2023 Theme: “Higher For Longer” - Interest Rates & Stock Prices
New month means new economic data!
We got some important new evidence for our "higher interest rates for longer" argument on Friday morning. It also suggests stocks could also head higher over the short term.
The key differentiator might be: which stocks, though.
The nice thing was that the new data was both direct and very clear:
US payrolls came in and were "the usual"
i.e.: strong and higher than expectations.
The details:
The US added 339,000 new jobs in May, far above the 195,000 expected.
Wages grew 0.3% which means on an annualized wages are growing 4.3% (this is high and above the 2% target for inflation).
Perhaps most interestingly, there were significant upward revisions for March (52,000 more) April (41,000).
This means those months the economy added far more jobs than we previously thought.
The overused word for all this is, once again, "resilience."
This economic strength leads us to a few conclusions:
Especially with the above revisions, it is once again abundantly clear that the US jobs market and therefore the US economy, is still very strong.
On the "shock factor" front, by our count, this makes 14 straight payroll reports that have come in stronger than expected. That remarkable string speaks to the continuing ability of the US economy to surprise.
Obviously, the chance of an imminent US recession with this kind of jobs data is essentially nil.
Bank failures? What bank failures?! That was, like, way back in March man.
Here is what the payroll growth month by month looks like with the new data and the revisions:
Add this all up and it would seem very difficult to expect inflation to keep falling anywhere close to the 2% target for the US Federal Reserve.
It also makes it very difficult to believe that the Federal Reserve is done hiking interest rates. June may see a pause but July will likely see an interest rate increase and don't count out September either.
Right now, a lot of Wall Street still sees CUTS at some point this fall. Back March many of those same analysts though that this would occur starting this month. That clearly is not happening.
In fact this report has raised expectations that the Federal Reserve might hike in a few weeks. We still don't think that will be likely. That is another item that will lead to support for the market.
The US central bank's voters have clearly telegraphed their plan to "pause" very clearly and the market seems to agree.
Any deviation from this plan would be a very negative but we remain confident that the pause will occur. The central bank is "locked in."
You can see this conviction of a "June pause" in two places:
First off, the odds of a Fed interest rate increase in the futures market has stayed very low, even after this jobs report.
Second, the stock market reacted joyously on Friday.
You can see the odds in the futures market in this nifty tool by the CME here. Methodology here.
Why did the stock market react so happily?
Well, a strong economy and the hope that the Federal Reserve is done raising rates is a sweet spot, at least over the short term.
Over a medium time horizon this situation is untenable. The above conditions will make one of two things true:
Either inflation will begin rising again or
The Federal Reserve will begin raising rates to head that off.
It is therefore very unlikely that this situation will continue for very long.
Okay, but stocks could keep going up for a bit? What else is new?
Yes and no. The most interesting thing about Friday's report however, might be what was happening under the hood of the overall rising market.
In short, the Bit Tech "Super 7" stocks we highlighted that have been doing so well suddenly underperformed small companies. One way to look at this simply is the Russell 2000, an index of smaller companies was up by ~3.50% while tech-heavy NASDAQ only went up by a miserly ~1.07%.
A strong economy means that regular companies will do well, not just the biggest and the brightest.
This is a big change and a very welcome one as it broadens the market rally and removes some of the vulnerability we stressed just last week. There is also likely some simple reversion to the mean at work here. The Super 7 "Big Tech" outperformance was getting very extreme.
Here are the comparative stats for May:
Once again, using the NASDAQ as a simple proxy, the tech index outperformed the industrial heavy Dow by over 9.29% in the month of May which makes it the 9th largest margin of monthly outperformance for the NASDAQ relative to the Dow ever.
The big question is whether this will continue?
We remain cautious. A Federal Reserve cornered by high inflation and a strong economy has no choice but to keep increasing interest rates. That may not occur this month but sooner rather than later investors will be forced to confront this tradeoff again.
We continue to think it is a great time to take profits in stocks and start thinking about buying some US bonds. For the first time in years, you now have alternatives to stocks. That is something worth celebrating, it is also a reason to keep expectations about stock market gains muted at these valuations.
We also have mentioned buying oil or energy stocks over the last 2 months. If the US economy is going to do far better than people expect then, regrettably, we will burn more oil. Energy has underperformed this year. That could be about ti change in the second half, relatively speaking.
The stock market isn't the only vulnerable part of the US economy however....
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