The week ahead: trading US inflation and UK labour market data

The current trading environment is proving that it doesn’t pay to be a value investor or a growth investor. It doesn’t help your performance if you trade in the short term only, or the long term only. In this environment you have to be both a long- and short-term investor as well as a growth and value investor since market themes are changing on a daily basis. Comments during the weekend from Fed officials including Patrick Harker from Philadelphia and Loretta Mester from Cleveland, suggested that a tapering announcement from the Federal Reserve next week would be a good thing for stocks since it would suggest that the FOMC has faith in the strength of the US economic recovery and it would be a sign that the worst of the Delta Covid variant is behind us. So, as we start a new trading week, stock markets are recovering from their worst week since June led by energy stocks and financials and tapering is now a good news story for risky assets. 

Weaker earnings balanced by positive Fed speak 

The capricious nature of global risk appetite right now makes it hard to make a call on a long-term strategy. We think that it’s best to take things day by day. For example, the markets did not react to the news that a growing number of analysts have cut their EPS estimates for the S&P 500’s Q3 earnings season. This was extremely likely to happen, firstly to reflect the slowdown in the US economy on the back of the latest wave of Covid, and secondly because record highs in both earnings and sales growth has to stop at some point. Thus, the news that EPS estimates are being revised lower are unlikely to have too much of an impact when 1, earnings are high anyway, even with the downgrade, and 2, general stock market momentum is to the upside. This reminds us of the famous phrase “don’t fight the Fed.” Usually this refers to policy announcements, however, last weekend we had two Fed members literally spell out that a “hawkish” Fed that takes the first steps towards tapering monthly asset purchases, should be good for the S&P 500, it’s hard to argue with that. 

Why a deeper pullback in stocks is necessary? 

Needless to say, after the performance that we witnessed in stock markets throughout the summer, daily rallies are not too impressive. This is because the stock market gains are not widespread. Bulls need to be concerned since only a little over 50% of the S&P 500 is currently above their 50-day moving averages, thus making it harder for the main US index to eke out daily gains. For the Nasdaq there are fewer than 50% of companies above their 50-day moving averages, which is why the tech-heavy index has lagged other global markets in recent months. When this happens, it suggests that the market lacks conviction. Due to this, we think that a deeper pullback in stock markets is necessary. While we think that stocks will pick up towards the end of the year, we think that the next month or so could be rocky. Potential drivers of a deeper sell off include: 1, actual weaker EPS figures during Q3 earnings season that will start next month, and 2, post next week’s Federal Reserve meeting, especially if the Fed appear to be embarking on an “aggressive taper.”

Could US inflation data lead to a “bad taper” from the Fed? 

Ahead this week, US inflation is released on Tuesday at 1330 BST. The market is looking for a rise of 0.4% for August, with the annual rate falling back slightly to 5.3% from 5.4%, still an uncomfortably high level for the Federal Reserve to live with. The biggest question for the Fed will be “are price increases broadening?” During the recent rise in inflation, price increases have mostly been focused on the rising price of raw materials, second-hand cars and electronic goods due to the global shortage of microchips.  One has to wonder, why more production hasn’t come on board already, but for now prices are still elevated. The risk for the Fed is that price rises are becoming more widespread, hence we will focus on the annual core CPI rate, which strips out food and energy costs. The market is expecting core US CPI to come in at 4.2%, down slightly from 4.3% in July, however, any increase in this number could bring back fears about a “bad taper” from the Fed next week. The dollar index was mostly flat at the start of this week, and the greenback has lost a lot of its upward momentum since peaking around 19thAugust. The market was not comfortable with the dollar index above 93.00, and it is currently trading around 92.60. A weaker inflation print, that could trigger fears about a sharp growth slowdown in the wake of the latest Covid surge in the US, could send this index back down below 92.00, the lowest level since June. Ironically, this could help stocks. However, a stronger print, especially a headline CPI print above 5.5%, could set alarm bells off that the Fed will need to act quickly to stem price pressures, and this could boost the dollar and weigh on stocks. This week’s inflation data is, essentially, a binary outcome for major US asset prices. 

A tight UK labour market and rising wage growth: a long time coming

It is also worth looking at the UK labour market data also released on Tuesday. The unemployment rate is expected to fall further to 4.6% from 4.7%, the claimant count rate is expected to fall sharply, dropping by more than 71k, and wages for July are expected to increase by a whopping 8.2%. These are all signs of a very tight labour market, and it could weigh on the FTSE – a higher cost base is bad for earnings – while pushing up the GBP. We, however, do not think that the BOE will be overly concerned about rising wages and a tightening labour market at this stage for a couple of reasons. Firstly, wage stagnation was a major feature of the UK labour market since the financial crisis, thus these large gains are merely playing catch up. Secondly, such rapid wage growth could force employers into boosting productivity, which could finally reverse the UK’s years of weak levels of productivity. Thus, do not expect the BOE to react to higher wage growth straight away and any move higher in GBP after Tuesday’s labour market data release, could be faded.