The name of the game right now on Wall Street is volatility. This is playing out in the recent whipsaw action in the equity market that has produced some pronounced swings in the direction of trading on both a daily and intra-day basis. After a sharp rally to start the week, the major indexes gave back some of those gains yesterday, though they were able to climb well off their early session lows. This morning, we are looking at a relatively flat start to the trading day stateside.
In general, the direction of trading is being driven by two major factors: the strength of the U.S. dollar and the movement in Treasury market yields. When the U.S. dollar is strengthening and bond yields are rising, equities, most notably those of higher-growth companies, come under pressure. It is no coincidence that the U.S. equity market pared much of its early losses yesterday when the intra-day price of the U.S. greenback stabilized.
Given that there is still several weeks to go before the commencement of the next Federal Open Market Committee (FOMC) meeting on November 1st, which most pundits believe will bring another three-quarter-point hike to the benchmark short-term interest rate, we think trading until then will likely be driven by both corporate earnings (more below) and economic data. The latter will likely affect Treasury market yields and the value of the dollar. Stocks were initially under pressure yesterday when the Automatic Data Processing (ADP) report on private-sector job creation came in a bit stronger than expected. The Fed is looking for a drop in hiring and a slackening in the labor market to help ease inflationary pressures, but the series of ADP reports have not thus far shown such a move.
This morning, there is little news on the economy to report. The only statistic of significance was another snapshot on the health of the U.S. labor market. At 8:30 A.M. (EDT), the Labor Department reported that initial jobless claims for the week ending October 1st totaled 219,000. That figure, though up from the previous week’s figure of 193,000, was still another indication of a continuing tight labor market.
Investors will be closely watching tomorrow’s report on September nonfarm payrolls. A higher-than-expected figure (the consensus is that nonfarm payrolls increased by 275,000 positions last month) would likely weigh on stocks, as it would suggest that central bank has more work to do on the monetary policy tightening front to slow hiring and ultimately wage inflation. Conversely, if the release shows a notable drop in jobs creation, it may raise sentiment that the Fed could be less hawkish at next month’s FOMC meeting, and it may bring renewed talks of a half-point hike to the federal funds rate. That said, none of the regional Fed Presidents to speak this week have sounded any less hawkish.
Within the labor report, investors should pay close attention to the average hourly wage and labor participation rate, as those readings may give some clues to whether inflation in the labor market is starting to ease. If more people are reentering the labor market and the number of job openings are declining, which we learned on Tuesday, it may start to put downward pressure on salaries.
Then there is the oil market to consider and its effect on the both the U.S. and global economies. Yesterday, the Organization of Petroleum Producing Countries (OPEC)-plus announced a sizable production cut of two million barrels of oil per day, which would in reality cut supplies by roughly one million barrels per day when factoring in the production from other non-OPEC members. The largest supply cut since the early days of the coronavirus pandemic, and ahead of what is expected to be a difficult winter heating season for the European Union, as less shipments of oil and natural gas from Russia are expected, will likely push crude prices notably higher. This would also make the Federal Reserve’s task of reducing inflation all the more difficult. While the oil news will not impact the core-Personal Consumption Expenditures (PCE) Index reading, the headline figures would probably come in higher than expected. The oil news gave a big boost to the oil stocks yesterday and could serve as a tailwind for the sector in the weeks to come.
In addition to the economic data, market watchers will be paying close attention to the upcoming third-quarter earnings season. Those reports, particularly the results from the big banks and the mega-cap technology companies, will be under the microscope as they will provide another assessment on the health of the U.S. economy and the state of inflation. Given the recent profit warnings from Corporate America, and the market’s negative reaction to those reports, we think those companies that miss expectations may feel the wrath of Wall Street. In particular, entities that do a significant amount of business overseas likely were penalized by the strength of the U.S. dollar. Last week, technology behemoth Apple (AAPL) noted that the impact of a higher dollar will reduce its overseas profits when translated back into U.S. dollars.
So what is an investor to do in this volatile market? Our first recommendation is not to adhere to a sector-specific trading strategy, but to focus more on individual companies, as not every entity in each sector has the same financial wherewithal. We would look at stocks of high-quality companies that have strong balance sheets, generate ample cash flows, and a have a history of strong interest coverage ratios, the latter of which will allow them to more effectively manage a higher interest-rate environment. These corporations also are more apt to maintain their dividends, which provide investors with a steady source of income in a period of trading where nothing is certain, given all of the aforementioned economic and stock market variables. – William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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