A couple of the stories we’ve been watching this week had notable information released about them. The first news was that Apple’s iPhone 8/ 8 Plus was met with little excitement in China which caused AAPL stock to fall again. There were barricades put up in front of the Apple store on the day the iPhone was released to coordinate the expected crowd, but only a few people showed up. This is a negative signal that the upgrade cycle, which I discussed previously, won’t occur in China which has the biggest userbase ready to get the new devices. This is also bad publicity for Apple which has been dealing with negative stories about how the iPhone 8/ 8 Plus wasn’t a good enough improvement from last year and about how the watch has had connectivity issues. The iPhone lines may have declined because of online buying, waiting for the iPhone X, or because Chinese competitors have a great set of devices for sale at lower prices.

The other story we’ve been following is the healthcare debate. It appears the chances of the bill becoming law have fallen dramatically because John McCain came out against the plan. It’s better than McCain has come out against it now opposed to at the last second, but the odds have definitely dropped. Now the GOP must convince either Collins or Paul along with Murkowski to support it. That’s not an impossible feat, but it is improbable because both Collins and Paul have spoken negatively about the bill. Humana stock was up 0.19% signaling the stock market doesn’t think it will be passed. In the betting market, the chance of the Senate voting on the bill has fallen to 13% which is down from 42% yesterday. The chance of the Senate passing the plan is down to 11% from 38%.

This means the health benefit manager stocks can rally. It’s probably bad news for tax reform. In theory, it’s possible that Mitch McConnel can get rid of the Senate rules so that the bill can be passed without needing 60 votes after September 30th. The problem is that John McCain wants to work with the Democrats and many Republicans don’t want that. No matter what the healthcare plan is, it will start with only being able to lose 1 more Senate vote. I’d argue the plan is dead in the water. The tax reforms might still come in a muted way. That depends on how the Senators align. I wouldn’t be surprised if nothing gets done by the end of the year. It would have been a death knell for this bull market if this news would have come out 10 months ago, but now we have decent economic news and great earnings besides Q3.

Will Low Volatility Continue?

The story of the year in the markets is low volatility as even the worst month of the year combined with the threat of nuclear war hasn’t been able to spike volatility for more than a few days. This is the calmest September ever. The chart below is an interesting comparison which attempts to explain the recent bout of very low volatility and project where it will go in the future. It compares the real Fed funds rate with 1 year realized volatility. The real Fed funds rate is the difference between CPI and the Fed funds rate. In this chart, it is advanced 24 months implying it is a leading indicator. As you can see, this means volatility will stay low for a while. There’s no reason volatility can’t be below average next year, but it’s very likely there will be a bump considering how unusual this year has been.

Economic News

The September IHS Markit Flash PMI was released on Friday. It showed strong private sector growth and a spike in inflation. The headline composite index was down slightly to 54.6 from 55.3. This was partially because of hurricane related weakness. The service activity index was 55.1 which is down from 56 last month. The manufacturing PMI was 53 which was up two tenths of one percent from last month. Finally, the output manufacturing PMI was flat at 52.4.

The report was consistent with slightly over 2% GDP growth. That looks like a very reasonable estimate. The report was consistent with 180,000 jobs created which I think is too high because Florida and Texas make up 14% of the country’s employment. The biggest takeaway from this report is definitely the increase in inflation as input price inflation hit a 27 month peak. The following statement was made about this: “The biggest impact of hurricane Harvey was evident in manufacturing supply chains, where resultant supply shortages were a key driver of higher prices. Supply delays were the most widespread in two and a half years, while input price inflation rose to the highest since 2012.” This shows how powerful the inflation boost was. It should increase the CPI headline number for September. There will be demand for goods to rebuild which will sustain the price inflation. From August 29th to September 19th, the 10 year breakeven inflation rate increased from 1.74% to 1.87% possibly because of the storms.

Given the fact that the Fed likes to say everything is transitory such as the economic weakness from the storms, it’s surprising to see the Fed assuming there will be a sustainable boost in inflation to justify a hawkish stance. The October and November data will be key because if they soften, the Fed will have to move back to dovish. The 1 hike in December and the 3 hikes in 2018 will be taken off the table.

Conclusion

I mention AAPL stock often because it is the biggest company in America. If it goes into a tailspin, it can affect all three major indexes. Obviously, the market can survive that, but some will wonder if this reflects widespread consumer weakness. I’m still think it will be a good trade opportunity to go long in the next few days heading into the launch of the iPhone X. Even if you don’t know for sure what the results will be, you can sell it right before the launch.