The United States isn’t an island. We’re part of the global economy. What happens in the rest of the world affects the United States. – Janet Yellen, former Federal Reserve Chair
For the second consecutive week, the stock market posted solid gains and it marked the first back-to-back winning streak since July. The three major stock averages rose at least 1.5% even though economic data reinforced a slowdown in the economy. Both the August employment report and the Institute for Supply Management manufacturing index were worse than expected but that didn’t seem to matter for investors. Instead, the mere fact that the U.S. and China agreed to resume trade talks in Washington next month was the catalyst the market needed to move higher. Tensions in Hong Kong between the government and protesters also eased last week after Hong Kong’s leader said she’d withdraw an extradition bill that caused months of mass protests. The protests were seen by many as being disruptive to the economy. The editor of the Global Times, who has been very accurate in his predictions about the trade negotiations so far, thought that there is a better possibility of a breakthrough in the talks this time. This optimism also seemed to dovetail with remarks by Federal Reserve Chairman Jerome Powell on Friday as he said that uncertainty around trade policy was causing companies to forego making decisions about investments. The slowing economy and persistent low inflation are why many pundits are expecting that the Fed will remain accommodative and cut short-term interest rates later this month. There is a high probability that the cut will be a quarter-percentage point from the current range in the federal funds rate of 2% and 2.25%. But despite the uncertainty around trade policy and the near-certainty of an interest rate cut, Powell does not expect the U.S. to fall into a recession. This belief was also confirmed by the Fed’s Beige Book, which reported that the economy had expanded at a “modest pace” and that the majority of business owners remained optimistic about the near-term outlook for the economy, despite the trade uncertainty.
The August employment report showed that 130,000 new jobs were created, which were far fewer than expected, and that the unemployment rate remain unchanged at 3.7%. Wage growth increased at a 3.2% annual rate but wage gains have been stronger over the last three months and the labor participation rate rose to its highest level since August 2013. Earlier in the week, ADP reported that private payrolls grew by 195,000 in August, much better than expected and the best showing since April. The ISM manufacturing index in August declined to 49, the lowest level in more than three years and below the 50 threshold, which indicates contraction. But the ISM non-manufacturing or services sector index expanded at a faster than expected rate in August and was solidly in expansion territory. The U.S. economy is mostly service-oriented.
For the week, the Dow Jones Industrial Average added 1.5% to close at 26,797 and the S&P 500 Index climbed 1.8% to close at 2,978. The Nasdaq Composite Index also rose 1.8% to close at 8,103.
Both the August producer price index (PPI) and the consumer price index (CPI) are expected to only edge up slightly as inflation continues to be benign. Retail sales for August are forecast to rise just modestly after posting a huge increase in July. The University of Michigan consumer sentiment index for September is expected to rebound after registering its weakest reading in August since late 2016.
The European Central Bank (ECB) meets to review monetary policy and is expected to reduce its benchmark interest rate further into negative territory as it attempts to jump start Europe’s slowing economy.
Only a few companies are scheduled to report earnings this week and the most notable include Oracle, Broadcom, Gamestop, Casey’s General Stores and Kroger.
After last week’s strong showing in the stock market, the S&P 500 Index is only about 2% from its intra-day high set back on July 26th. At the moment it appears that the recent upward momentum in stocks could continue. Investor sentiment has turned more positive as recent economic data, which has been mostly favorable, seems to suggest that the economy will grow modestly and avoid a recession. Expectations that the Federal Reserve will cut interest rates by 25 basis points at its meeting on September 17th are also high. Inflation data this week should indicate that prices are under control and there is no reason to believe that this will change over the near-term. Slowing economic growth coupled with low inflation should make the Fed’s decision to cut rates an easy one. Although the odds of a trade agreement between the U.S. and China at next month’s meeting are low, trade tensions do appear to be easing as both countries are feeling the effects of the ongoing trade war. Stronger wage growth in the August employment report and faster growth in the services sector bode well for consumer spending, which accounts for nearly 70 percent of total economic activity. With improved sentiment on trade, the stock market could make a run at the record highs established back in July.