Mid-week market update: Evidence of a negative seasonal pattern has been circulating on the internet for the S&P 500. As one of many examples, LPL Financial pointed out that the S&P 500 has typically topped out in early August and slides into late September.
The bear case
Tobias Levkovich, chief U.S. equity strategist at Citi, says there’s an almost “palpable” sense that every 1% dip is a buying opportunity. “We are less convinced,” he said. “Fund managers fully concede that the rate of profit expansion will slide but most fear more upside and relative performance issues than a double-digit decline at the moment, yet they prefer a higher quality tilt to portfolios.”
It can’t last forever, can it? Levkovich is sticking with his 4,000 year-end price target for the S&P 500 — which means he thinks the market may drop by 10%. And he has a specific month in mind when it might, if not fall apart, at least get ropey. “The paucity of immediate catalysts for a pullback is cited regularly, although we worry about higher taxes, cost pressures eating into profitability, tapering and more persistent inflation all coalescing in September (typically the toughest month seasonally for the S&P 500),” he said.
While, as Chair Powell indicated last week, we are clearly a ways away from considering raising interest rates and this is certainly not something on the radar screen right now, if the outlook for inflation and outlook for unemployment I summarized earlier turn out to be the actual outcomes for inflation and unemployment realized over the forecast horizon, then I believe that these three necessary conditions for raising the target range for the federal funds rate will have been met by year-end 2022.
A dovish Fed
Last December, the Committee indicated that it would continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least $40 billion per month until substantial further progress has been made toward its maximum employment and price stability goals. Since then, the economy has made progress toward these goals, and the Committee will continue to assess progress in coming meetings.
The phrase “assess progress in coming meetings” (plural) is an important clue about the timing of a tapering announcement. The FOMC meeting schedule is September, November, and December. The July FOMC statement implies that the earliest that a taper announcement will be at the November meeting. Fed vice-chair Richard Clarida also said today that the Fed has no intention of surprising the market on tapering, though he could see an announcement later this year.
In addition, Fed governor Lael Brainard also gave an important clue about the conduct of monetary policy in a speech to the Aspen Economic Strategy Group. On the subject of labor market recovery, she stated that she “expect[s] to be more confident in assessing the rate of progress once we have the data in hand for September”, indicating that the Fed needs to see confirmation of a labor market recovery in its September data, which will be available in early October.
Currently, it is difficult to disentangle the effects on labor supply of caregiving responsibilities brought on by the pandemic, fears of contracting the virus, and the enhanced unemployment insurance that was designed in part to address such constraints. Importantly, I expect to be more confident in assessing the rate of progress once we have data in hand for September, when consumption, school, and work patterns should be settling into a post pandemic normal.
These signals are consistent with the consensus expectation of a tapering announcement in late 2021, with actual action in early 2022.
However, recent data is supportive of a more dovish tone. The Citi Economic Surprise Index, which measures whether economic data is beating or missing expectations, has been falling.
The data has been soft. As an example, today’s release of ADP Non-farm Employment Change badly missed expectations. This raises the likelihood of an NFP payroll miss on Friday.
Other bullish reasons
Resolving the bull and bear cases