Each month, representatives from Allianz Investment Management LLC provide commentary on market and economic indicators, including Federal Reserve actions, interest rates, credit markets and economic releases such as inflation, GDP, consumer confidence, housing, retail sales and job unemployment news.
Allianz Investment Management LLC September Market Update
Equities had a fantastic month during August with the monthly gains on the S&P 500 being the strongest in over three decades. However, the exuberance appears to have met a roadblock as lofty valuations are squared up against the risks on the near-term horizon. First, we have yet to see Congress make any meaningful progress on another round of stimulus, which is weighing on risk assets. In addition, the U.S. election is just around the corner and the expectation for volatile markets is almost certain given the uncertainty and the potential for a contested result. Overall, the upside for equities will be diminished until further clarity presents itself on key topics such as the election, fiscal stimulus, and a vaccine.
There has been an interesting anomaly regarding market volatility that market participants have witnessed in recent weeks. Despite the S&P 500 Index making new highs, the CBOE Volatility Index (VIX) has remained elevated and near the mid-20 level. This signals that investors perceive the market to be more volatile one month forward, which can be attributed to the lofty levels that the broad stock indexes achieved. In addition, VIX futures for October are even more elevated as investors continue to expect the upcoming election to be a significant driver of equity volatility.
Treasury yields continue to be range bound as the tug of war between virus uncertainty and additional supply is driving the ebbs and flows in the Treasury market. Indeed, we have seen the macro backdrop improve over the past four months, but there is some uncertainty around the speed of the recovery from here. The Fed is really keeping a lid on rates as Treasury purchases remain at $80 billion per month. On the flip side, inflation has been rebounding faster than expected which has led to some moderate steepening of the yield curve. On balance, we do not expect Treasury yields to break out of the narrow trading range until we see a widely adopted vaccine and some meaningful improvement in the economy, both of which are not likely to occur until 2021.
The grind higher in West Texas Intermediate (WTI) crude oil prices appears to be hitting a wall as the combination of China purchases slowing and OPEC adding production caused prices to peak close to $44 per barrel. In August, WTI crude oil gained 5.81%, but fundamentals and a slowing economic outlook have already led prices to decline by over 12% in September. In general, prices have been following the macro backdrop in sync, and the sooner that picture starts to improve again, the quicker we will see oil prices stabilize.
The ISM Manufacturing index continued its climb in August, rising to 56 from 54.2 in July. Within the data, new orders increased to the highest level since 2004 while the employment index remains weak. ISM Services Index came in mostly as expected at 56.9. Muted employment and supply chain constraints are becoming more evident in the services sector as inventory levels decline and order backlogs edge higher. Overall, both the manufacturing and services sectors appear to be rebounding since the COVID-19 shutdowns, but employment and supply chain implications will be important to watch going forward, especially as we get closer to the election.
Posting a modest growth of 1.2% from June (vs 2.1% expected), July retail sales suggest that the recovery has lost steam. Retail auto sales dropped by 1.2% month over month, affecting the headline figure. Excluding autos, retail sales rose by a stronger 1.9%, ahead of expectations of 1.3%. Consumer spending was positive in 9 out of 13 categories with electronics and appliances registering the strongest growth followed by gas stations and clothing. It is worth mentioning that restaurants posted a 5.0% gain month over month despite the new restrictions on bars and indoor dining announced by several states. Looking ahead, the expiry of additional Federal unemployment benefits at the end of July and uncertainty over future finances could influence consumer spending in August.