MARKET COMMENTARY

The Dow Jones Industrial Average notched its fourth straight winning week as the index’s member companies posted strong Q3 results. McDonald’s, Coca-Cola, Visa, Caterpillar, and Merck all topped estimates. The index’s composition allowed the Dow to sidestep the wreck in big tech from the likes of Meta, Google, Amazon, and Microsoft, which all collapsed on disappointing earnings and/or weaker than expected outlooks. The Dow, which serves as a proxy for the overall health of the underlying economy, also got a lift from a stronger than expected Q3 GDP report. The U.S. economy expanded at a 2.60% annualized clip in the third quarter, driven by healthy consumer and business spending and surging exports to Europe. Across the pond, calm returned to the UK’s financial markets as Rishi Sunak became Britain’s 57th Prime Minister. Known for his fiscal conservatism, the prime minister will have the critical task of rebuilding the government’s credibility following his predecessor’s policy missteps at a time when the UK is still battling inflation at 10.10%. Overall, better than expected earnings data and strong economic reports combined to send the Dow surging 5.72% for the week. 

Exports Drive U.S. GDP Rebound

After two consecutive quarters of negative GDP, U.S. GDP bounced back strongly in Q3, rising an annualized 2.60%. That beat the Dow Jones estimate of 2.30%. Growth was driven by increases in consumer, business, and government spending along with a rise in exports. Consumer spending rose 1.40% during the quarter, down from the 2.00% pace in Q2. The deceleration was a result of persistent inflation that has required that consumers be more deliberate in the allocation of their dollars. The report showed consumers continued to opt for experiences over goods which resulted in spending on services rising 2.80% while spending on goods fell -1.20%. Turns out, war is good for business. For the quarter, exports rose 14.40% driven by military exports to Europe, and record shipments of oil, petroleum products, and natural gas needed to fill the gap from Russia. It wasn’t all good news for economic growth, however, as residential investment plunged -26.40%. This follows a slide from Q2 of -17.80% with homebuyers finding themselves increasingly shut out of the housing market due to the Fed’s interest rate hikes. Although the Q3 report shows the economy’s resilience by continuing to expand amid high inflation and higher interest rates, it could prove difficult to pull off a repeat in Q4. Energy exports to Europe drove much of the growth in Q3. At the moment, Europe appears well stocked for the winter months with gas storage near capacity at a time when weather remains favorable. Also, while consumers and businesses have continued to spend despite high inflation, the math will get more difficult with the Fed expected to keep increasing rates through the end of the year.

Household Spending Rises Amid Higher Prices and Incomes

U.S. household spending continued to rise last month. Consumer spending rose 0.60% in September as households spent more on services such as transportation and rent. The Fed’s preferred inflation measure, the personal consumption expenditures (PCE) price index rose 0.30% in September and was up 6.20% from the year ago period. September’s annualized reading matched August’s pace. The PCE reading is the Fed’s go-to inflation gauge compared to the more widely followed consumer price index from the BLS. The PCE is a more sensitive measure because it adjusts for consumer consumption behavior, in particular substitution of less expensive goods, when determining the cost-of-living increases rather than simple price moves on a fixed basket of goods. Excluding volatile food and energy prices, the index rose 0.50%. That pushed the index to a 5.10% yoy increase from August’s 4.90%. That’s a notch below February’s 40-year high of 5.40%. Meanwhile, personal income rose 0.40% in September driven by wage growth and interest income. September’s reading follows upward revisions to July and August which rose 0.40% and 0.50%, respectively. With inflation remaining elevated, consumers continued to dip into their savings, which pushed the savings rate to 3.10%. That is well below the pre-pandemic high of 8.3% and it is a testament to the compounding effect that the income gap relative inflation is having on families. The Fed is undoubtedly aware of the need to bring prices down before the consumer is entirely tapped out.

Final Thoughts

It was a surprisingly strong performance for market’s this week and arguably one that was better than earnings and economic reports may have justified on their own. The week’s reports did remove concerns over whether the bottom was falling out on the economy, but markets generally have been trading in the lower end of a trough since mid-September and this week’s better than expected announcements provided the lift to bring markets back to reason. It was nice to have validation that the economy remains on stable ground, but that is not to say it is blue skies from here. We have yet to feel the full impact of rate hikes, and more of those are on the way just next week. While consumers and businesses continue to spend, there are some signs of weakening. Jobless claims remain low, but corporate announcements of job cuts are increasing. These statements would be true whether we’re headed into a recession or the panacea of a “soft landing”, but with core inflation still above 5% there is still a lot more twists to come. Interestingly, the prevalence of analysts and media outlets willing to call this week’s surge simply a “bear rally” diminished considerably this week. The news this week was not without its lowlights, and the absence of reports labelling this week’s rally as just a temporary reprieve was notable given the reflex to do so over the last three weeks. It could be that analysts were reluctant to go on record during a week when GDP came in better than expected, but it is more likely that the confluence of earnings, data, and new stewardship in the UK have calmed many of the doubters, keeping markets from being spooked.

The Week Ahead

Stocks look to close October on a high note amid a big week for economic news. The Fed holds its two-day rate-setting meeting where it is widely expected to announce its fourth consecutive 75 bps hike. That will bring the benchmark lending rate to a range of 3.75%-4.00%. Traders will also pour over nonfarm payrolls and manufacturing for signs of slowing growth.