Stocks have been under pressure ever since Federal Reserve (Fed) Chairman Powell strongly reiterated that the Fed would continue pursuing its higher interest rate policy until inflation returns to its 2% long-term target.

While the tight labor market suggests more interest rate hikes to come, there are signs that inflation is past the peak. The August labor market report was encouraging, with a rising labor-force participation rate, and a slower-than-expected increase in hourly wages. Meanwhile, the incoming economic data remains consistent with slower economic growth but not recession. Given the uncertainty around inflation and the Fed’s higher interest rate response, we remain neutral toward stocks and favor the Health Care and Energy sectors. All of this is discussed below.

Subdued But Still Positive Manufacturing Activity

The ISM Manufacturing PMI (a timely business survey) was unchanged in August at 52.8 (above 50 signals expansion), its lowest level since June 2020, but above the consensus of 52.0. It shows a steady pace of factory activity growth last month, although much softer than earlier in this cycle. The ISM estimates that the latest PMI corresponds to 1.4% annualized economic growth, which suggests a below-trend expansion but not yet a recession. Industry breadth has narrowed, as only 10 of the 18 ISM industries expanded last month, the fewest since May 2020. This is also consistent with continued, but slower, growth.

Importantly, cost pressures continued to ease. There were 14 commodities, the most since May 2020, that fell in price. At the same time, the number of commodities that rose in price or were in short supply continued to diminish. As a result, the ISM Prices Index fell for the fifth decline in a row, to the lowest level since June 2020. It is no longer consistent with significant upward pressures on either producer or consumer price inflation.

Consumer Confidence Rebounds

The Conference Board’s Consumer Confidence Index rebounded 7.9 points in August to 103.2, above the consensus of 97.0. It was its first increase in four months and the most since June 2021. While the level is well below its cycle peak in mid-2021, it remains consistent with continued economic expansion. On a y/y basis, confidence is off 12.0 points, but momentum has improved over the past couple of months, a sign of receding recessionary fears.

Labor Market Strength Continues

Nonfarm payrolls expanded by 315,000 in August, in line with expectations of 318,000. A rebound in the participation rate from 62.1% to 62.4%, which matched the March high for the year, caused the unemployment rate to rise to 3.7%, above the consensus for an unchanged reading of 3.5%, and above all economist forecasts. Average hourly earnings rose 0.3%, below the consensus of 0.4%. That left the y/y change at 5.2%, below forecasts of 5.3%.

Last week’s Job Openings and Labor Turnover Survey (JOLTS) showed job openings rebounded 1.8% in July, its first increase in four months, to 11.2 million. But hires fell 1.1%, its fifth consecutive decline, to 6.4 million, the lowest level in nearly a year. While the number of open positions suggests labor demand remains close to a record high, the decline in hires points to a slowdown in the job matching process, likely due in part to a decline in labor supply. There continues to be nearly twice as many job openings as unemployed workers, implying continued upward pressure on wage growth.

Initial claims for unemployment insurance fell 5,000 last week to 232,000, contrary to the consensus for an increase to 245,000. It was the third consecutive decline, bringing the four-week average of claims down by 4,000 to 241,500. Although higher than its cycle low of 170,500 five months ago, the trend in claims is only slightly above what it was pre-pandemic and is still subdued by historical standards.

All of these labor market indicators suggest that labor demand remains solid, which is inconsistent with recession at this time and suggests the Fed will continue to hike rates aggressively.




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