Market Update

Key Highlights and News

• Saudi Arabia cut its oil price for October delivery amid signs it believes fuel demand is weakening. Saudi Aramco cut the price of Arab Light crude for Asia and also reduced the price for U.S. buyers. This was the second consecutive month of price cuts for barrels to Asia. It is also the first time in six months for a reduced price to U.S. refiners after Saudi crude exports to the country dropped in August to the lowest in decades as inventories remain elevated and demand has been lackluster. (Bloomberg)
• Senior Conservatives warned United Kingdom Prime Minister Boris Johnson that plans to water down Britain's obligations under the European Union withdrawal agreement could make a no-deal Brexit more likely. The Ministers of Parliament criticized potential legislation that could limit the need for customs checks in the Irish Sea and warned any move to walk away from the deal signed by Johnson last year would damage Britain's standing and make it harder to strike trade deals with other countries. (The London Times)
• China's top chipmakers are speeding up efforts to reduce their use of U.S. semiconductor equipment as fears mount that Washington will impose further curbs as part of a tech war. Several state-backed and publicly-traded companies are setting ambitious goals to test homegrown and non-U.S. equipment in their production lines. Chinese chipmakers have also stockpiled several years’ worth of inventories and domestic manufacturers have set aggressive targets to begin onshore production. (Nikkei Asian Review)
• U.S. executives sold $6.7 billion of stock, the most in five years, in their companies in August as stocks continued their big bounce from the March 23 low. The number of executives selling shares was the highest in two years. The selling followed a flurry of insider buying in March and April. Insider selling may reflect concerns about a perceived disconnect between the stock market and the macroeconomic backdrop. Meanwhile, The Conference Board Measure of CEO Confidence for the third quarter remained below 50 (more negative responses than positive) with more than a third of CEOs planning to make workforce and sizable capital expenditure reductions over the coming year. (Financial Times, The Conference Board)
• A new wave of layoffs is coming despite a faster-than-expected recovery from the initial paralysis that followed the coronavirus outbreak. These job reductions could be permanent as many furloughed employees may not have a job to return to. While corporate profit resilience has helped stocks rally, profits have been partly a function of aggressive cost cutting and an acceleration of digitization and automation. (Wall Street Journal)

What to Keep an Eye On

• China may gradually reduce its U.S. Treasury holdings to around $800 billion from more than $1 trillion. Concerns about the rising U.S. budget deficit, pressure on the dollar from ultra-easy Federal Reserve (Fed) policy, and the potential for Washington to hit Beijing with financial sanctions were cited as reasons for the possible sale. Other experts were more skeptical of an upcoming policy shift, citing concerns about the pain selling Treasuries could inflict on China’s remaining bond holdings and the fairly limited options China has when it comes to parking its approximately $3 trillion in reserves. (Global Times)
• The decline in white-collar jobs over past five months is already equal to or worse than during the Great Recession. According to job search firm Indeed, listings for higher-wage occupations remain 28% below 2019's trend while lower-wage postings are down 12% which may reflect increasing unwillingness of white-collar employers to add higher-wage employees amid an uncertain economy. White-collar layoffs may pose significant economic risks given spending by wealthier Americans tends to support lower wage jobs. (Politico)
• The economic recovery over the last six months or so has been surprisingly resilient but recovering the remaining ground may be tougher. The economy has been given a big boost from unprecedented monetary and fiscal stimulus and, while the expiration of enhanced unemployment benefits on July 31 has depressed spending by the unemployed, this has been offset by gains elsewhere. However, there are concerns that the easy gains from reopening are behind us as the fiscal stimulus impasse and uncertainty surrounding a coronavirus vaccine increases the chances that businesses in the most vulnerable sectors will close forever. (Wall Street Journal)
• The European Central Bank (ECB) may be a step closer to aiming for periods of inflation above its goal now that the Fed has adopted that strategy. The ECB could find the Fed's move a tempting option as the ECB resumes a strategy review that was delayed by the coronavirus pandemic. Such a shift would allow longer and looser monetary policy and mollify hardliners who seek to rein in stimulus programs on the rare occasions that inflation nears the current ECB goal. This is the ECB’s first strategic review since 2003 and is expected to conclude in the second half of 2020. The Fed performed a similar evaluation before deciding on its latest change. (Bloomberg)

Our Perspective

Crocodile Tears for the Phillips Curve

In 1958, William Phillips, an economist at the London School of Economics who briefly worked as a crocodile hunter in Australia, proposed the theory that as unemployment falls, inflation rises when employees are able to demand higher wages and prices adjust up to consumers’ increased spending. The thinking behind this inverse theory—known as the Phillips Curve--would guide Fed rate-setting policy for decades.  Until now.

