Manufacturing Slumps, Services Hold Strong: December Market Insight

Hello and welcome back to another episode of blue Chip now.

Now you have Daniel Dusina chief investment officer, matt mondoux, senior financial advisor and dan seder, managing partner. And we will kick off today with a discussion on the equity markets before moving our way into fixed income. This this episode will be a little bit different than usual, just because I think the the subject matter of this episode will be, I would say, focused on the markets.

But there’s there’s a lot of underpinnings that we want to on want to unpack. It’s not like there’s some specific news items or five specific stories we want to kind of highlight. So this one will be a little bit more fluid. But I think there’s enough to keep us, keep us entertained to say the least. So without further ado, I’ll jump into it.

And let’s start on the stock market side of the equation. We had December kick off with a fairly rough start, specifically, if you looked at information technology and crypto markets opened the month on somewhat shaky footing. You had the first day of the month where major indexes dropped and you saw investor sentiment somewhat shift away from the high growth tech and crypto linked stocks.

You had cryptocurrencies tumbling and that also dragged down some companies with cryptocurrency exposure. And so that risk off mood reflected some broader concerns. Those would be persistent inflation, uncertainty about interest rate moves by the Federal Reserve. And a general sense that valuations, especially in tech and crypto, may have gotten ahead of themselves. Do we know is there some other underlying issue with crypto, or is this simply a reflection of sentiment and about more investors?

To me it’s it’s purely sentiment driven. At least to my knowledge, there hasn’t been anything earth shattering from the perspective of the call it foundational underpinnings of crypto. I do think that even though cryptocurrencies have kind of been part of the sales pitch for them has been they’re a diversifier and hypothetically, they should not be related to or correlated with other securities.

I think what you get is what we saw in the very early goings of December, which is that they move with other risk assets. I think correlated to technology can be for sure. Well, they’re certainly not correlated to gold this year, right? 50% and crypto is that. Yeah. So so is it yet the safe haven status or the things that we you know, it gets labeled as really are coming through.

Right. Well and I think that also you know, the follow on point to that is that that market rebound that we saw immediately thereafter, I guess the point is that slump did not stick. You had a bit of a reversal after the very early innings of December in which I optimism and Federal Reserve rate cut hopes started to fuel a turnaround.

Over the next several trading sessions after I think it was just the first two days of December, you had, a wave of optimism around AI, particularly strength and some mega-cap tech names that helped really reignite investor appetite. And so by the end of last week, I that would have been December 5th. US Secretary benchmarks had posted some some fairly solid gains.

And so that rally was underpinned not just by tech stock enthusiasm, but also, by growing hopes that the Federal Reserve will be cutting rates this week, which has certainly served to boost investor confidence. Now, before I unpack some of that there, there are certainly mixed signals going on. I think, as evidenced by that first week of December trading.

And one thing we wanted to highlight is that manufacturing remains somewhat soft. One item that we watch, and according to the latest release from the Institute for Supply Management, or ISM, the US Manufacturing Purchasing Managers Index fell to 48.2 in November. That’s firmly below the 50.0 threshold that separates expansion from contraction and more notably, that marks the ninth straight month of contraction in the manufacturing sector.

A couple of quick tidbits on this report. Number one, I’ll call out at a headline this Purchasing Managers index and its services related counterpart, is survey driven. So specifically surveys purchasing managers about their thoughts on the path forward over the next six months. And it has a bunch of sub indices within it. So for example, the new orders index within this report dropped to 47.4, which is the third straight month of contraction.

And this one is generally thought of as a very forward looking piece of the report. So to see new orders dropping and firmly in contractionary territory, I think that is should be taken as a negative. And that really does just suggest that demand for manufactured goods is softening fewer orders, weaker production outlooks, which can sometimes signal a slowdown in that part of the economy.

At the same time, I wouldn’t say that all the parts of this manufacturing read were bad. The production index apparently returned to modest expansion territory, and interestingly, supplier deliveries improved and said another way deliveries are getting faster and inventories rose. So you’re kind of getting this mixed bag in which manufacturing kind of seems to be a weak link.

Demand is somewhat weakening, and firms are just generally exhibiting some level of caution. And that does tend to drag on gross corporate investment. And even things like hiring in manufacturing heavy industries. All of those things can ripple across the economy. And we do know, you know, manufacturing is a smaller component of the US economy. As we have these switch to consumption service space.

