MARKET COMMENTARY

Following a mid-week selloff, investors re-grouped on Thursday and Friday to recover most of the week’s earlier losses. Poor reports from the Institute for Supply Management (ISM) on both the manufacturing and services sector sparked a selloff and fanned concerns that the U.S. economy was finally wearing down in the face of slowing global activity and the U.S.-China trade war. Sentiment managed to turn more optimistic by late Thursday morning, however, as investors increased their bets that the Fed will provide additional stimulus by cutting rates further when they meet in October – in direct response to the poor ISM figures. Friday’s employment situation helped sustain the rally. Although the report was nothing to write home about, the unemployment rate itself managed to hit a 50-year low, which gave markets a sigh of relief that the consumer remains safe for the time being. It was a bit of a ride, but when it was all said and done, the Dow Jones Industrial Average managed to slip just -0.92% for the week.

Survey Says…

Markets took it on the chin mid-week from the ISM manufacturing and services reports. The reports survey manufacturing and services firms and act as a gauge for business conditions. Tuesday brought the ISM Manufacturing Index which showed the Index fell steeply to a reading of 47.8 in September, down from August’s 49.1. The month’s reading is well below 50, which is the demarcation between expansion and contraction. The report showed new orders, backlog, raw materials, inventories, exports and imports all contracted last month. Particular weakness was noted in new export orders which fell to 41. With the slow global growth environment and the multiple trade battles, a contractionary figure was entirely expected, but the sharp, month-over-month drop resulted in the ISM manufacturing survey posting its worst level in over a decade. It was the depth and change in rate in the index that had investors gripping the edge of their seats.

Bear in mind that the story in the manufacturing segment of the economy has been unfolding for over eighteen months. This has always been juxtaposed against a still raging services sector. The services sector employs nearly 9 times the number of individuals as manufacturing, and it contributes roughly six times as much to GDP. Suffice to say that so goes the services sector, so goes the economy, and until recently the services sector had been holding up just fine. That was until Wednesday when the ISM Services Index showed the services sector had dropped from 56.4 in August to 52.6 in September. To be clear, this still indicates expansionary conditions, but like the manufacturing reading, the change in rate was significant and it strikes at the foundation of an important economic pillar. If Tuesday’s manufacturing release spooked investors, Wednesday’s services report had investors genuinely running scared. There is no way to sugar coat the reading, it was not good, but it should be noted that it is not definitive as to whether a recession is around the corner. Technically, expansion has been observed on readings as low as 48.6, but it does indicate growth has moderated considerably over the last 12 months and the factors impacting the weakness in manufacturing are now beginning to spill over to the broader economy.

Markets Cheer Jobs

Following the disappointing ISM numbers, the market was really interested in seeing what impact that might have on hiring. On Friday, the Labor Department released its September jobs report. For the month, businesses added 136,000 new hires. While this missed the 145K consensus mark, the unemployment rate managed to fall to a new 50-year low of 3.50%. Workers showed wage gains, up 2.90% from a year ago, albeit this was a slowdown from the previous month’s 3.20% year-over-year gain. Also, the report represents the slowest pace of jobs growth in four months, suggesting businesses are growing more cautious. Still, employment reports are situational relative to their point in an economic cycle, and as one economist put it, this month’s report is still one of strength where “steady demand is approaching limited supply”.

Based on the string of disappointing data one would have thought the week would have been a complete wash out, and it probably would have been if not for the prospect of a rate cut at the FOMC meeting in October. As of Friday, the CBOE FedWatch Tool forecasted a 78% chance of a Fed rate cut later this month. This is a big jump from a 49% probability of a cut a week ago. With more than three weeks to go until the Fed’s meeting, the central bank will have a number of additional reports to consider, including consumer spending, to help them determine in their own minds whether the U.S. is simply experiencing a late cycle slowdown or whether it is stalling altogether.

The Week Ahead