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Markets and macro insights with Brian Flavin, Senior Equity Research Analyst
What has been happening in markets?
- Last Friday week, US Fed Chair Jerome Powell spoke at the Economic Policy Symposium at Jackson Hole. In his speech he said that the time has come for policy to adjust.
- It was the clearest indication yet that cuts will be happening in September but now the question is: by how much will they be cut? The odds still favour a 25bps cut, but there is a sizeable probability they could cut by 50bps.
- Given that inflation is decelerating, the latest reading being the Fed’s favourite gauge of core Personal Consumption Expenditures (PCE) coming in softer than expected last Friday, the focus turns to the employment mandate. This makes this week’s jobs report take on added importance. A strong jobs report would allow the Fed to cut rates at a slower pace than it might otherwise do, confident that it’s not being overly restrictive, and help the broader market. A weak report might increase the odds of a 50bps cut in September and see the market trade more defensively.
- Markets have had quite the rollercoaster in the last few weeks. The last jobs report triggered a sharp sell-off and concerns about recession in the US, only to turn around again on moderating inflation and a strong retail sales report.
- Nonetheless, if we delve a little deeper, we can make some interesting observations. First, the rebound in the S&P 500 has been broader based than we have been used to so far this year. Five of eleven sectors outperformed the index during this latest rebound versus just two driving much of the returns in the first half of the year. Second, of those five sectors that outperformed, four of them are considered defensive sectors.
What does all this signal to us?
- Typically, defensive sectors do better in a late cycle environment where their earnings tend to hold up better than more cyclical sectors. In recent months, the market appeared to be becoming complacent about a soft landing in the US economy, it’s not so complacent now and this suggests a dose of realism entering the equation.
- Questions remain about the strength of the US labour market and the extent of any growth slowdown. And while earnings expectations look solid, companies will be scrutinised more closely about the sustainability of those earnings. We saw that with some of the Magnificent 7 last month. And in that context, Nividia’s earnings last week were an important barometer. In the event, they met very high expectations which should be a good outcome for earnings.
- The US Consumer still seems to be in good shape, as demonstrated by the recent retail sales datapoint, while US consumer confidence also came in better-than-expected last week. This is the biggest driver of the US economy so even though we have weak manufacturing sentiment, it’s not enough to make us concerned about an impending US recession.
- However, the euro area and China remain fragile. Eurozone core inflation readings for August released last Friday softened in line with expectations, putting pressure on the ECB to deliver another rate cut. The weak dollar will also put more pressure on both those regions as well.
- Our positioning in equities continues to reflect a defensive quality, but with upside risk coming from sectors and companies in structural growth areas.
The week ahead: what to watch out for
The highlight of this week will be Friday’s August Non-Farm payrolls report. Which as mentioned above, takes on added importance this month because of what it might mean for Fed policy and because of the outstanding questions around the health of the US consumer. Other than that, we will get the ISM’s surveys of the manufacturing and services sector in the US tomorrow and on Thursday, respectively. The market expects small improvements in both over prior months, although manufacturing is still in contracting territory.
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