The Week Behind 

Spurred by a combination of weaker-than-expected economic reports that might give the FED reason to pause, equities started the week with a lift. However, on Friday morning, September Payrolls painted a contrary picture, revealing a decrease in unemployment: the metric the FED must see increase before slowing the pace of tightening. On the news, yields and the US dollar rose and the probability of a 75bp rate hike increased from 50% to 75%, resulting in another Friday sell-off. Despite the poor finish, all major indices managed to eke out gains in the first week of October: the Nasdaq ~0.75%, the S&P ~1.5%; the DOW ~2%.  

Highlights

• September ISM, a report that broadly measures economic contraction and expansion, fell below expectations: 50.9% actual v. 52.8%.
• JOLTs (Job Openings and Labor Turnover) came in below expectations, revealing job openings had fallen 10% in August, >1 millions jobs. 
• ADP Employment, a private-business survey, came in above expectations, but provided evidence wage inflation may be slowing: median annual pay for job-switchers declined to 15.7% from 16.2%, the largest monthly decrease in three years. 
• Initial jobless claims for the 1st week of October were 219k, the highest in 4 weeks. 
• While the jobs numbers itself came in below expectation, September Payrolls also showed unemployment decreased from 3.7% to 3.5% as labor force participation decreased. 

CPI: A Score To Settle

With last Friday’s payrolls, the debate surrounding the labor market has gone decidedly in favor of the bears. To start the month, the Bears lead the Bulls 1-0. The only other macro-factor (broad economic factors: inflation, unemployment, FED, etc…) left to debate this month is inflation. Consequently, CPI is shaping up to be a binary event. A cool CPI gives the Bulls a win, tying the score at 1-1, stabilizing the market. A hot CPI gives the Bears another win, making the score 2-0 in their favor, catalyzing further downside.

From a technical perspective, the payrolls report has caused the market’s pressure points – yields and the US Dollar – to race back to their boiling points. CPI has the influence to cause these pressures to either boil over or simmer down. If these pressures boil over to new cycle highs, we can expect equities to break down to new cycle lows. If these pressures simmer down, we can expect market stabilization. It will also set a better tone to analyze micro-factors, company earnings, with a more balanced perspective.

The Week Ahead

Earnings season properly kicks off in the latter half of the week. However, before the market can shift its focus from the macro to the micro (from economic reports to company earnings), we need to make it through September CPI on Thursday. Last month, Headline and Core were 8.3% and 6.3%, respectively. This month, consensus is 8.1% and 6.5%. For markets to stabilize and create a better backdrop for earnings season, CPI needs to come in at or below expectations, especially Core, to provide the FED a reason to consider slowing the rate of tightening. 

There is some hope for a benign number. Higher interest rates have had some impact on both qualitative and quantitative housing metrics. Commodities have behaved, specifically agriculture and energy. An increasing number of companies have begun discounting, which is deflationary, to deal with rising inventory. Full disclosure, I thought these same factors would appear in last month’s CPI. They did not. Perhaps, CPI will get the full effect of these deflationary factors this month. However, I do not have a new, concrete reason to believe they will. Therefore, I do not have a prediction for Thursday. However, identical to payrolls, I will look at treasury yields and the US dollar to determine whether or not the number was bullish or bearish for stocks. 

The Importance of Earnings

In this market, there are more “blow ups” than “glow ups”. Earnings can provide a catalyst for either. Given the unique set of circumstances, for which there is no precedent or model, uncertainty surrounding earnings is justifiably high. To avoid the “blow ups”, you need to look through your portfolio now and consider reducing positions in companies you are not confident will perform in this environment. 

Some stocks are easier to evaluate than others. Healthcare and energy are two sectors whose demand is typically not related to the economy. In good times or bad, sick people need medicine and people need to put gas in their cars and/or heat/cool their homes. However, some are not so simple: consumer discretionary companies – Lulu, Dick’s Sporting Goods, Best Buy, etc… – may miss their numbers if they do not have products consumers want or have to resort to heavy discounting to move inventory at a lower gross margin. With respect to stock prices, while macro factors (economic forces: inflation, FED, etc…) may overwhelm micro factors (company-specific revenue, earnings, etc…) over the next couple weeks or months, earnings ultimately allow the market to differentiate between winners  and losers once panic subsides.