By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast
The past week observed a return to market volatility, or in other words, a roller coaster ride. On one day, Dow Futures pointed to a drop of more than 500 points, but the market showed some stabilization in the afternoon and closed 250+ points down. The wild ride continued the next day, with the Dow finishing up 400+ points.
Some of the initial volatility occurred earlier in the week when the ISM Services Index came in less than the market consensus. The index showed continued expansion in the service sector but deceleration from the previous month. The headline number was less than the market expectation and investors reacted negatively.
Why was the reaction so harsh for a report that still showed expansion in services? Investors have been expecting strong growth in the service sector of the economy. Last year, consumers were flush with cash, due to a combination of stimulus checks and limited leisure and hospitality experiences. Consequently, consumers spent heavily on durable goods. Households shopped for goods that could be delivered to the front door, made lots of home improvements, or bought things like bikes and kayaks, camping equipment and electronics.
Moving past all that, households now have pent up demand for services. They want to pursue activities with others, like dining, travel, or experiences. When the ISM Services Index came in less than expected, the market reaction was negative, losing 400+ points early in the trading session, and then finishing down 200+ points on the day. The less than positive ISM Services Index led investors to believe that the big party everyone had been waiting for might be a little bit less.
A couple days later in the week, we had the big drop in early Dow Futures and the decline of 250+ points for the day. A lower yield on 10-year government bonds, along with the earlier ISM Services deceleration, produced fear among some investors. Early in the year, we saw the opposite. Big drops in the NASDAQ due to a 10-year yield that had surpassed 1.7% caused the reflation trade, with investors rotating to value over growth stocks.
Fast forward to last week, and the market expressed concerns with the declining 10-year yield. Since early April, rates on 10-year bonds have been on a declining trend. Last Thursday, the market reacted quite harshly to lower interest rates, not higher! A declining 10-year yield was telling investors that growth might be less than previously anticipated. Add the results from the ISM Services Index, and the market was in a grouchy mood. It finished down 250 plus, but this was a significant improvement from early futures that were pointing to a 500+ decline.
One of the issues on the service side of the economy is available workers. As discussed in previous columns, worker shortages are making it increasingly difficult for firms to realize the growth potential, given the strong demand. The ISM Services report alluded to that. The employment component of the report showed contraction, in the presence of overall expansion in the service economy. The decline in the ISM Services employment component can be seen with the difficulty in hiring, evident through the record number of job openings. The latest Bureau of Labor Statistics JOLT (Job Openings and Labor Turnover) report showed that job openings continue to remain at record levels, with leisure and hospitality increasing by 10,000.
Locally, initial claims for unemployment are at the lowest level during the pandemic, and now are almost comparable to levels that existed prior. Initial claims across the five counties of Southern Indiana reached a pandemic high of 5,300+/- and the latest show a level of 185. Continuing claims reached a pandemic high of 10,500+/-, and now stand at 1,400+/-. Pre-pandemic initial and continuing claims were 104 and 565, respectively.
Despite some of the recent hiccups, we can still be optimistic regarding overall growth. Consumers continue to be flush with savings, and pent-up demand has not been fully satisfied, especially on the services side of the economy. Low inventory levels in manufacturing, along with supply chain issues and labor bottlenecks, suggest significant production in the pipeline. The ISM Backlog of Orders Index was at historical high levels but receded slightly last month. New orders remain high, and inventories low. Consumers continue to spend and are now willing to take on more debt. Consumer debt reached a year over year bottom in early 2021 but has been increasing since. While the 10-year yield is expressing some hesitation in earlier growth prospects, strong growth is still in the pipeline.