Following the best August performance in more than three decades, US stocks continue to find support from positive data. Manufacturing activity showed a sharp acceleration in August with the ISM index expanding to 56. That was well above the market forecast of 54.5 and the highest reading since November 2018. The leading indicator was supported by new orders which increased to 67.6 last month, but the employment component of the index continued to show weakness suggesting that factories are still slow to bring back employees. If the ISM services index due to be released on Thursday shows a similar reading, that would suggest jobs remains a weak spot in the US economy. However, investor focus today will be on the ADP employment change data which is expected to show 950,000 jobs were added in the private sector in August versus 167,000 in July. The ISM surveys along with the ADP report may provide an early indication of what to expect from Friday’s non-farm payrolls report.
Improving economic data, along with expectations that interest rates will remain near zero for several years, are great ingredients for risk assets. Investors do not seem to be worried about overstretched valuations as long as the Fed is willing to depress interest rates and continue providing the liquidity needed to keep yields in check.
Despite this optimism, investors need to re-think how to approach a market that’s sitting at record highs with two months remaining to the US presidential elections. Latest polls have shown the race between President Donald Trump and former Vice President Joe Biden have narrowed significantly over the past few weeks. According to Real Clear Politics, the difference is now less than 1% point in favour of Biden. The narrowing gap has translated into a sharp rise in future contracts for the Vix volatility indices. At the time of writing, the October Vix contract is sitting above 33 while spot Vix is hovering near the top of August trading range at 26. A rising stock market with elevated volatility is not a healthy sign and usually indicates turmoil ahead. So, expect risk to be skewed to the downside with big moves as we head into October.
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