Market volatility has been the theme as this rolling corrective price action continues. The S&P 500 alternated between daily gains and losses of 1+% for 4 straight sessions this week. That was the longest stretch since early in the pandemic. Volatility is nothing new to this time of year. September is historically the worst month on the calendar for stocks. October is generally a decent month, as a whole, but has experienced the greatest number of bottom formations before a year-end rally. September weakness often spills into October. Welcome to October.
There were so many issues that plagued the Market this week which spooked investor sentiment. It started with the political games in Washington surrounding the debt ceiling and infrastructure. It ended with a much weaker Job Report. There was plenty to chew on in between. It was an eventful week. There’s some serious stuff going on. The Market is taking it all very much in stride. It’s pretty impressive actually. There has been plenty of opportunity for a more serious sell-off. The S&P kissed a 6% decline from the highs this week. And then it bounced back hard erasing half of those losses. Here’s another rapid rundown of what happened and why it’s important:
A Can of Chicken
Congress upped the ante on its political gamesmanship. They switched from kick the can to a game of chicken. Someone blinked. The game of chicken was won, if you can call it that. Now it’s back to another game of kick the can, which has been the Congressional favorite for decades. The American people are the unfortunate losers in Washington’s political games. As the looming threat grew, Senate Republican leader Mitch McConnell offered to raise the limit to avoid an immediate risk of default. This caused friction within the GOP, with many feeling that McConnell blinked and lost. Apparently, Senator McConnell was concerned that playing the hardline would ultimately result in Senators Joe Manchin and Kyrsten Sinema joining their fellow Democrats in removing the filibuster, something they had opposed. That said, 11 Republicans decided to back McConnell’s move to allow a 61-38 cloture vote to proceed. The Senate passed a debt-limit extension along party lines. It only bought 2 more months. The House will return to Washington on Tuesday for their turn to vote. They’ll be doing this again in November as this deal only runs to December 3rd. Canned chicken: That seems to sum up Congress.
From one of our Washington sources:
The country’s growing polarization is reflected in the current composition of elected representatives in Congress, where zero-sum games are rewarded, and compromise is punished. As a result, lawmakers increasingly struggle to pass legislation. As a result, this has led to a growing politicization of institutions like the courts and the Federal Reserve to pursue partisan victories. The debt limit used to be a routine vote. In recent years debt limit debates tended to involve a divided government. House Democrats used the debt limit as leverage when Trump was in office to increase spending. House Republicans used the debt limit as leverage when Obama was in office to reduce spending. Democrats currently have unified control of the government. Republicans are not asking for any concessions but instead are looking to score political points by trying to force Democrats to take a politically difficult vote to increase the amount of debt so they can label them the “party of debt” heading into the 2022 congressional midterm elections. Democrats resent this, and the result has been a series of public statements by Schumer and McConnell that have been difficult to walk back making an eventual compromise difficult. Polls show voters would blame Democrats more than Republicans in the event of default which suggests Republicans have the stronger negotiation position since they have less to lose. If Republicans win the House and/or Senate in the 2022 congressional midterm election, expect more debt limit fights in the remaining two years of the Biden presidency.
With the immediate crisis averted for now, the focus returns to the Democrats’ “social infrastructure” push, which seems to have already been downgraded from a $3.5 Trillion stimulus to something in the $1.9 – $2.1 Trillion range. Senate moderates Manchin and Sinema have persistently held ground on a much lower number and seem willing to declare victory at a lower spend than the Progressives want. Remember, the initial plan from Senator Bernie Sanders was $6 Trillion. The Democrats need complete unity to pass any major bill through budget reconciliation.
Energy Crunch
There is an energy crunch, which could very well lead to crisis around the world. As the United States moves forward with its green initiative, the cost of fuel keeps surging. Oil and Gas companies are not investing in new production, limiting supplies while demand is on the rise. The result is higher prices. There’s no sign of them stopping. Natural Gas prices have doubled this year. The price at the pump has spiked too. It is putting serious pressure on global growth, not to mention monetary and fiscal policies.
Higher Energy prices have been the primary driver of stagflation worries. Stagflation occurs when inflation rises and economic growth slows. It’s not a good thing. This is happening as colder weather grips the Northern Hemisphere. Remember the crisis in Texas last Winter? That could prove to have been a preview for the rest of the world. China has ordered coal miners to boost production. Manufacturers are slowing production as countries and businesses are battling to secure supplies. Electric companies in the US are already alerting customers about big winter price hikes. Warnings about potential gas shortages are also starting to get attention.
