Markets Begin Q4 on an Up Note, but Volatility Persists

U.S. equities finished higher to begin Q4 on a high note, but the volatility that attributed to September's wild ride and saw the S&P 500 snap a seven-month winning streak, carried over as October is another historically choppy period for stocks. The markets got an initial boost from upbeat trial results of a potentially first oral treatment of COVID-19 from Dow member Merck & Co and partner Ridgeback Biotherapeutics. However, despite the news, the Health Care sector underperformed, while the Information Technology sector finished to the upside after initially being the laggard. A host of economic data was processed, with key September manufacturing reports showing stronger-than-expected growth, personal income and spending rising in August, and September consumer sentiment unexpectedly being revised higher. In other equity news, Exxon Mobil said the surge in natural gas prices is expected to boost Q3 earnings. Lawmakers on Capitol Hill continued to struggle to find common ground on the debt ceiling and infrastructure spending, though they did agree yesterday to avoid a government shutdown, at least for now. Treasuries gained ground to apply some pressure on yields, and the U.S. dollar continued to pare a recent rally, while gold was higher and crude oil prices saw slight gains. Europe finished mostly lower amid the flood of data, while markets in Asia fell in light volume with bourses in China and Hong Kong closed for holidays.

The Dow Jones Industrial Average jumped 483 points (1.4%) to 34,326, the S&P 500 Index increased 50 points (1.2%) to 4,357, and the Nasdaq Composite gained 118 points (0.8%) to 14,567. In moderately-heavy volume, 912 million shares were traded on the NYSE and 4.6 billion shares changed hands on the Nasdaq. WTI crude oil rose $0.85 to $75.88 per barrel. Elsewhere, the gold spot price rose $2.10 to $1,759.10 per ounce, and the Dollar Index—a comparison of the U.S. dollar to six major world currencies—moved 0.2% lower to 94.05. Markets were lower for the week, as the DJIA lost 1.4%, the S&P 500 decreased 2.2%, and the Nasdaq Composite tumbled 3.2%.

Dow component Merck & Co. Inc. (MRK $81) lifted optimism regarding the fight against COVID-19, after announcing positive results of a late-stage trial of its investigational oral antiviral medicine that it developed with partner Ridgeback Biotherapeutics. The companies said the pill significantly reduced the risk of hospitalization or death in non-hospitalized adult patients with mild-to-moderate COVID-19. MRK said it plans to seek Emergency Use Authorization (EUA) in the U.S. as soon as possible and to submit applications to regulatory agencies worldwide, adding that if authorized, it could be the first oral antiviral medicine for COVID-19. Shares of MRK rallied nearly 9%, while other biotech stocks saw pressure, notably an over 11% drop for Moderna Inc. (MRNA $356), to weigh on the Health Care sector, which was the worst performing S&P 500 sector.

Exxon Mobil Corporation (XOM $61) announced that rising energy prices, notably the surge in global natural gas, will boost Q3 earnings-per-share. XOM said gas is on track to be the biggest uplift to earnings in Q3 compared to Q2, surpassing the typically more profitable crude oil, amid steep competition for supply in Europe and Asia that has boosted prices. Shares were higher.

Following a choppy September, October is kicking off and has been historically volatile for stock market performance, but has typically set the stage for a strong seasonally Q4 period. Volatility is likely to remain after the stock market has wobbled noticeably as of late on persistent concerns over the debt ceiling, the ultimate impact of intensifying global supply-chain disruptions on inflation, along with increased expectations that the Fed is moving closer to tightening policy which has resulted in a recent spike in Treasury yields. For a look at the market environment, check out the Schwab Center for Financial Research's article, Market Volatility: Schwab's Quick Take.

Moreover, Schwab's Chief Investment Strategist Liz Ann Sonders provides her latest article, Songs of Experience: Reminiscences of a Strategist, offering lessons she has learned in her 35 years on Wall Street, which are especially relevant given the recent market action.

Find all our market commentary on our Market Insights page at www.schwab.com and follow us on Twitter at @SchwabResearch.

September manufacturing growth surprisingly accelerates, personal income and spending rise

The September Institute for Supply Management(ISM) Manufacturing Index (chart) showed manufacturing growth (a reading above 50) unexpectedly accelerated. The index rose to 61.1 from August's unrevised 59.9 level, and versus the Bloomberg consensus estimate of a dip to 59.5. The stronger-than-expected report came as growth in new orders was unchanged but held onto a robust 66.7 figure, while production growth dipped to 59.4 from 60.0, and expansion in new export orders declined but remained in expansion territory. Supplier deliveries jumped 3.9 points to 73.4, inventories rose 1.4 points to 55.6, and employment increased slightly but moved back in expansion territory. Inflation pressures persisted, rising 1.8 points to 81.2, but remaining well off the 92.1 mark in June that was the highest reading since July 1979.

