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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.

Kevin R. Caron, CFA
Senior Portfolio Manager
973-549-4051

Chad Morganlander
Senior Portfolio Manager
973-549-4052

Matthew Battipaglia
Portfolio Manager
973-549-4047

Steve Lerit, CFA
Client Portfolio Manager
973-549-4028

Paul Clark, CFA
Senior Portfolio Manager
Municipal Fixed Income
415-364-2635

Rick Marrone
Senior Portfolio Manager
Municipal Fixed Income
415-364-2917

Daniel Urbanowicz
Senior Portfolio Manager
Municipal Fixed Income
973-549-4335

Suzanne Ashley
Internal Relationship Manager
973-549-4168

Eric Needham
External Sales and Marketing
312-771-6010

Jeffrey Battipaglia
External Wholesaler
973-549-4031

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.

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