Covenant Weekly Market Synopsis for October 12, 2018

October 15, 2018

Last Week Today: Q3 Earnings season kicked off last week, with 47 companies posting results. Overall, the earnings reports were OK, but macroeconomic concerns swamped earnings reports, driving markets down. Earnings season really gets rolling this week, with nearly 200 companies scheduled to report. After a smattering of negative preannouncements, investors are keen to learn both about the quarter behind, but even more importantly what management teams expect in Q4 and in 2019. | The International Monetary Fund reduced its 2018/2019 global GDP growth forecast from 3.9% to 3.7%, mainly on restrictive trade policy concerns. | New home sales in NYC declined 39% in Q3, with a median price decline of 9%. | President Trump criticized the Fed’s monetary policy as “crazy” tight but said he would not fire new Fed Chair Jay Powell.

Although markets staged a counter-rally on Friday, it was a poor week for risk assets. Developed markets (domestic and international) equities declined by about -4%, but in a change of pace emerging markets outperformed “only” falling by -2.0%. At the mid-point of the month, most broad equity market indices are down more than -5%. US Treasuries rallied on the week as the yield on the 10-year declined by -0.07% to 3.16% amidst a modest steepening of the yield curve. Precious metals were mixed (gold +1.1%, silver -0.4%), copper gained +1.4%, and WTI Crude fell -4.0% to $71.34 a barrel. Market losses caused the VIX Index (a measure of S&P 500 volatility) to jump +43.8% to 21.31, slightly above the long-term historical average. For more detail on weekly, month-to-date and year-to-date asset class performance, please click here.

Economic Data Update: Below is a summary of Q3 economic data and our current outlook.


Labor Market

  • The labor force expanded, but at 0.5% it grew at the lower end of its recent range of 0.5% to 1.0%.  Note: If the labor force were growing at 1%, the unemployment rate would remain stable with 150,000 jobs added each month. Instead, the six-month average job growth has been slightly above 200,000 explaining why the headline (U-3) unemployment rate has declined from 4.1% at the end of Q1 to 3.7% in September.
  • Tight labor market conditions are giving rise to accelerating wage growth – while year-over-year wage growth was 2.8%, the three-month average is 3.2% for production and hourly employees.
  • The Small Business survey labor scarcity index is at an all-time high, indicating skilled labor is in extremely short supply.
  • Bottom Line: The demand for labor is outstripping the supply of labor leading to a declining unemployment rate and, after a long delay, rising wage pressure. The Fed is well aware of this dynamic, and it is one of the key reasons the Fed is forecasting another rate hike in December and three more in 2019.


  • Aggregate year-over-year (YOY) income (= total people working x total hours worked x wages) increased by approximately 4.8% on a nominal basis, or 2% on an inflation-adjusted basis.
  • The savings rate is in the mid-6% range, which is close to the historical average, implying consumers have dry powder in the event of leaner times.
  • Real, inflation-adjusted disposable income per capita grew at 2.2% YOY.
  • Actual wage growth is catching-up to survey data from several months ago that suggested wages would increase.
  • Core retail sales spending rose 9.4% YOY, or by approximately 6.7% on an inflation-adjusted basis. It’s worth noting that data over the last couple of months indicate a modest weakening in this data series.
  • Bottom Line: The strong demand for labor, associated rising real wages, and a decent savings rate is giving rise to elevated consumer confidence. These conditions augur for continued spending, a key ingredient for a stable economy in which approximately 70% of GDP is comprised of consumption.



  • Two consecutive quarters of negative growth for residential and non-residential structures – Q3 is likely to show a further contraction.
  • Single-family home permits are flat YOY; multifamily permit growth is negative YOY.
  • Existing home sales trending downward from 4.9 million last year to 4.75 million currently.
  • Bottom Line: Private residential and non-residential sectors are in a mild recession. A contributing factor is affordability as the rise in housing prices has outstripped wage growth for a long time now, a situation exacerbated in high tax states through the removal of the State and Local Tax deduction in the recently passed tax reform package.


  • ISM Manufacturing and Services surveys indicate strong pricing pressure.
  • Wage pressures are now evident and unlikely to abate absent stronger labor market growth – the NFIB Small Business survey’s actual and forecast compensation levels are high by historical standards.
  • Large corporations (i.e., 3M, Home Depot, and Costco) are reporting heightened margin and price pressures.
  • Core PPI (less volatile trade services) is up 3% YOY, and intermediate services were up 3.3% YOY – in other words, inflation is present in the manufacturing and services pipeline.
  • Bottom Line: After an extended period, inflation is no longer missing in this economic recovery. However, it remains to be seen if businesses will be able to raise prices (in which case inflation will rise at the consumer level, i.e., a rising CPI Index) or if companies will have to eat it (lower profit margins). The latter scenario will be particularly troublesome for the stock market, which has already priced-in double-digit profit growth. One of the two scenarios will come to pass unless increasing productivity comes to the rescue to stave off both consumer inflation and margin deterioration.

Bottom-Bottom Line: The economy remains on solid footing, and the Federal Reserve holds the keys to the future trajectory of economic growth. The Fed’s job is being made more difficult by the late-cycle, pro-growth tax reform and fiscal policies of the government, forcing their hand to raise rates to a level they believe will forestall meaningful inflation, while remaining nimble enough to reduce rates once those effects pass to avoid a hard landing (i.e., a recession). Engineering a soft-landing has only been accomplished once in the post-war era (in the late 90’s). In the meantime, the economy will continue to expand at an above-trend rate for at least the next couple of quarters, but it is unlikely to achieve the 4.2% annualized rate witnessed in Q2.

Be well,