The ISM said, "Manufacturing performed well for the 16th straight month, with demand, consumption and inputs registering month-over-month growth, in spite of continuing unprecedented obstacles and ever-increasing demand. Panelists' companies and their supply chains continue to struggle to meet demand due to difficulties in hiring and a clear cycle of labor turnover, as workers opt for more attractive job opportunities. Disruptions from COVID-19, primarily in Southeast Asia, continue to have an impact on many industry sectors. Congestion at ports in China and the U.S. continues to be a headwind, as transportation networks remain stressed. Demand remains at strong levels, despite increasing prices."

The final September Markit U.S. Manufacturing PMI Index was unexpectedly revised higher to 60.7 from the preliminary 60.5 level, where it was forecasted to remain, but below August's reading of 61.1. A reading above 50 denotes expansion. Markit's report differs from the ISM's release as it polls a larger swath of companies varying in size and it weights its components differently.

Personal income (chart) rose 0.2% month-over-month (m/m) in August, matching the Bloomberg forecast and following July's unrevised 1.1% gain. Personal spending grew 0.8%, above estimates of a 0.7% gain and compared to the prior month's downwardly-adjusted 0.1% dip. The August savings rateas a percentage of disposable income was 9.4%.

The PCE Price Index increased 0.4% m/m, above expectations of a 0.3% gain, and in line with July's unadjusted increase. Compared to last year, the deflator was 4.3% higher, north of estimates to match July's unadjusted 4.2% gain. Excluding food and energy, the Core PCE Price Index rose 0.3% m/m, above expectations of a 0.2% increase, and matching July's unadjusted rise. The index was 3.6% higher y/y, topping estimates of a 3.5% gain, and in line with July's unadjusted rise.

The September final University of Michigan Consumer Sentiment Index (chart) was surprisingly revised higher to 72.8, compared to expectations for it to be unadjusted at the preliminary reading of 71.0. The upward revision came as positive adjustments were made to both the current conditions and expectations components of the survey. The overall index was higher versus August's 70.3 level, as sentiment regarding both expectations and current conditions improved sequentially m/m. The 1-year inflation forecast remained at August's 4.6% rate, but the 5-10 year inflation forecast ticked higher to 3.0% from the 2.9% level in the prior month.

Construction spending (chart) came in flat m/m in August, versus projections to match July's unrevised 0.3% gain. Residential spending increased 0.4% m/m, but was countered by a 0.4% decline in non-residential spending.

Treasuries gained ground with yields volatile following a recent jump that has come from the Fed's monetary policy decision last week which delivered notable changes in the Central Bank's economic/inflation projections and rate hike expectations, while hinting that formal details of balance sheet tapering may come in November. Schwab's Liz Ann Sonders provides analysis of the decision in her commentary, Fed Tapering Coming Soon; Dots Plot Has Thickened.

The yield on the 2-year note dipped 3 basis points (bps) to 0.26%, while the yields on the 10-year note and the 30-year bond decreased 6 bps to 1.47% and 2.04%, respectively.

Europe mostly lower following flood of global data, Asia falls in lighter volume

European equities finished mostly lower, with the global markets remaining wobbly in the face of rising inflation pressures amid the intensified global supply-chain challenges and growing expectations that central banks may be set to begin to rein in extremely-accommodative polices put in place to combat the pandemic. The markets eyed some positive COVID-19 treatment news out of the U.S., and digested a host global economic reports. Japan, Australia and South Korea all reported upbeat Manufacturing PMIs, and Japanese large manufacturing sentiment unexpectedly improved solidly for Q3. Meanwhile, the Eurozone Manufacturing PMI as reported by Markit showed growth slowed more than initially estimated but remained solidly in expansion territory for September, and U.K. manufacturing growth came in stronger than initially projected. In other economic news, German retail sales rebounded in August but at a pace that was below estimates, and Eurozone consumer price inflation accelerated in September as expected. The euro and British pound rose versus the U.S. dollar, which has come off a recent rally to the highest level in a year following the upbeat COVID-19 treatment news. Bond yields in the Eurozone and the U.K. slipped.

Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, offers his latest article, Payback Time With a Potential Payoff. Jeff notes how a gradual slowing of stimulus heralds a potential drop for the world's stock markets, but the evidence suggests a possibility for a positive outcome. Jeff also discusses in his article, Can Investors Avoid Rising Supply Chain Risks?, how supply chain issues are worsening, increasing the risk to sales, production, and inflation. He points out how European stocks may offer an opportunity to avoid these risks.

The U.K. FTSE 100 Index was down 0.8%, Germany's DAX Index dropped 0.7%, Italy's FTSE MIB Index declined 0.3%, and Switzerland's Swiss Market Index traded 0.6% lower, while France's CAC-40 Index and Spain's IBEX 35 Index were little changed.

