most aggressive tightening cycle in a generation. More to come on that debate, especially because last week’s services PMIs did so little to solve it.

It's important to remember that markets don’t really have the same navel-gazing luxury as economic forecasters and market strategists when it comes to timing: economists can afford to be more philosophical, but markets have to react in the here-and-now. That forced traders into choosing which interpretation of service sector trends to emphasize: S&P’s slightly dour view, or the ISM’s decidedly more upbeat one. On Wednesday, when both surveys were released, they chose the ISM’s rosier one.

But as we saw last week, good news for the economy is sometimes bad news for the market (and vice versa), especially when the Fed is still part of the equation. So, in a reversal of last week’s thankfully-worse-than-expected jobs data, this week’s unfortunately-better-than-expected services PMI data (at least as far as one survey was concerned) became an excuse for markets to trade lower.

Confused? Me too. So here’s a recap:

1) Last week’s services PMI data was important because it could’ve either confirmed or denied that the services sector was joining the manufacturing sector in contraction, thereby helping solve the riddle of whether or not the U.S. economy was headed for recession.

2) It did neither of those, because one PMI survey screamed “growth” while the other hinted at “contraction."

3) But markets, who live in the here-and-now, had to choose one interpretation or the other – and they chose “growth."

4) That rosy interpretation is probably good news for the economy, but bad news for the markets because it leaves the Fed in the equation, which led to

5) markets giving back last week’s gains in the latest iteration of the “bad news is good” dynamic that is dominating markets right now.


Okay, let’s move on. If the PMI data didn’t necessarily agree with itself last week, one economic release that did enjoy almost perfect internal consistency was the Fed’s Beige Book[3]. That collection of economic anecdotes from around the Fed’s various districts was virtually unanimous in suggesting that economic growth was noticeably slower, but still mostly positive. In fact, maybe the most interesting thing about last week’s Beige Book was seeing how creative the Fed’s copywriters could get in finding synonyms for the word “meh” (for the record, the winner of last week’s Beige Book Bingo was the word “slight”, which was used by no fewer than four of the Fed’s 12 districts when trying to describe the economy’s current tone…)

Finally, let’s close with one last example of “agreeing to disagree”: the United Autoworkers Union versus Detroit’s Big Three. As we’ve discussed for several weeks running, the UAW and The Big Three are on a collision course that could see as many as 150,000 autoworkers idled and on strike as soon as next week if ongoing contract negotiations fail to produce an agreement by the end of this week. At issue are all sorts of things like maximum workweeks, tiered wage systems and a host of others.

But the centerpiece of the disagreement is an aggressive wage increase sought by the union. While the labor market’s persistent strength gives more than a measure of credibility to that demand, one anecdote from last week’s news ticker might nonetheless give union leaders pause: In a fascinating but perhaps under-reported development, retailer Walmart – not unionized, but still estimated to be the single biggest employer in the U.S. – said it was eliminating a tiered wage system in which it previously brought in workers for its online business at a slightly higher rate than employees who filled similar roles in its old-fashioned brick-and-mortar stores. But no more: In maybe the best sign yet that labor markets are perhaps finally beginning to soften, Walmart determined that a tiered wage system was no longer needed to attract new applicants and will begin paying new hires at the same rate across functions. That, perhaps more than payrolls data or weekly jobless numbers, might be a sign that these kinds of negotiations may not favor labor quite as strongly as they once did.

Full disclosure: About a hundred and ten years ago, while an undergrad, I carried a UAW card and was once part of a labor dispute similar to the one currently pitting the UAW against the Big Three. I’m trying hard to separate that experience from my role as economic commentator, but you should judge for yourself whether I’m over-emphasizing it here. Still, it’s hard for me to shake a feeling that economists might one day look back on this contract negotiation as an inflection point for the jobs market. So, grab some popcorn and watch as events unfold: it might tell us a LOT about where the economy goes from here.

What to watch this week

Economic Events, September 11–15            

Monday: No major economic releases scheduled

Tuesday: NFIB small business confidence

Wednesday: CPI inflation, Atlanta Fed business inflation expectations

Thursday: PPI inflation, retail sales, weekly jobless claims

Friday: Empire St. Manufacturing, UofM consumer sentiment, industrial production

It’s inflation week. We’ll get the latest read on inflation at the consumer level on Wednesday when the Bureau of Labor Statistics releases CPI data for August, followed a day later by the inflation at the wholesale level in the form of the producer price index (PPI).

Both releases matter, and none other than Fed Chair Jerome Powell has admitted that these will be primary inputs into the FOMC’s decision on rates later this month. However, as the somewhat muted reaction by markets to alternating too-hot-or-too-cold economic data over the last two weeks might suggest, investors have probably lost their single-minded focus on the Fed – maybe for good, at least as far as this rate cycle is concerned. That means there is probably a fairly high threshold for both the CPI and PPI data to move markets in a big way. I wouldn’t rule out a significant reaction in either direction if the inflation data are a big surprise; I just wouldn’t lose too much sleep over it unless you expect a shocker on one side of the estimate or the other.

Next down the list of potential market-movers is Thursday’s retail sales release. As discussed previously, the U.S. consumer’s ability to keep spending is starting to feel almost heroic, what with surplus savings on the wane, student loan payments set to resume shortly and the jobs market showing signs of becoming a little less bullet-proof. Sure, it’s possible to argue that consumers are increasingly relying on credit to keep up the pace of spending (as last week’s consumer credit release suggested: Revolving credit balances expanded by more than $9 billion in July[4]), but does it matter? If people are still spending, then the economy can keep on ticking – at least until the music stops. Thursday’s release will provide a hint at how durable that propensity to spend really is.

Two confidence releases are also worth a look: small business confidence from the National Federation of Independent Businesses on Tuesday, and a preliminary look at September consumer sentiment from the University of Michigan on Friday. The single most important commodity within any modern economy the confidence of its various stakeholders, and if the recent softening in both business and consumer confidence continues (or even accelerates), questions will naturally start to arise about the durability of growth. Tune in this week for more.

Toward the bottom of the list are two releases designed to illustrate trends on the productive side of the economy, both due out Friday: industrial production and the Empire State Manufacturing survey from the New York Fed. At this point, the cat’s kind of out of the bag with regard to manufacturing – everybody knows trends there are weak. Assuming no massive blow-ups in the meantime, the next attention-grabbing trend in these types of manufacturing-related releases will probably be when they return finally decisively (and consistently) back to growth. Never say never, by my gut tells me we’re a long way from that, so I’m not sure I’d spend a ton of time obsessing over these data for now.

Finally, because so much time has passed, it’s getting easier and easier to forget that 22 years ago to the day our nation suffered the worst tragedy in our shared history. And that’s a blessing: Nobody who witnessed those events unfold in real-time cherishes those memories or hopes for their return. But as awful as the September 11 attacks were, we can at least look back on one unexpectedly beautiful consequence and envy it: In the immediate aftermath of 9/11, we enjoyed a national unity unlike anything before or since. So while we pause to remember that terrible day 22 years ago, maybe we can devote a little time as well to contemplate where that unity and sense of pride have gone and why they both seem so unreachable today. That introspection, my friends, is perhaps the biggest gift we could give to ourselves as a country.





Tom Nun, CFA


Tom Nun, CFA, Portfolio Strategist at Empower, works alongside teams overseeing portfolio construction, advice solutions, portfolio management, and investment products and consulting.

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