Russian President Vladimir Putin proposed to stabilize energy prices with an offer to export record volumes of natural gas to Europe. Putin sees an opportunity. Putin seldom misses an opportunity. The Russian offer could pressure European officials and regulators into approving Nord Stream 2, the controversial pipeline which links Russia and Germany. Russian gas has flowed to Europe for years. Some have sought alternatives, reluctant to build a Russian dependency. High prices are the result as Winter is around the corner. They have spilled over to the US Energy Secretary Jennifer Granholm hinted at the possibility of releasing crude oil from the government’s strategic petroleum reserve. The average price at the pump across the country sits around $3.19 per gallon. That is the highest in 7 years. The price of West Texas crude hit $80 on Friday. That’s a level not seen since 2014. Granholm also didn’t rule out a ban on crude exports, saying it was an additional tool that could calm markets and bring oil prices down.
In case you’re wondering, Natural Gas is the most common source of electricity in America, accounting for roughly 40%. Renewables, Nuclear and Coal account for approximately 20% each. Natural Gas has increased significantly over the last decade, largely at the expense of declining Coal use. Nuclear energy consumption has stayed fairly static, not growing but not shrinking much either, in response to the Japanese nuclear disaster a decade ago.
Here’s the deal: We are clearly in another transition within the American Energy story. The Shale Revolution led to Energy independence from our adversaries. But climate change and the growing push towards renewables and electric vehicles are creating serious turbulence within the system. The momentum keeps building. One of the largest oil spills in California’s history occurred last weekend. Over 125,000 gallons of oil leaked into the waters off Orange County and devastated the marine life. It is a complete and total tragedy.
Fossil fuels are not the future for American energy. But the future is still out there and fossil fuels are very much the present, in conjunction with a portfolio of other sources. This transition needs strategic and careful management. It needs to be done responsibly. We cannot afford to sacrifice the reliability nor affordability of our power supply. Following the blackouts in Texas last Winter and the constant rolling blackouts in California, it is beyond clear that America’s energy grid is in need of upgrades and modernization. Until it gets it, higher costs are coming to we American consumers.
Jobs
A mere 194K jobs were created last month, less than half of what was expected. That is the lowest number on the year. The unemployment rate fell to 4.8%. This follows a weak August report too, though they were revised higher today. The Job situation in America remains very challenged. This is not the Labor Market we want. But it’s the Labor Market we have. People are just not re-engaging employment at the rate they used to, and jobs need to be filled. Companies are struggling to keep up with demand and it’s become more and more costly to find workers.
The labor participation rate is down to 61%. It peaked at 67% in Y2K, before the Dot-com bubble burst. It’s been on a steady decline since. The rate for women fell below 56%. The participation rate is the calculation between the labor force divided by the total working age population. Companies have to pay more to get people to take jobs. Improvements were found in Retail, Restaurants, Manufacturing and Construction. The Public Sector saw a significant shrink. There could be some seasonal situations in play there. But Education employment remains a big challenge. I’ve heard it’s very difficult to find substitute teachers right now.
Covid is still a problem. The Delta variant still had its fingerprints in the September report. 1.5 Million Americans that have a job called in sick due to illness. That is the highest rate since the January peak. Clearly the virus continues to weigh heavy on people going back to work. There’s also the issue of the cost of childcare. For many, it costs more to pay for childcare than they take home from work. This raises questions as to the health of the Economy and what the Fed will do now. There are indicators that September was another peak in cases, and things have started improving in October. We shall soon see. So far, the flash economic indicators show a pickup in economic activity ahead. United Airlines said this week they expect December to be its busiest travel month in 2 years. That’s a good sign for hotels and restaurants, and other businesses tied to travel.
Back to the Market:
This corrective price action in the face of all of these issues sure has soured sentiment. This week’s Investor’s Intelligence report showed the number of Bulls fell to 40.4% from the prior week’s 46.5%. This marked the lowest level since the Spring of 2020 when Bulls were recovering from a 30.1% low around the pandemic bottom. As a reminder, investor sentiment is considered a contrarian indicator. This low level of Bulls suggests a meaningful low could be near. For reference, the 2021 high for Bulls was 63.7% which occurred both in mid-April and first week of January. Bulls were also running above 60% over the Summer before sentiment began to deteriorate. In fact, there are now the equivalent number of Bears to Bulls, something that often takes place around lows too.
Earnings Season begins next week. Corporate America releases its report cards. It’s the time where we get to focus on facts. Inflationary pressures and supply chain problems are weighing on estimates, which could add to the list of speed bumps heading into year-end. The Market sell-off seems to have priced in some of this. The big question in our minds remains what this all means for the Fed’s tapering plans. You may recall Chair Powell said he felt the employment test for tapering had been “all but met” and he was not looking for a “knockout” September report. This was clearly not a knockout report and higher prices have become a serious issue for consumers. The Fed doesn’t want to be tightening, even with a slight taper, if America is headed towards stagflation. The Market is trying to recalibrate off all of these developments and anticipate what’s next. It’s the Market’s way.
That’s a rundown on what we think are the important things going on. Keep those belts buckled. October just started.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
