Growth expectations surged in the first half of the year, but that pattern seems to be changing. While vaccinations ignited hope of a fast and full economic recovery, we now see slowing. The slowdown is significant enough to prompt us to cut in equity exposure this month in tactical portfolios. We now see the WCA “Barometer” (chart A below) likely slipping to around 60 from 70 over the next few months. There are several drivers of this change.

Chart A

WCA Fundamental Conditions “Barometer”

Employment Fades


The delaying of return to work for many casts a wet blanket on the service sector recovery. According to an Institute of Supply Management survey during the past month (Chart B below), employers say they are less likely to hire. This view is contrary to earlier expectations of labor shortages leading to amped-up hiring later this year. A slower service economy potentially compounds slowing in manufacturing and needs to be watched. The ISM survey confirms the weakness seen in August’s payroll report where only 235,000 jobs were created versus a July report of 943,000 jobs.

Chart B

Capital Spending Already Weak, Could Services Follow?

Should the larger service side of the economy soften as suggested by recent employment trends, it would compound existing weakness in capital spending by business. While a more minor part of the economy, manufacturing is more cyclical, thereby offering timely clues about growth. Capital goods, which is a component of manufacturing, can be even more telling (Chart C, below). This category of production addresses business investments of many kinds and tends to foreshadow changes in profits, a key driver of stocks. As shown in the chart below, businesses may be turning more tentative about spending despite shortages requiring new production facilities and new environmental spending programs. Recent announcements of shutdowns of some automobile manufacturing reflect softening manufacturing trends.

Chart C

Thankfully, the recent slowdown has not fed into expectations for corporate earnings, but continued weakness in business spending or new weakness in services would likely cut into earnings expectations and hurt the bull case for stocks. So far, however, earnings projections are holding up. The chart below shows how analysts are maintaining forecasts for corporate profits (Chart D, below) despite recent data trends. Based on bottom-up analyst estimates, profit forecasts are up 40% in a year, reflecting high hopes for a full recovery.

Chart D

Conclusion

The takeaway here is not all bad, and there is reason to think some of the recent slippages may prove temporary. Growth is still positive as the New York Federal Reserve GDP Growth “Nowcaster” is near 3.8%, down from 5.5% in May. There is reason to think supply constraints and other factors will fade over time. While COVID-19 trends are moving in the wrong direction, progress on many fronts is being made. Tactical portfolios still remain overweight stocks versus bonds, only less so given recent trends.

In the next few weeks, we will get new insights about policy, too. A fiscal package is working its way through Congress, and the Federal Reserve is debating the future of asset purchases. These factors, along with those discussed above, will be essential to watch from here.

WCA Fundamental Conditions Barometer:

We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. The analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.

Disclosures:

WCA Barometer – We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. Analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.

Standard & Poor’s 500 Index (S&P 500) is a capitalization-weighted index that is generally considered representative of the U.S. large capitalization market.

The S&P 500 Equal Weight Index is the equal-weight version of the widely regarded Standard & Poor’s 500 Index, which is generally considered representative of the U.S. large capitalization market. The index has the same constituents as the capitalization-weighted S&P 500, but each company in the index is allocated a fixed weight of 0.20% at each quarterly rebalancing.

The Washington Crossing Advisors’ High Quality Index and Low Quality Index are objective, quantitative measures designed to identify quality in the top 1,000 U.S. companies. Ranked by fundamental factors, WCA grades companies from “A” (top quintile) to “F” (bottom quintile). Factors include debt relative to equity, asset profitability, and consistency in performance. Companies with lower debt, higher profitability, and greater consistency earn higher grades. These indices are reconstituted annually and rebalanced daily. For informational purposes only, and WCA Quality Grade indices do not reflect the performance of any WCA investment strategy.

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