Why One Key Troubled Sector Could Ruin Strong U.S. Stock Market Rally

Journalist:
Joseph Young @iamjosephyoung
September 18, 2019

As markets approach the year’s end, the sentiment around the U.S. stock market is improving with important fundamental sectors like housing and manufacturing outperforming the expectations of analysts amidst a pending Federal Reserve rate cut.

However, throughout the past two months, analysts expressed concerns over the likelihood of a partial trade deal with China in the fourth quarter of 2019, fearing that a lack of a deal with China could intensify the downward trend of the U.S. manufacturing sector, leaving Wall Street vulnerable to a potential pullback.

James Knightley, Chief International Economist at ING, said that the rebound of the U.S. manufacturing sector is not sustainable, which may slow down the rally of the U.S. stock market in the short term.

Manufacturing is key for the stock market to sustain its momentum

U.S. manufacturing output turned negative in August for the first time in three years, according to the latest ISM PMI data. | Image: JIM YOUNG / AFP

With a partial trade deal with China on the line and a rate cut by the Federal Reserve in the books, the expectations of an extended stock market rally have noticeably increased in recent weeks.

Strong numbers from the U.S. manufacturing sector in August released by the Federal Reserve further fueled the rising sentiment around Wall Street as the Dow Jones look towards achieving a new all-time high.

However, some economists like Knightley said that the ongoing trade dispute with China and slowing global economic growth will continue to act as major roadblocks for the manufacturing sector, creating a challenging ecosystem for producers.

“U.S. manufacturing output bounced more than expected in August, but the combination of weaker global growth, a strong dollar and lingering trade tensions are huge headwinds that will result in weaker activity through the rest of the year,” wrote Knightley in a column published on THINK Economic and Financial Analysis by ING.

The gloomy prospect of the manufacturing sector is likely to encourage the Federal Reserve to discuss the merit of additional rate cuts moving into the first quarter of 2020, a trend that may temporarily alleviate some of the pressure on the U.S. stock market.

If the Federal Reserve does not meet the expectations of investors with additional rate cuts in the near future, the struggling manufacturing sector could leave the stock market vulnerable to a larger pullback.

Knightley noted:

“This rather gloomy story is already evident in the ISM manufacturing survey, which as the chart below shows, is running at levels consistent with manufacturing output falling 2.5% year-on-year. This is not going to be good news for employment and future wage gains. As such it reinforces our view that the Federal Reserve’s mid-cycle easing will continue tomorrow with additional interest rate cuts likely in December and 1Q20.”

Investors react negatively to the current state of the market

Although the Federal Reserve announcing a rate cut on Wednesday is considered highly likely, pre-market trading indicates that investors remain anxious about the geopolitical risks in the global economy and performance of several main industries in the U.S., including manufacturing.

The Dow Jones set to open with a 50-point drop as the U.S. stock market sees bearish sentiment. | Chart: Yahoo Finance

Investors are likely shifting towards a short term bearish stance because the trend of the U.S. stock market would begin to rely on the Federal Reserve and whether policymakers would consider additional rate cuts heading into 2020 if geopolitical risks continue to intensify.

The Sevens Report founder Tom Essaye said:

“The drama is centered on just how strongly the Fed will signal that it’s going to cut rates again by the end of 2019. It’ll be the ‘dots’ and statement that determine whether the Fed meets market expectations (and spurs a short-term rally) or if we see another ‘hawkish’ cut and uptick in volatility.”

This article was edited by Sam Bourgi.

Joseph Young @iamjosephyoung

Hong Kong-Based Finance Analyst. Contributing regularly to CCN and Hacked. Providing unique insights into the fintech space since 2012.