Stocks in Asia finished solidly lower to close out the week, on the heels of the drop in the U.S. yesterday that snapped a string of seven-straight monthly gains for the S&P 500. The global markets remain volatile as Q4 begins amid the continued noticeable rise in global bond yields on rising inflation pressures amid the intensifying supply-chain challenges and growing expectations of monetary policy heading toward the tightening path. Stocks are falling despite a host of upbeat economic reports in the region, headlined by Japan's Q3 report on sentiment among large manufacturers from Tankan, which showed a solid unexpected improvement quarter-over-quarter. Moreover, Manufacturing PMIs out of Japan and South Korea both showed growth accelerated in September, and Australian activity slowed slightly but remained comfortably in expansion territory.

Japan's Nikkei 225 Index dropped 2.3% with the yen rallying after a recent drop. Schwab's Jeffrey Kleintop discusses how Japanese stocks became the world's best performers in September and the third quarter in his latest article, It's All Over for Japan (and That's Good). South Korea's Kospi Index declined 1.6%, Australia's S&P/ASX 200 Index fell 2.0%, and India's S&P BSE Sensex 30 Index traded 0.6% to the downside. However, volume was lighter than usual as Hong Kong markets were closed for a holiday and China was also closed as the country begins its Golden Week holiday celebration.

Stocks see largest weekly drawdown since January

U.S. stocks fell sharply to close out September, which stayed true to its historical volatile norm. The S&P 500 posted its largest weekly drawdown on a points basis since January, which snapped a seven-straight monthly winning streak. The markets were skittish as Treasury prices continued to slide to extend the recent steepening of the yield curve and weigh on longer duration higher valuation segments of the markets that have been holding up the broader indexes as of late. The rise in bond yields and market skittishness has come courtesy of the continued hawkish tilt from the Fed and other global central banks to bolster expectations that stimulus measures would soon begin to be reined in. Also, inflation pressures and uneasiness intensified as the global supply-chain disruption continued to worsen, while stagflation uncertainty festered as more companies warned of the impact, while the Delta variant impact continued to show up in data from pockets of the economy. Meanwhile, the debt ceiling and infrastructure spending stalemates continued, although a stopgap spending measure passed to avoid a government shutdown for now. Finally, the U.S. dollar extended a recent rally, hitting the highest level in a year, alongside the upward move in bond yields, and crude oil prices added to a surge to register a sixth-straight weekly gain.

As such, the Energy sector rallied and was the lone group in the green for the week, while the Information Technology sector fell sharply and contributed the most to the market's selloff. Outside of Energy, weakness was broad-based with value/cyclical sectors—Financials, Materials, and Industrials—also posting losses after recently showing signs of outperformance.

With October kicking off Q4, volatility is likely to persist and next week's economic docket could add to the choppiness. ISM and Markit will follow up Friday's strong manufacturing reports with the Services PMIcounterparts though both are expected to show growth decelerations. Other reports that could garner some attention include, August reads on factory orders and the trade balance, ADP's September private sector employment report, and jobless claims for the week ended October 2. However, the docket headliner will likely be the key September nonfarm payroll report, which will come as the markets grapple with a more hawkish Fed and the timing of policy tightening. Employment is expected to grow by 488,000 jobs last month following August's severe miss of a 235,000 gain and the unemployment rate is expected to dip to 5.1% from 5.2%. Fedspeak will slow down a bit but a few officials are slated to speak and this week's surprise resignations of Fed governors could foster some added scrutiny on any commentary they provide.

Next week's international economic calendar is also poised to bring some reports that may contend for attention, with releases worth noting including: Australia—Services PMI, trade balance and the Reserve Bank of Australia's monetary policy decision. China—Services PMI. India—Services PMI, as well as the Reserve Bank of India's monetary policy decision. Japan—consumer price inflation figures out of Tokyo, household spending, and labor earnings figures. Eurozone—Services PMIs, investor confidence, retail sales and a speech from European Central Bank President Christine Lagarde, along with German factory orders, industrial production and trade balance. U.K.—Services PMI.

As noted in our latest Schwab Market Perspective: Choppy Waters, although the S&P 500 index has climbed steadily year to date, overall index performance is masking a lot of choppiness beneath the surface. Global stocks face waves of worry about near-term issues, despite favorable longer-term economic forecasts. And while it's clear the Federal Reserve is moving toward tighter policy, the pace of the change is uncertain. Meanwhile, Congress is wrestling with multiple issues that could affect markets.

Important Disclosures

Schwab Center for Financial Research ("SCFR") is a division of Charles Schwab & Co., Inc. The information contained herein is obtained from third-party sources and believed to be reliable, but its accuracy or completeness is not guaranteed. This report is for informational purposes only and is not a solicitation, or a recommendation that any particular investor should purchase or sell any particular security. The investment information mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinions are subject to change without notice in reaction to shifting market conditions.

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Markets Begin Q4 on an Up Note, but Volatility Persists

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