Last week, the Federal Reserve confirmed what the markets had already priced in: It plans to slow the pace of its asset purchases later this year, likely in December, and will likely raise interest rates late next year or in early 2023.
Though Chairman Jerome Powell's overall tone on Sept. 22 was measured, leaving the door open to a policy pivot if the Fed doesn't meet its targets, in my view the current plan to cut back on emergency economic stimulus is justified.
U.S. retail sales, employment and manufacturing data continue to indicate fundamental strength in the economy. Wage and shelter cost increases are real, and so are global supply chain issues, which are pushing up input costs for goods and services.
The Fed's asset purchases are $120 billion each month. If tapering means reducing purchases by, say, $15 billion per month, that still leaves us with enormous liquidity in the system through mid-2022. Add to that the new infrastructure spending, and it's no surprise that the equity market doesn't seem rattled by the Fed's plans.
While the uncertainty of the delta variant, Fed watching, seasonal choppiness and China concerns are driving sentiment, the backdrop of strong economic fundamentals is creating favorable conditions for equity market bargain hunters. Across several sectors, even the best economically sensitive companies with solid financials can see their stock prices decline, providing active investors with the opportunity to get top companies on sale.
Indicators Point to Ongoing Strength
The latest U.S. retail sales report shows that consumer spending, which constitutes 70% of GDP, is strong. Retail sales rose 0.7% in August versus expectations of a decline of 0.8%, despite delta and supply chain concerns. Control group retail sales (excluding receipts from volatile sectors such as auto dealers, building-materials retailers and gas stations) were up a whopping 12% year-on-year. For a pre-COVID comparison, retail sales were up 18.6% compared with two years ago, according to an analysis from Merion Capital.
Clearly, consumers are gaining confidence to spend. When you consider that the personal savings rate is still quite high at 9.6%, compared with the historical norm of 5%, we are still sitting on some pent-up demand. This bodes well for future GDP growth and corporate earnings.
The jobs picture is also trending better. The latest four-week moving average for U.S. initial weekly jobless claims was 2.804 million, a decrease of 15,750 from the previous week's revised average. These numbers showed that claims hit the lowest level for this average since March 21, 2020. In the latest U.S. non-farm payroll report, wages continued to accelerate, rising 4.3% on a year-over-year basis and 0.6% on a monthly basis, versus estimates of 4% and 0.3% respectively.
Competition for employees is fierce: The Bureau of Labor Statistics' Job Openings and Labor Turnover Survey (JOLTS) showed the number of job openings nationwide increased to a series high of 10.9 million on the last business day of July, versus 10.1 million at the end of June.
Though supply chain issues persist in manufacturing, August industrial production came in at just 2% below pre-COVID levels. By comparison, last year at this time we were down 17% versus pre-COVID levels, demonstrating the V-shaped recovery, according to Merion Capital.
Business conditions are improving in some key metropolitan areas. The Federal Reserve Bank of New York's Empire State business conditions index rose an impressive 16 points to 34.3, compared with expectations of a 17.2 reading. The manufacturing survey showed that new orders, shipments, and unfilled orders all increased substantially, as did plans for capital and technology spending.