But but still, it’s important. This data is important. That’s where I was going. What. And when you said smaller how much smaller. What are what are we talking about I believe and correct me if I’m wrong. Data. It was like an 8020 were probably 80% services. I think manufacturing is more like 20%. Well that’s it okay. Yeah, it’s somewhere around there.

I don’t have an exact number, but, last we looked at this, I mean, the numbers in my head or something like 70, 30, 80, 20 somewhere around there. So it is, I mean, whatever the number is, I think if you just think of the majority right, services driven economy and I think that’s, you know, it’s I don’t want to say obvious, but like that’s what people think about.

I mean, we’re not an export driven economy. We’re not a China where we are we are adding to GDP because we’re we’re producing things and selling them to other countries or individuals of other countries. So even though that is the case, you do have some semblance of that knock on effect from a weak manufacturing environment. I mean, the employment base, even though it the manufacturing sector is not a dominant portion of GDP, there still is a healthy component of labor that that is related to manufacturing.

So that ripple effect is is where you might see it pretty pretty predominantly. And there’s been a there’s been a push to bring manufacturing back to the United States, but with it being the the minority and services being the majority. But what about services. Yeah. Services that one. So just as you know, I mentioned before, like we have this these purchasing manager indexes, there is one for the services side of things as well.

So I would say there it’s been a bit of a different story where you’ve had the manufacturing PMI been in contraction for I think nine straight months. The services side has remained in modest expansion. So the latest ISM services PMI reading rose to 52.6 from 52.4 prior. So you’re seeing not just expansion but accelerating expansion. And what that suggests is that business activity in services continues.

Companies are seeing work getting orders, delivering services, employment and services oriented sectors ticked up slightly, though that one did remain below 50, which signals that slight contraction on a subindex level. And that just kind of tells you a similar story to what we’re seeing across the broader labor market. And it’s that hiring remains fragile despite some overall growth in the services components of the US economy.

So services good, manufacturing bad services is way larger than manufacturing. Are things really that bad? I would argue no. I think it’s this is very consistent with how I’ve been looking at the economy for the majority of this year, and it’s that I just I would caution individuals in the US to expect the banner growth, for example, the, you know, close to 4% GDP growth we saw in the second quarter of this year.

I don’t think that there’s a high likelihood that that persists and continues in the to call it current quarter in the quarters immediately to come. But that doesn’t mean that we’re going to immediately enter into a, you know, negative GDP growth type environment. Yeah. And and bad. So you have you have the economy, which is one thing. And you have the markets, which are something completely different.

If there’s signs of cracks in the economy, what what does that necessarily mean for the markets. Well, you know, this is one of the situations or can be one of the situations where bad news is good news. Right? So, so if you start to see services soften, you could see more aggression from the fed on rate cuts, which could also, you know, prop up the markets or give the markets could perform well under that environment.

So looser monetary policy. But money market yields dropping cash on the sidelines, moving from cash to something else. Something else could be stocks. Exactly. And that’s that. That’s out there. You know the other counter. And we might get to this a little more in depth. But you know, if it’s, you know, stagflation like where we have persistent inflation with low growth, then cutting rates for the fed becomes very challenging.

And that that would be a situation you expect you could expect markets to tread water. So I think you know the the mixed report you know it’s not it’s not all bad news. It’s not all good news. There’s always an element of uncertainty in markets. Do kind of all the worry as we say. But but yeah you know the Fed’s got a tough job going forward.

And you know could the market doing better. Sure. I mean I said the the economy. Yeah. But but it’s it’s really not all that bad. When is Jerome Powell up. Is that I honestly I think that’s next year right. Yeah I know I know it’s coming up. I know he doesn’t have to be, it’s just it’s looking like he’s not going to be the front.

Yeah. As chairman. Well I guess on that on that point. So the Federal Reserve has their December meeting this week, the ninth and the 10th of December, and it’s become an an all but certainty that we will get another 25 basis point rate cut, which I think, Matt, you alluded to this, I don’t I’m in the camp where I don’t necessarily see a 25 basis point rate cut as overly necessary at this juncture.

I mean, you’ve seen the market clearly anticipate it. That’s why you got a a grind higher in the equity market, and you’re seeing it by way of lower short term bond yields, at least U.S. Treasury yields. To me, the risk of cutting rates in a healthy economy and stoking further inflation is much higher than the benefit that you would receive from front running economic softness.

That’s just my perspective at this specific juncture. I would even say you you could argue we talked about this before the podcast. I mean, you’re seeing that in the data, right? Yeah, yeah. And I just, you know, to me it’s it’s like you had this wonky period where we had no official government data and now you’re getting some of that start to roll in.

