MICHAEL J. HALLORAN, CFA | Equity Strategist of Janney Montgomery Scott
Wyncote Wealth Management Group

Highlights for this week include: 

• September manufacturing surveys are consistent with healthy economic momentum, but respondents continue to cite inflationary pressures as a concern. 

• Stronger-than-expected second-quarter economic growth reflected upward revisions to every major category. 

• However, inflation readings remain above the Fed’s 2.0% target, suggesting the Fed has additional work to cool inflation. 

While higher bond yields and energy prices pose a headwind, we continue to favor stocks, which remain supported by a solid economy, strong corporate earnings, and the ongoing Al investment boom. 

Manufacturing Business Surveys Consistent with A Healthy Economy but Inflationary Pressures 

The Institute for Supply Management (ISM) and S&P Global just released their manufacturing business surveys, which provide timely insight into the economically sensitive manufacturing sector. Encouragingly, these surveys are consistent with healthy economic momentum. 

New orders continue to strengthen while inventories are lean. This sends a potentially encouraging signal for further manufacturing growth in the coming months, but strong demand with limited supply also means inflationary pressures remain a key area of concern, especially amid high oil prices. This is most notable in the production of machinery and equipment, linked in many cases to rising Al-related spending. 

Second Quarter Economic Growth Consistent with A Healthy Economy 

We received the final reading of second quarter (Q2) economic growth this week. Stronger-than-expected Q2 economic growth (2.2% annual rate vs 1.5% expected) reflected upward revisions to every major category. Personal consumption rose at a solid 3.8% rate, while business investment grew at a 9.0% rate as firms continue to spend on the data center buildout for Artificial Intelligence. 

Large revisions to personal income lifted the second-quarter personal saving rate to 4.4%, up from the 2.8% initially reported, consistent with a healthier consumer. The healthy labor market remains a key support for consumers, as evidenced by historically low weekly unemployment claims (coming in once again at 197,000), which are arguably the best labor market indicator. 

Further Signs of Sticky Inflation 

The Federal Reserve’s preferred inflation metric is the Personal Consumption Expenditures (PCE) price index, with the August data released this week. The data came in better than expected, with the headline reading at 3.4% y/y and the core (excludes volatile food and energy components) at 3.0% y/y. However, these readings 

remain above the Fed’s 2.0% target, suggesting the Fed has additional work to cool inflation. The market is assigning the highest probability to one more 0.25% interest rate hike by year-end. 

We Continue to Favor Stocks 

Strong economic growth but persistent inflation is having a negative influence on Treasury yields, which rose above 5.3% this week, a level not seen since 2002. While higher bond yields and energy prices pose a headwind, we continue to favor stocks. Stocks remain supported by a healthy economy, strong corporate earnings, and the ongoing Al investment boom. 

The S&P 500 rose 2.3% in the third quarter and is up 13% year to date, led by Energy, Technology, and Health Care. Despite the rise in stock prices, valuation is more favorable today due to strong earnings growth this year. The consensus forward 12-month earnings growth estimate has risen by 29%. This has resulted is a 13% decline in the forward P/E valuation multiple, which has declined from 23x a year ago to 19x today. 

We currently favor the Energy, Technology, and Health Care sectors. We view Technology and other industries benefiting from the Al investment boom as core portfolio holdings. These companies should remain key beneficiaries of substantial spending on computing capacity, data centers, power generation, and other infrastructure needed to support the continued adoption of Al. 

Disclaimer 

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