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Market volatility intensifies as fears of recession mount


Manufacturing and employment reports issued today disappoint investors

Capital market volatility has increased following several disappointing economic indicators’ release this week, fueling concerns over slowing economic growth. On Tuesday, the Institute of Supply Management (ISM) survey of manufacturing supply chain executives, known as the Purchasing Manager Index (PMI), fell to 47.8, with levels above 50 indicating expansion in the manufacturing sector and levels below 50 indicating contraction. Only three of the eighteen manufacturing industries surveyed reported growth in September, with global trade remaining the most significant issue and business sentiment remaining cautious due to policy-related uncertainty.

Second, the national private sector employment report today from the ADP Research Institute showed a smaller than expected increase in September payrolls (135,000 versus an estimate of 140,000) plus a sizeable downward revision in August payroll increases (from 195,000 to 157,000 net jobs added).

In response to the lower than expected manufacturing sentiment and lower than expected growth in private payrolls, risk assets have declined in price this week, with the S&P 500 falling 1.8 percent today, bringing the two-day decline to 3.0 percent. A measure of U.S. equity market volatility, the Chicago Board Options Exchange (CBOE) Volatility Index (VIX), has risen more than 30 percent during these two trading days, albeit from low levels prior to this week’s movement. Foreign equities have not been spared, with foreign developed stocks dropping 3.0 percent and foreign emerging equities 1.5 percent.

The weakness in the manufacturing and payroll data is notable, but they are not inconsistent with our current narrative of a slowing but still positive U.S. economy. Also, business confidence remains impaired by policy concerns as we head into third quarter corporate earnings season. The ISM manufacturing index has fallen six consecutive months, and while the current reading is below the expansionary threshold, this measure is not at levels consistent with a broader economic recession. The ADP payroll report, while showing sluggish growth in payrolls, has also been consistent within a context of a tight labor market. At recent meetings with executives from large manufacturing firms the last two weeks, finding and retaining quality labor was a central concern along with policy-related uncertainty. Unemployment remains at historically low levels, while workers remain highly confident of job prospects as seen by a near-record high in voluntary quit rates.

As we wait for third quarter earnings season to begin in earnest in a couple of weeks, we will be monitoring price action in the S&P 500 with an eye towards two key technical levels, 2,840 and 2,800. After hitting the all-time intra-day high of 3,028 on July 26th, 2,840 has represented a market bottom, or a floor, during recent periods of market volatility this summer, reached three separate times in August (5th, 15th, and 23rd). Beyond this recent price floor, 2,800 would represent the next significant level which the market has held since late March, outside of a period of heightened market volatility in late May/early June due to trade-related concerns.

So how do the week’s developments impact our views on the forward investment landscape? Given recent disappointing economic data, the absence of corporate fundamental news, and continued policy-related uncertainty both domestically and with respect to key trade partners, the capital market reaction appears justified, although it could quickly become overdone. Prior to this week, expectations for economic growth in the United States had been sufficiently recalibrated to account for slowing but positive growth that data releases on average were surprising to the upside for the first time since February, according to the Citi Economic Surprise Index.

Our chief concern centers on weakening economic momentum amid unresolved trade negotiations. Our systematic data checks, which span nearly 800 global economic variables, continue to register a slowdown, albeit from a strong base. Recall that in 2017 and early 2018, the prevailing capital market narrative was one of “synchronized global growth” with many major economies experiencing strong activity across corporations and consumers. However, in early 2018, China began to weaken, as did Europe and Japan, and eventually North America followed suit.

As the trade war continues, CEO and CFO sentiment has fallen from high to still-above average levels, with optimism about future spending plans curtailed somewhat; consumers have yet to slow down consumption decisions. We are carefully monitoring indicators that help assess if the growth picture could weaken beyond the manufacturing sector, and we will be scrutinizing third quarter corporate earnings reports for additional evidence. While we must respect the adverse case scenario, that is not our base case at this time. Our job is to help improve the odds of your success, and we think remaining diversified and disciplined within your financial plan is the best path for you. Please do not hesitate if we can answer any questions and we thank you for your trust.

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