I don’t see any. I mean, what is really the realistic difference between waiting now until early next year to assess and rifle through the outstanding data and then make a decision to move whether or not 25 basis points now versus three months from now actually matters. You know, that’s up for debate. But I guess in reality, you know, you are getting the bond market start to move around pretty meaningfully.

But isn’t that when market moving events occur? So if, if the markets are anticipating a 25 basis point cut and then it doesn’t happen, that’s what you see. You’ll see choppiness volatility down. You’ll see a downward move in the market 100% I mean to me there’s the most meaningful catalyst for why equity. The equity market kind of drawdown that we saw at the very beginning of December didn’t stick is because of anticipation of rate cuts.

But, you know, you have seen a bit of a mixed bag in terms of rate movement. So, you know, against this kind of mixed economic backdrop that we talked about earlier, you have long term U.S. Treasury yields, especially call it the ten year and beyond has gotten that jolt upward. Today. We’ve got the ten year Treasury real Treasury yield that has risen to around 4.19%.

And that’s that’s at its highest in over three months. So in addition to, you know, some of the fed activity, there’s there’s some other items that will drive travel treasury yields, you know, for example, broader global market stress, a sell off in Japanese that you’re starting to see some of that these minutia type items that do have an impact.

But then also you’re kind of seeing what’s being reflected as a bear steepening dynamic. A steepening U.S. Treasury yield curve, meaning short term rates down, long term rates up. Why might this be happening? Well, it might be happening because even though investors may suspect that you have short term rates on, you know, moving downward, longer term inflation or economic risks can cause longer term bond yields to remain high.

So in other words, you’re starting to see fixed income investors demanding more compensation for longer duration risk. So that could be because they see inflation or economic uncertainty remaining stubborn or because they’re losing confidence in bonds. If growth weakens. This is this is a fluid situation right now. You know, I think of the ten year. So it’s a risk free asset for U.S. Treasury, which could be up for debate.

But that go with me here. You know, with economic uncertainty were high. You would expect to see yields fall. So so really, at the end of the day, this seems to me to be investors saying that they want to be compensated for the higher level risk of persistent inflation. Yes. Yeah. I think that’s fair. Like that’s exactly why I’m saying I don’t know if we need to be cutting interest rates like so aggressively right now.

And I think that’s what the bond market is telling you. The equity market is telling you they love it, but the bond market is telling you they’re basically debating it right now and in your face. So I you know, at the same time, like if we there’s this constant, you know, push and pull between rates and other items.

I mean, certainly if you, if you were to get, this, this spike in yields to kind of play out a little bit further, of course, the natural or direct, the fact is that, you know, you could make borrowing more expensive for companies and households cool investment in spending from corporations. But they can also weigh on equity valuations, especially for those high growth and rate sensitive sectors.

So, you know, that’s just going to be something to continue to watch. And you know, this whole divergence between a weak manufacturing sector and, and a services sector that has held up, I think stepping back a little bit, you’re getting a suggestion that the US economy might be undergoing this sectoral risk shifting, heavy industry, manufacturing and trade exposed to global supply chain issues and tariffs and cost pressures.

Those things might continue to lag. I think there’s just a lot in flux there. Well, you’ve got consumption driven sectors aka services, you know, very related to consumer spending that carry more weight. This this shift isn’t going to be even. And what I would say is that, you know, despite all this and despite all the concerns, I mean, you have held or haven’t had a consumer that has held up relatively well and, you know, at the highest levels, consumer spending is by far and away the most impactful item of of U.S GDP.

So, that’s where I would be concerned that if you get this stagflation like conditions, meaning high inflation and no growth, you know, that’s where it would be really challenging. And again, why I would be a, proponent of holding rates firm here. But again, we can go into the minutia and slice and dice things all we want.

But above all else, things do appear to be fine. On the surface, the economy is still growing. Corporate results have actually been fairly compelling, and I don’t necessarily see that changing. There’s just a lot of complications with a data lag and a Federal Reserve that’s moving. And a year that has been, quite eventful, but a good year for stocks that a good year for bonds.

Right. Yeah. Yeah. Well say well good year for international stocks. Yeah. Across the board. So a couple of markets and yeah. All right. Well that’s a wrap on blue chip. Now for this this go around. We always thank you for listening and look forward to speaking with you again soon. Not sure if we’re going to record again for the holidays, but that happy holidays have been holidays.

Well said. Enjoy that time with friends, family and otherwise. Thanks for listening. Speak to you next time.