US jobs in focus as weak manufacturing data sends stocks into a spin

In a worrying sign for the US economy, the jobs component of the important ISM Manufacturing PMI sank to a four-year low.

The weak ISM manufacturing report hurt parts of the US sharemarket that have particular significance in the Australian market. Picture: AFP

Bad news was bad news as US manufacturing data missed estimates, sending stocks into a spin.

In a worrying sign for the US economy, the jobs component of the important ISM Manufacturing Purchasing Managers’ Index sank to a four-year low. Apart from the lows hit during the Covid-19 pandemic, it was the lowest point for the jobs indicator since the Global Financial Crisis.

The 10-year Treasury yield fell to a six-month low of 3.94 per cent amid rising expectations of US interest rate cuts. But whereas falling bond yields helped stockmarket valuations in recent months, the data cast doubt on the “Goldilocks” narrative promulgated by the Federal Reserve.

Combined with a renewed sell-off in US mega-cap tech stocks after some mixed reports in the past week, the weak ISM manufacturing report hurt parts of the US sharemarket that have particular significance in the Australian market, most notably banks.

Ahead of Friday’s important release of US non-farm payrolls data for July, the wobble in US stocks flowed through to the Australian market with the ASX 200 suffering its biggest fall in 29 months.

A day after hitting a record high of 8148.7 points after domestic inflation data gave a substantial chance of interest rate cuts in Australia before the end of the year, the S&P/ASX 200 dived 171.5 points or 2.1 per cent to 7943.2 points on Friday.

It was the biggest one-day fall in the ASX 200 since March 10, 2023.

On the charts, the ASX 200 formed a worrisome “Evening Star” reversal pattern after hitting its record high this week. That suggests it has formed a top that could hold for some months.

Investors were expecting the July non-farm payrolls report to show solid jobs growth of 175,000 and a steady unemployment rate of 4.1 per cent for July. After the weak manufacturing data, stronger than expected jobs growth would be preferable to any weakness in that report.

About 32 basis points of US rate cuts were priced for the next Fed meeting in September.

Based on that market pricing there was a roughly 64 per cent chance of the Fed starting its easing cycle with an outsized rate cut of 50 basis points at that meeting. Such a big rate cut could indicate that it was fighting a rearguard action and should have cut sooner to prevent a recession.

“After one of the longest Federal Reserve policy pauses in history, markets spent the bulk of July discounting a September start to rate cuts with near 100 per cent certainty,” said Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.

Catalysed by a convincing slowdown in June inflation, including improvement in ‘sticky’ components, the upshot was plunging US Treasury yields, with the bellwether two-year rate down 46 basis points, accompanied by a rotation in equity leadership emblematic of the traditional policy-easing playbook.

But after the latest ISM Manufacturing report and the Fed’s decision to set the market up for rate cuts rather than kick off the easing cycle last month, investors should keep their late-cycle playbooks close at hand, particularly in the event that the Fed does find itself fighting a rearguard action.

Of course such concerns could be put to rest by a robust non-farm payrolls report.

While there was a significant rotation from mega-cap tech to small caps last month – based on the idea that small caps will have better leverage to interest rate cuts, Ms Shalett said the most noteworthy positive for US equities was improving breadth.

More than 80 per cent of S&P 500 stocks traded above their 200-day moving average, indicating greater confidence in a soft-landing economic scenario, at least until the ISM data hit.

“Economic surprises, however, have been mixed, and the earnings season has produced limited positive surprises, with forecasts reflecting negative revisions breadth and hints of scepticism about returns on generative AI investments,” Shalett added.

The implication was that recent gains hinged “almost exclusively” on valuation multiples.

However, Morgan Stanley’s Wealth Management investment committee is cautious.

While a soft landing remains the base case, the path to a Goldilocks scenario is “narrowing”.

US consumers are increasingly solely dependent on jobs for consumption.

Corporate management teams face aggressive margin expansion expectations, while global growth is slowing and pricing power is fading, as policy uncertainty around tariffs, taxes and regulation rises. For the Fed, the potential for mistakes remains high, given government debt levels, the size of the Fed’s balance sheet and money supply growth.

“True soft landings are bumpy and trendless, and the Fed will proceed slowly and deliver shallow accommodation, with Fed funds falling to approximately 3.5 per cent by early 2026,” Shalett said.

In this scenario, she says it’s best to focus on asset class diversification as well as valuations and “growth at a reasonable price” among equities.

“We favour the equal-weighted S&P 500 or active stock picking in high-quality cyclicals or defensives, while avoiding the temptation to chase small-cap momentum or the Magnificent Seven bounce,” she said.

Originally published as US jobs in focus as weak manufacturing data sends stocks into a spin