In this week’s note, I’m going to go over two main points.
- First, I believe that the relationship between the employment numbers of last week combined with the Fed’s course of interest rates has a direct effect on the economy and earnings. The second important point is that I wanted to touch on the various places money can go from a major asset level.
- For this second one, US stocks are showing continued recovery that is supported by current earnings reports, cash is still king given that while in cash, one can’t lose, but bonds are starting to show relative value given that 10–30-year interest rates are declining while short rates are continuing to be pushed higher.
Friday the Labor Department released numbers for July. The number came in at 528,000 jobs created versus the expected 258,000. This was 2X higher and clearly showed that the underbelly of our economy still is showing great strength from an employment perspective. What was expected was for interest rates to spike (as huge employment reflects sticky inflation) and a swoon in the stock market since it has bounced fairly aggressively from its mid-June lows. Well, that wasn’t what we got! Don’t be thrown by the employment report purporting to show a strong and strengthening economy. It was an outlier number. The headline number doesn’t make a lot of sense, especially given there was a sharp three-month Job Openings drop. Also, many of the reported jobs were part-time jobs (I looked deeper into the data). Total civilian employment is down for the second month in a row. Powell is achieving a slowing labor market. Seasonal adjustments, second jobs being added, and the way the report is calculated must have allowed the stronger than expected headline number. The most important insight is the number of civilians employed fell yet again.
As can be seen in the graph above, in reality, labor is just now back to where it was before the shutdowns during the pandemic. One last issue I want to touch on is that even though the unemployment rate is at a very low 3.5%, a large part of this is people simply leaving the workforce. Fewer people are working and those that are picking up second and third jobs. Also, how many of the August jobs were summertime hires? I don’t think we will really know the answer to that till September / October time period.
This brings me to a very important relationship that is tough to quantify with so many moving parts. And this is why I titled today’s note as I did. It’s really hard to think that a 3% interest rate is a high number unless the most recent memory one has is that interest rates were at zero not long ago. A few more points that are important are:
- The Fed is raising interest rates just as the economy is accelerating into the jaws of a recessionary slowdown. If the rate of economic growth is now declining, how much further can the Fed afford to push rates if it could take a fragile patient (US Economy) and put them back in intensive care?
- The immense cost of higher rates. Given the almost $6 Trillion additional capital in the markets post COVID, every 1% interest increase equates to an additional $568 Billion in interest cost to the Federal Government. This is a huge number.
- Oil and Food coming down in price, and the Fed passing this new pork fat bill- which raises tax rates to many, additional economic slowing is expected.
Now let’s look at the markets. These are the different asset classes and what I believe we are seeing:
- Cash - cash is considered king given that virtually all other asset classes are not moving with consistency in a positive direction. It must be remembered though that cash is a short-term parking spot during times of friction, not a true investment.
- Currencies - King Dollar continues to lead. It is clear that many countries are raising interest rates from a negative number to zero or slightly above, but what is not being addressed is the dreadful slowdown that most countries are still in. Hence, even though they are raising interest rates as we are raising ours, we continue to be the cleanest dirty shirt in the hamper.
- Commodities - Commodities have risen strongly since the Pandemic printing press was put into full motion, but of late, given oil and food prices moderating, there has been a fairly good pullback in commodity prices. Is this an end to inflationary growth or just digestion? This is yet to be determined. But, given that the Biden administration just put forth a lesser version of their Build Back Better Bill, this should be another large slug of cash being dumped on the system that could put higher prices back on the horizon.
- Bonds - As I mentioned earlier, interest rates longer than 5 years seem to be leveling and moving back lower due to the economic slowdown the Fed is trying to orchestrate. This creates opportunistic interest rate options that provide the ability to diversify and balance portfolios. Caution must be maintained though given that this fall-off in rates could be temporary if inflation numbers continue to show stickiness.
- Foreign Stocks - For this, I give you this picture:
International securities particularly in the emerging market area continue to be fraught with landmines.
- US Equities - US stocks are showing signs of bottoming. Is this an infamous bear-market rally or a re-engagement of the bull market that took a post Pandemic hiatus? I really think that we are faced with a dual-pronged market. Part of the market is still super healthy and will continue to rally off lows and the other half will sputter a bit due to negative GDP numbers.
In the end, I believe that Powell and the company have enough knowledge of what could happen if they are to raise rates too much too fast. This is why he seems to be giving himself a window of opportunity to not be overly hawkish in the September meeting. Also, we are entering what is seasonally the best time of year. And last, this $6 Trillion sitting around on the sidelines wants to find a home. This all leaves me with what I believe could surprise the most people (usually what happens):
School is beginning to start, and this is when participants in the olden days migrated back to Wall Street and away from the Hamptons. Should good tidings come to Wall Street, the summer could end and Q4 could be a good Christmas shopping period.
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