Weekly Market Update: Economic Growth Exceeds Expectations While the Fed Remains Attentive

What We’re Watching this Week:

• Personal Consumption Expenditures (PCE) Index will be released Friday.
• New home sales data will be released by the National Association of Realtors this week.
• Looking ahead to the GDP data for Q3.
• Report on durable goods orders expected.

Highlights from Last Week:

• Retail sales exceeded expectations.
• Industrial production increased.
• New construction for housing rose.
• U.S. economic indicators pointed to a decrease in overall economic health.

A sharp rise in government bond yields has increased volatility in stocks and bonds. Last week, the S&P 500 and Canadian TSX experienced significant declines of more than 1%, while the Bloomberg U.S. Aggregate Bond Index dropped by more than 2%. Higher yields can raise borrowing costs, lower stock valuations and negatively impact bond prices.

Geopolitical concerns, Federal Reserve officials’ tough statements and surging long-term bond yields at 16-year highs contributed to a significant weekly decline in the major indices. The S&P 500 Index plummeted the most in a month. The Nasdaq Composite Index had the worst performance – almost entering bear market territory with a 19.91% drop from early-2022 highs. Growth stocks underperformed value stocks. The STOXX Europe 600 Index fell by 3.44% in Europe due to uncertainty over interest rates and Middle East conflict fears. Disappointing earnings reports further worsened the overall negative market sentiment, with major Continental stock indexes, including Italy’s FTSE MIB, Germany’s DAX, France’s CAC 40 Index and the U.K.’s FTSE 100 Index all closing lower.

In October, the New York Fed’s Empire State Business-Conditions Index, which measures manufacturing activity in the state, decreased by 6.5 points to -4.6 – slightly better than the expected -6 according to a Wall Street Journal survey. A reading below zero indicates worsening conditions. The New Orders Index dropped by 9.3 points to -4.2, while the shipments index fell to 1.4. Unfilled orders saw a significant decline of 19.1 points to -13.9. Employment increased slightly in October, and prices decreased modestly. Despite the drop in October, firms remained relatively optimistic about the six-month outlook. The manufacturing sector has shown volatility over the past two years, with negative readings followed by improvements. Some economists see signs of stabilization, while others remain skeptical about a turnaround. The nationwide ISM Factory Index improved to 49% in September, which was the highest reading in almost a year but still indicated unfavorable conditions.¹

In September, U.S. retail sales exceeded expectations by increasing 0.7%, indicating that households have sufficient purchasing power to support economic growth. This boost was driven by strong demand at auto dealers and online stores, with higher gasoline prices also contributing. Economists had predicted a 0.3% increase in sales. Retail sales comprise about one-third of consumer spending and are often a gauge of economic strength. Auto dealers saw a 1% increase in sales, with auto sales accounting for about 20% of all retail sales. Gasoline station receipts also rose nearly 1%, but this was mainly due to higher gas prices and isn’t favorable for households. Retail sales still grew a robust 0.6% when excluding car dealers and gas stations, providing a better picture of consumer demand. Online retailers continued their strong performance with a 1.1% sales increase. Bars and restaurants experienced a 0.9% sales rise, typically a sign of a healthy economy and job security. Over the past year, restaurant sales increased by 9.2%, more than twice the inflation rate. On the downside, sales declined at large electronics stores, clothing stores and home improvement centers, such as Home Depot and Lowe’s. Additionally, August’s sales figures were revised upward to show a 0.8% increase, up from the initially reported 0.6%.²

U.S. industrial production, as reported by the Federal Reserve, increased by 0.3% in September, surpassing expectations of a 0.1% gain, according to a survey by The Wall Street Journal. However, the output in August was revised significantly lower from the initial estimate of a 0.4% gain to a flat reading. Manufacturing showed a 0.4% rise in September, with motor vehicle production increasing by 0.3%. The growth in motor vehicle production was somewhat restrained due to an ongoing strike against three automakers. Capacity utilization rose to 79.7% in September, up from 79.5% in August. This figure reflects the extent to which the nation’s factories, mines and utilities are operating at their full capacity. In more specific details, utility output decreased by 0.3% in September, while mining output, which includes oil and natural gas, rose by 0.4%. This marked the fourth consecutive monthly increase. Additionally, the index for defense goods saw its fifth consecutive monthly gain of at least 1%.³

In September, the construction of new homes in the United States rebounded by 7% to reach an annual rate of 1.36 million units, following a 1.5% decline in the previous month, as reported by the Commerce Department. Wall Street economists had expected a 6.8% increase to 1.37 million units. Building permits, which indicate future construction plans, fell by 4.4% to a rate of 1.47 million, slightly below the anticipated 6% decline to 1.45 million. Key details include a 3.2% increase in the construction pace of single-family homes in September, while apartment-building construction surged by 17.1%. Housing starts rose in the Midwest, South and West, with the Northeast being the only region to experience a drop. Permits for single-family homes increased by 1.8% in September, while permits for buildings with at least five units or more fell by 14%. Approximately 1.68 million homes were under construction as of September. Overall, economists anticipate that housing starts may trend lower in the coming months, as builders appear to lose confidence due to rising mortgage rates, which have now exceeded 8%.⁴

