How We Should Think Of The Summer 2022 Stock Market Rally?

July is over but its memory stays with us.

Was it the start of a new trend or will it be a blip and another bear market rally in a historically tough year for financial markets?

As ever, it is hard to know what the future but there are a few remarkable and hard data points that are inarguable.

To recap, over the last month or so:

• The S&P 500 is up over 8% and is now only 13% off its all-time highs set in January.

• The Nasdaq technology index has rallied over 19% off the lows.

• Oil has fallen beneath its price at the outset of the Russian invasion of Ukraine.

• Other commodities, such as grains, have also weakened as supplies begin to slowly make their way out of Ukrainian ports and onto the global market.

• Perhaps least discussed and most interesting is the junk bond market has rallied very strongly. In fact, it just had the best month since 2011 and this suggests that economic growth will not collapse as some have feared (and cheered?).

This rally has been pretty striking, very welcome and a surprise to many (including us).

For one thing, higher rates were supposed to break a lot of things and instead unemployment is at a record, record low (see below) and the stock market is down but now only around 13% off its all time high.

As we have written about before, we were ready for a strong bounce but this is exceptionally robust and is concentrated in sectors that suggest we will be cutting, not raising rates in the medium term.

Anyway, all of this was true and then Friday's Bureau of Labor Statistics Employment Report came out.

In short, it showed that:

• The US job market is in rude health!

• Non-farm payrolls rose 528,000 for the month of July

• The US unemployment rate was 3.5%

• Both easily beat estimates (258k for jobs) by a wide margin and demonstrate the most fundamental strength of the US economy right now - jobs.

• Unemployment is back at pre-pandemic level and, most importantly, it has tied for the all time record for very few Americans actively looking for work.

And as a result of this strength however, a lot of the above recent trends were immediately reversed.

You read that correctly. News that the economy (and especially jobs and employment!) continue to be very strong caused a negative reaction from the stock market.

The reason? Well, "good news is bad" is the current and outright strange prevailing dogma among investors.

Why?

Well the strength of the labor market suggests that the economy is still growing and will continue to do so.

Counterintuitively, this strength puts the Federal Reserve in a bind.

They cannot stop raising rates if the economy is so evidently robust. One of their mandates (employment) is fulfilled while the other (inflation) is not and so they must clearly take action to correct the latter, not the former.

Furthermore, the strength of the labor market also suggests that we could have yet another strong inflation print next week.

Remember, that the monthly US inflation number is the "one chart to truly rule them all..."​

Now it is true that employment is a lagging, not leading, indicator of economic health but it is difficult to argue that a severe economic downturn is just around the corner when the job market continues to strengthen and is, in fact, already at a record level.

Bizarrely, this means that a strong labor market report on Friday was a negative signal for the US stock market. In particular, it was a negative for large sectors and critical companies that are supposed to do poorly in higher interest rate environments.

i.e.: technology stocks or the Nasdaq index.

Hence the reversal of much of the price action last month. Look for that continue over at least the short term as the Federal Reserve comes to grips with needing to raise interest rates because the employment side of their mandate is clearly doing fine.

Harder to say that about the inflation side of their dual-responsibilities and all the focus will be on next week's inflation data now.

Under the hood of the report, the central bank may be particularly alarmed that average hourly earnings were up at a 5.8% in July and the June numbers were revised to 5.4% (up from 3.8%). Rising wages may be great for those employed but it is a bad sign for lower inflation.....

Away from the short term swings, the most important development might be simply that the US economy continues to hang in there, despite all the "haters." That is a wonderful fact and one to be celebrated. People looking for work are becoming employed and if we can just lower inflation sharply then it the outlook could be tremendously positive.

That soft landing scenario may still be challenging may be difficult but it remains possible and, though it might hurt right now, avoiding a deep downturn would be sweet - long may it continue.

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