For the first time in 36 years, the manufacturing sector is contracting; the ISM manufacturing index printed at 48.6.  New orders dropped 4 points to 48.9 while production decreased 3.7 points to 49.2.  Only 5 of 18 industries expanded.  The anecdotal comments explain the underlying reasons:

• "The oil and gas industry is realizing that [the] ‘low’ oil prices are now the new reality with expectations to continue at this level for some time." (Petroleum & Coal Products)
• "Still seeing deflation in raw materials." (Chemical Products)
• "Bookings and new orders are lower than expected." (Computer & Electronic Products)
• "Automotive remains strong." (Fabricated Metal Products)
• "Business is still good." (Transportation Equipment)
• "Downturn in China and European markets are negatively affecting our business." (Machinery)
• "Strong dollar is slowing our sales to China as they can buy in Europe." (Primary Metals)
• "Medical device continues to be strong." (Miscellaneous Manufacturing)
• "Incoming orders have leveled off from the summer." (Furniture & Related Products)
• "Month-over-month conditions are stable." (Food, Beverage & Tobacco Products)

The strong dollar, weak oil market and slowing international environment continue to provide headwinds for this sector. 

In contrast to the manufacturing sector, services continue to expand.  While the headline number declined 3.2%, it still printed 55.9. Other sub-indexes are all still in strong territory. There is, however, a bit of softness to anecdotal comments:

• "Customers’ outlook on their revenues is softening." (Management of Companies & Support Services)
• "Moderate activity level. Some suppliers are providing longer lead times due to their own increased backlog." (Professional, Scientific & Technical Services)
• "Conditions are holding steady for a profitable year and 4th quarter." (Finance & Insurance)
• "Affordable Care Act impacting our business, reducing revenue while increasing cost of care. Several states consolidating medical/behavioral providers which have impacted existing business negatively." (Health Care & Social Assistance)
• "Overall food [cost of goods sold] (COGS) has remained generally lower throughout 2015 due to strong dollar, less exports to other countries and low corn prices." (Accommodation & Food Services)
• "Continuing competitive pressure in the grocery retail industry has led to implementation of lower prices across all markets and increased focus and efforts from the organization to reduce cost of goods [sold]." (Retail Trade)
• "Q4 retail expectations high, and prep for December peak volumes up in all aspects of staffing, inventory build, and supply purchasing." (Transportation & Warehousing)
• "Year-over-year sales for the same month are down 3 percent."(Wholesale Trade)

The weakness is hardly fatal and may in fact be nothing more than statistical noise.  However, it’s work keeping an eye on. 

The BLS released a solid employment report on Friday, with the headline number of 211,000 jobs added with a steady unemployment rate of 5%.  The agency revised previous months higher by 35,000. Hourly earnings increased 2.3% Y/Y. The participation rate ticked up 0.1% while the employment/population ratio was unchanged. Jill Mislinski at Adviser Perspectives has a long piece on the reports details.  Essentially, while the headlines number is solid, a fair amount of slack remains.

Finally, the Fed released the Beige Book, which offered the following view of the economy:

The twelve Federal Reserve District reports indicate that economic activity increased at a modest pace in most regions of the country since the previous Beige Book report. Economic growth was modest in the Districts of Cleveland, Richmond, Atlanta, Chicago, St. Louis, Dallas and San Francisco. In the Minneapolis District the economy grew moderately, while in the Kansas City District growth was steady on balance with mixed conditions across sectors. In the New York District economic conditions leveled off since the previous report, and in the Philadelphia District aggregate business activity continued to grow at a modest pace. In the Boston District, growth was somewhat slower despite reports of revenue increases.

The Atlanta Fed’s GDP now model projects 4Q GDP of 1.5%. Moody’s is slightly higher at 1.9%. The Cleveland Fed’s interest rate GDP curve is also 1.9%.  Meanwhile, the Atlanta Fed’s recession index is 13.3%. 

Economic Summary: this was a mostly solid week. The service sector continues to expand, and the employment report contained mostly solid information. Industrial weakness, however, is becoming an issue.  Industrial production is one of the four coincident indicators and it has been weak for the last year thanks to the strong dollar, declining oil and weaker emerging economies.  Now the overall ISM index is below 50.  Granted, it’s only one month so far.  However, there is little reason for a strong rebound in the coming months: The dollar will at minimum remain at about the same levels with the Fed all but certain to hike, oil will probably remain weak and emerging economies won’t be rebounding anytime soon.      

The Market Enviornment: The market is expensive. The current and forward PEs for the SPYs and QQQs are 22.71/22.95 and 17.44/19.85, respectively.  And 4Q revenue projections are not looking good.  From Zacks:

Estimates for the current period have come down quite a bit since the quarter got underway, in-line with the trend that we have been seeing quarter after quarter for almost three years now. Total earnings for the S&P 500 index (SPY) are expected to be down -6.5% from the same period last year, the third straight quarter of earnings declines for the index. The current -6.5% decline in Q4 earnings is down from an expected decline of -1.1% in mid-September. The magnitude of negative revisions to Q4 earnings estimates is greater than what we saw in the comparable periods for the preceding two quarters.

From FactSet:

The estimated revenue decline for Q4 2015 is -3.0%. If this is the final revenue decline for the quarter, it will mark the first time the index has seen four consecutive quarters of year-over-year revenue declines since Q4 2008 through Q3 2009.

Regardless of the percentage decrease, the consensus is for lower revenue growth.  And that translates into a weaker market.

Looking at the market, the SPYs appear to be consolidating in a triangle pattern:

However, there is a remarkable lack of breadth in the other sectors. The transports haven’t been able to break above the 200 day EMA since the beginning of August:

The IWMs can’t maintain momentum above the 200 day EMA:

Neither can the mid-caps (IJHs):

The lack of participation from sectors outside of the SPYs makes any move higher deeply suspicious. That, combined with the weak revenue projections, makes a sustainable rally a very difficult possibility.