The number of Americans filing for unemployment benefits in the last week dropped to a nine-month low of 198,000, contrary to expectations of an increase due to rising U.S. interest rates. This figure decreased from a revised 211,000 in the previous week. It’s the first time new jobless claims have fallen below 200,000 since mid-January. These low jobless claims indicate minimal job losses and suggest a stable economy. Unemployment claims tend to exceed 300,000 and rise further when a recession approaches. Economists had predicted around 210,000 new claims for the week ending October 14. Key details reveal that new jobless claims decreased in 45 out of 53 states and territories reporting such data to the federal government, with claims rising in only eight states. Before seasonal adjustments, the number of raw or actual claims reached a low of 181,181, one of the lowest levels in more than 50 years. On the other hand, the number of individuals collecting unemployment benefits from all programs in the U.S. increased by 29,000 to 1.73 million. However, most laid-off workers are finding new jobs relatively quickly.⁵

In September, home sales in the U.S. dropped to their lowest level since 2010, primarily due to the impact of high mortgage rates on the housing market. According to the National Association of Realtors, sales of previously owned homes decreased by 2% to an annual rate of 3.96 million. The decline in sales, while still significant, was slightly better than the 3.9 million expected by Wall Street. Compared to September 2022, home sales were down by 15.4%.

Key details include a rise in the median price for existing homes in September to $394,000. This marks the third consecutive monthly increase and a 2.8% increase from a year ago. About 26% of properties were selling above their list price. Housing inventory remained limited, with the total number of homes for sale in September falling by 8.1% from the previous year to 1.13 million units, the lowest since 1999. Homes listed for sale spent an average of 21 days on the market, up from the last month’s 19 days.

Sales of existing homes only increased in the Northeast in September, rising by 4.2%, with a median price of $439,900 in the region. All-cash buyers accounted for 29% of sales, which is the highest since January 2023, and about 27% of homes were sold to first-time buyers. The U.S. housing market is experiencing a significant slowdown primarily driven by high mortgage rates, deterring buyers and sellers. This slowdown is expected to continue, with existing home sales in 2023 projected to be at their slowest pace since the 2008 housing bubble burst, reaching a pace of 4.1 million, according to real-estate brokerage Redfin. Lawrence Yun, the chief economist at the National Association of Realtors, highlighted that mortgage rates and limited inventory have been the key factors affecting the market, and the situation may worsen as interest rates continue to rise.⁶

In September, the leading economic index in the U.S. declined by 0.7%, marking the 18th consecutive month of negative performance. This index, comprising 10 indicators to gauge the economy’s direction, was worse than the 0.4% decline economists polled by the Wall Street Journal had anticipated. A prolonged negative trend in this index is often seen as a warning sign of an impending recession. However, despite this, the U.S. is still expected to achieve substantial economic growth in the third quarter.

The coincident index, which measures current economic conditions, increased by 0.3% in September, while the lagging index, offering a retrospective view, increased by 0.2% during the same month. Nine of the 10 indicators in the leading index remained flat or declined in September. While the economy doesn’t currently show signs of an imminent recession, it’s important to note that the late stages of a business cycle often do not provide clear warnings of an impending downturn. The Federal Reserve has raised short-term interest rates significantly, which may take time to impact the broader economy.

Looking ahead, experts predict that the U.S. economy has displayed resilience amid rising interest rates and high inflation. However, the Conference Board, which publishes the leading index, forecasts a possible shallow recession in the first half of 2024.⁷

On Thursday, Federal Reserve Chairman Jerome Powell, during a speech at the Economic Club of New York Luncheon, expressed the Central Bank’s attentiveness to recent economic data that indicates resilient U.S. economic growth and strong labor demand. If this trend persists, it may necessitate further interest rate hikes.

Powell mentioned that additional signs of persistently above-trend growth or labor market tightness not easing could jeopardize progress on inflation and prompt tighter monetary policy. The Fed is cautious, dealing with both old and new uncertainties. Balancing the risk of raising interest rates too high with the risk of keeping them too low to combat inflation is challenging.

Powell highlighted their attentiveness to tighter financial conditions due to rising long-term bond yields. The Fed has raised its policy interest rate to 5.25%-5.5% over the past 19 months, with a “restrictive” policy stance that exerts downward pressure on economic activity and inflation. The rapid pace of tightening may continue to affect the economy in the coming months.

Powell welcomed lower inflation readings but noted that inflation remains too high, requiring more sustained data improvement. He also observed that the labor market, while strong, is slowing. Economic growth has consistently exceeded expectations this year, with a solid third quarter forecasted and a cooling-off period.⁸

Sources:

¹https://www.newyorkfed.org/survey/empire/empiresurvey_overview#:~:text=Business%20activity%20edged%20lower%20in,while%20shipments%20were%20little%20changed

²https://www.census.gov/retail/marts/www/marts_current.pdf

³https://www.federalreserve.gov/releases/g17/current/g17.pdf

⁴https://www.census.gov/construction/nrc/pdf/newresconst.pdf

⁵https://www.dol.gov/ui/data.pdf

⁶https://www.nar.realtor/research-and-statistics/housing-statistics/existing-home-sales

⁷https://www.conference-board.org/topics/us-leading-indicators

⁸https://www.federalreserve.gov/newsevents/speech/powell20231019a.htm

Important Information:

Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.

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