Focused Investing: Economy & Markets Update

October has the reputation as a terror for the capital markets. October 1929 is seen as the start of the bear market of the Great Depression. October 1987 holds the record for the largest single day plunge when the market fell more than 22%. Leading into October this year, there were reasons to believe we could see a return of the October Terrors. Oil prices were rising rapidly, and job growth was still strong, thus opening the possibility that inflation could reverse the recent declines causing the Fed to raise rates more than expected. These and other factors combined leave open the possibility of seeing another October market plunge.

What Happened Last Week

Last week the big economic news was the jobs report, both the ADP report and nonfarm payrolls. The ADP Employment report came in at 177,000 jobs created in the private sector and fueled the belief that nonfarm payrolls would increase by about the same level. This was not to be as nonfarm payrolls jumped 336,000 and both July and August numbers were revised up by a total of 119,000 jobs. The initial reaction in equities was to drive the indexes lower and yields jump by about 0.15% on the 10-year Treasury. However, by the end of the day, equities were up about 1.2% as investors digested the strong jobs report. It is our belief that the findings in this report increases the odds that the soft-landing the Fed is working towards will happen. The 10-year Treasury yield ended the day up about 0.08% as investors continue to come to grips that rates will be higher for longer. The ISM manufacturing and services indexes also served as support to the idea that the economy will slow in the fourth quarter. Manufacturing showed an improvement in activity, but is still contracting, while the services sector showed a reduced level of activity. Combined, manufacturing and services suggest lower levels of economic activity.

This Week

The most important reports out this week, will be available on Wednesday, when we get producer price inflation, and Thursday, when consumer price index is reported. It is expected that inflation will soften a little. Friday begins third quarter earnings season as the big banks Citigroup, JP Morgan, Wells Fargo kick off earnings.

What We Think

We believe the jobs number last week was positive and the equity markets reacted correctly with the day’s increase. The strong growth boosts our confidence that, in an economic slowdown, corporations will be less likely to cut headcount to save margin, but will be more willing to sacrifice some of that margin and hold on to workers. To us, this means any recession is more likely to be shallow and have a relatively low increase in unemployment than past recessions. Additionally, we believe this will create a rebound in equities that is broader than the current rally. We are not yet through October, but we believe a spooky event that sends markets plunging is low though markets could very well retreat by the end of the month.

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