The Fed’s consignment of the Phillips Curve to the dustbin of history is a subtle but momentous policy shift. In recent weeks, Fed members have begun to discuss a new approach which may be further detailed at their meeting this week. Briefly, the new strategy will increase the Fed’s attention on achieving maximum levels of employment and decrease efforts to maintain inflation, defined as Core PCEat or below its long-term average of around 2%.

The Fed’s new marching orders were explained by Federal Open Market Committee member Raphael Bostic. Turning the Phillips Curve on its head, he said "as long as we see the trajectory moving in ways that suggest that we are not spiraling too far away from our target, I'm comfortable just letting the economy run and letting it play out." Fed policymakers are in agreement that the Fed should not raise rates preemptively as unemployment falls "unless you see inflation," Bostic added.

A Long Road Back

Part of the Fed’s challenge in steering monetary policy through the pandemic is the nature of this economic cycle. Typically, cycles follow a peak-to-trough gradual progression through the phases of expansion, decline and recovery. The Fed monitors early signs of economic growth to assess the pace of recovery and to consider a round of rate hikes to counter inflationary trends. A “U-shaped” recovery is the typical trough-to-peak cycle.

The current cycle, however, may be unlike any other the Fed has witnessed. The collapse in economic production and employment in the spring was swift and dramatic and prompted the Fed to roll out a wide range of programs to turn the tide.  Now the question is whether signs of a return to normalcy—such as restaurant reservations back to 86% of pre-pandemic levels--will fade should a second wave of infections occur or progress on a vaccine disappoints.

Meanwhile, other indicators of growth remain stubbornly negative: the Transportation Security Administration logged a strong increase in airport screenings as the Labor Day holiday approached, but screenings remain nearly 60% lower than before the pandemic.And while unemployment declined to 8.4% as of the September 4 report, the number of jobs the Bureau of Labor Statistics (BLS) defines as permanently lost continues to rise--up 500,000 to 3.4 million.

Faced with conflicting and thus less-than-reliable indicators of economic recovery, the Fed has indicated that it is prepared to keep rates at rock-bottom levels and allow Core PCE inflationary growth to “run hot” and pass the former 2% red-line by as much as 50 basis points, even as it considers additional monetary stimulus measures. It would be unusual to see inflation surpass 2.5%. Core PCE inflation ticked above 2.4% a few times in 2006 and 2007, but the last sustained period took place in the early 1990s.

Not All Boats May Rise

While all industries show job losses for the six-months ending September 4 according to the BLS, job losses during that period were most pronounced in services, down 10.3 million, leisure and hospitality, down 4.1 million, and manufacturing, down 760,000.

We are concerned about the potential for what some investors view as a “K-shaped” recovery. In this scenario, certain areas of the economy—most notably those that rely on tech-savvy, white-collar workers, recover more quickly than blue-collar workers in the most affected industries such as services, leisure, and manufacturing. If workers in these sectors continue to face an uncertain employment future, increasing income inequality and social tensions may be the result.

The next several weeks, as the country moves towards an election complicated by responses to the pandemic, may see heightened market volatility. As always, we encourage clients to maintain portfolios structured for achieving long-term goals and to keep in communication with their advisors.

Economic and Market Perspectives is a publication of HighMark Capital Management, Inc. (HighMark). This publication is for general information only and is not intended to provide specific advice to any individual or institution. Some information provided herein was obtained from third-party sources deemed to be reliable. HighMark and its affiliates make no representations or warranties with respect to the timeliness, accuracy, or completeness of this publication and bear no liability for any loss arising from its use. All forward-looking information and forecasts contained in this publication, unless otherwise noted, are the opinion of HighMark, and future market movements may differ significantly from our expectations.