by Liz Ann Sonders, Chief Investment Strategist, Jeffrey Kleintop, Kathy Jones and Kevin Gordon, Charles Schwab & Company Ltd.
Competing narratives have emerged to describe the state of the U.S. economy.
Meanwhile, Chinese data has been surprisingly strong as government stimulus takes hold, which may lift sentiment and stocks of companies with China exposure. However, given the problems in its property market, China's economic growth is unlikely to see a V-shaped rebound.
U.S. stocks and economy: The downside of data dependency
Yet it's worth noting that job growth, a key pillar of U.S. economic resiliency, has been slowing rapidly lately. Payroll growth has slowed considerably since the post-pandemic re-opening phase in 2021. Looking at the three-month average of monthly job gains, the fall to 150,000 in August marked the lowest since the COVID-19 pandemic began in March 2020. This is mostly in line with the average seen during the past few economic expansions, but the pace of decline this year has been sharper than what is typically seen in an expansion.
This underscores an important aspect of economic data that investors should always consider: It's often the case that "better" or "worse" tend to matter more than "good" or "bad" when it comes to shifts in the economy. Investors should pay as much—if not more—attention to rates of change.
Payroll growth has slowed markedly
Source: Charles Schwab, U.S. Bureau of Labor Statistics, Bloomberg, as of 8/31/2023.
Y-axis is truncated for visual purposes. Recessions are determined by the National Bureau of Economic Research.
BLS is waiting longer for a response
Source: Charles Schwab, Bureau of Labor Statistics (BLS), Bloomberg, as of 6/30/2023.
Historically, survey response rates have been used as a measure of how representative a survey is of the sampled population. Response rates of surveys don't relate well to nonresponse bias, but the pattern of the response rates may give insights into survey processes. The Job Openings and Labor Turnover Survey (JOLTS) program produces data on job openings, hires, and separations.
As shown in the chart below, the percentage of S&P 500® index members trading above their 200-day moving average has fallen sharply since the end of July. Market breadth has been rather unimpressive so far this year, even though the S&P 500 itself has mostly trended higher. A continued divergence would be worrisome and reminiscent of the backdrop in late 2021. At that time, waning strength below the surface correctly signaled that the rally for the S&P 500 was losing steam.
S&P 500 breadth has not matched performance lately
Source: Charles Schwab, Bloomberg, as of 9/8/2023.
The 200-day moving average calculates the simple average of the closing price of a stock over the most recent 200 trading sessions. The line drawn from those numbers shows the trend of a stock over a long duration. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.
Fixed income: Bond market remains volatile
As a result of these uncertainties, bond market volatility remains elevated. At a reading of 104 index points, the Merrill Option Volatility Estimate (MOVE) index—a measure of bond market volatility—is down from recent peak levels above 190, but is still well above the pre-pandemic average of about 75.
The MOVE index has declined but is still above pre-pandemic levels
Source: Bloomberg. Daily data as of 9/8/2023.
The MOVE index is a market-implied measure of bond market volatility that calculates the implied volatility of U.S. Treasury options using a weighted average of option prices on Treasury futures across multiple maturities (2, 5, 10, and 30 years). Past performance is no guarantee of future results.
Real Treasury yields are at the highest levels since 2009
Source: Bloomberg, daily data as of 9/11/2023.
US Generic Govt TII 2 Yr (USGGT02Y INDEX), US Generic Govt TII 5 Yr (USGGT5Y Index), US Generic Govt TII 10 Yr (USGGT10Y Index). Past performance is no guarantee of future results. A basis point is 1/100th of a percentage point, or 0.01%, meaning 200 basis points would be equal to 2%.
In addition, the Fed is still reducing the size of its balance sheet through its "quantitative tightening" program, allowing the bonds it holds to mature without reinvestment. A smaller balance sheet tends to reduce the quantity of reserves in the banking system, which should mean slower growth in lending. The Fed's bond holdings have declined by about $1 trillion since the peak in April 2022, which equates to a drop to 31% of gross domestic product (GDP) from 37.5%.
The Fed's balance sheet has declined
Source: Bloomberg, Federal Reserve, weekly data as of 9/6/2023.
Reserve balance on Wednesday close for Treasury bills, Treasury notes, Treasury bonds, Treasury Inflation-Protected Securities (TIPS) and mortgage-backed securities (MBS).
Looking ahead, the bond market is still facing hurdles that could drive yields higher and keep volatility elevated. However, in the long run, inflation is still likely to be the major driver behind the direction of yields. We continue to expect that the cumulative impact of the Fed's tightening policy to date is enough to keep inflation trending lower.
Global stocks and economy: China surprises
China's growth problem lies in its property market, which is estimated to have contributed as much as 29% of GDP in recent years. Developers' actions and comments suggest they are starved of capital both in terms of debt issuance and cash flows from new property sales. Concerns have increased about losing down payments, which are typically made years before delivery of a completed unit. Because property comprises about 70% of wealth for Chinese households (according to analysis of data from China's National Bureau of Statistics), worries about the housing market appear to be eroding overall consumer confidence and the pace of spending on goods.
China consumer confidence back at lockdown lows
Source: Charles Schwab, Bloomberg data as of 9/7/2023.
The China consumer confidence index is based on a survey of 700 adults from 20 cities across the country. The composite index covers the consumer expectation and consumer satisfaction index, thus measures the consumers' degree of satisfaction about the current economic situation and expectation on the future economic trend. The Index measures consumer confidence on a scale of 0 to 200, with 200 indicating extreme optimism, zero indicating extreme pessimism, and 100 representing neutrality.
Rising air pollution in China may be signaling a manufacturing rebound
Source: Charles Schwab, U.S. State Department, Bloomberg data as of 9/7/2023.
The Average for China Air Quality Index (AQI) is published by the U.S. Department of State and developed by the U.S. Environmental Protection Agency (EPA). EPA converts readings of particulate matter that is 2.5 micrometers or smaller (PM 2.5) via formula into air quality index value. The blue line reflects the change in the index since the beginning of January 2023, shown in 4-week increments. The gray line shows the average change between 2016 and 2022.
Given the property market overhang, China's economic growth is unlikely to see a V-shaped rebound. Yet, more stimulus announcements and upward surprises suggesting they are beginning to work could lift sentiment and stocks with China exposure.
2 The Federal Reserve has been reducing its balance sheet (also known as "quantitative tightening") by not buying new securities to replace securities that are maturing. This reduces overall demand for government-backed and mortgage-backed securities, leading to higher interest rates, and also reduces the amount of cash in the financial system.