Push & Pull

By Crest Capital Advisors on July 7, 2023

Dow: (1.96%) to 33,734.88
S&P 500: (1.16%) to 4,398.95
Nasdaq: (0.92%) to 13,660.72
Russell 2000: (1.27%) to 1,864.66
10-Year Yield: 4.06%
Outperformers: Real Estate 0.21%
Underperformers: Healthcare (2.87%), Materials (2.01%), Technology (1.46%)

US stocks were lower this week, though the downside was fairly modest despite persistent Fed rate hike expectations that drove a big backup in bond yields (the benchmark 10-year Treasury reached a closing yield of 4.06%, the highest since early March.).

Bearish talking points this week continued to center around the risks of “higher-for-longer” Fed policy. The market median terminal rate now stands around 5.40%, the highest since before the March banking turmoil, and reflective of yet another 0.25% rate hike at the next FOMC meeting. A tightening credit backdrop also remains a key downside risk. Morgan Stanley analysts warned this week that corporate borrowers, particularly lower-quality borrowers, are increasingly coming under stress from rising floating rate obligations, which could squeeze margins in quarters ahead.

But, the bullish narrative was also little changed this week. The soft-landing theme remains the key upside risk, a dynamic seen in several disinflationary data points this week including falling prices paid components in both ISM manufacturing and Services reports. There were some emerging signs of the labor market cooling without outright contracting as well, including the first headline payrolls miss in 15 months, the initial jobless claims four-week average holding near highest levels since November 2021, fewer May job openings than expected, and the job vacancy-to-unemployed ratio falling in May to the lowest level since October 2021. Other pieces of the bullish narrative include optimism around the upcoming Q2 earnings, the recent rise in yields attributed to stronger economic growth rather than inflation fears, AI optimism, FOMO, resilient consumer spending, and surprising housing market strength.

In short, we’re witnessing a push/pull market as bears and bulls press their respective positions and outlooks. Stocks have been overdue to take a breather and this week’s mixed data gave traders the perfect excuse to make that happen. Neither case has been fully proven yet, so we’ll look for more data to determine the next 10% direction in the market. Looking ahead to next week, we’ll get some key pieces to make this determination with the release of June’s CPI and PPI data mid-week and the kick-off of the Q2 earnings season with the major money central banks on deck at the end of the week.

The Trend is your Friend

June nonfarm payrolls showed job gains of +209k vs. the +230k estimated and 306k in the prior month (revised down from 339k). This is the lowest payroll number since December of 2020. The official unemployment rate drops to 3.6% from 3.7% (due to rising labor force participation) and average hourly earnings grew 0.4% vs. the 0.3% expected (the one datapoint Fed hawks can quibble with). Notably, this was the first miss v. consensus expectations in 15 months!

This payroll report took on added significance this time around due to persistent Fed rhetoric around more rate hikes coming partially due to “tight labor market conditions” and Thursday’s ADP private sector jobs report…a report that tends to be discounted each month but took on added significance this time around as it showed a blowout 497k new jobs for the month. Well, the “official” government report came in today and showed private sector jobs were really just 149k…so that means ADP was off by a factor of more than 3x! Turns out, stocks and bonds ‘freaked out’ on Thursday based on faulty data from ADP. A move we fully expect will be unwound in the days/weeks ahead.

Importantly, what today’s payroll report clearly does is reassert the downward trend in job creation (See chart below); and the revisions have made the spring seasonals less favorable. This should alleviate some pressure on the Fed to continue to tighten monetary policy.

More Jobs Commentary

Expansions end when payroll cycles end. In our view, the labor cycle is the business cycle, and losing jobs is the definition of a recession. The resiliency of our labor markets has been the primary reason we’ve managed to shrug off all the imminent recession calls.

But, the labor market remains at risk, particularly if the Fed continues to plow ahead with more and more rate hikes. Indeed, if we had gotten a blockbuster labor report on Friday, in-line with the ADP report from the previous day, then another rate hike from the Fed would have been all but guaranteed.

But as it is, 209k net payrolls is actually a goldilocks report. Not too hot, and not too cold. That’s the good news.

But here’s Powell a few short weeks ago….

“The US labor market remains very tight” (Emphasis his)

-Jerome Powell (6/28/2023)

He continues to believe that a “tight” labor market leads to inflation. He seems to think this amount of people getting a job in a single month means the labor market is tight.

In our view, neither of these assumptions is true. In a tight labor market, you can’t hire anyone without taking them from another job and you would therefore see NO payroll growth. You also don’t see payroll growth beyond population growth in a tight labor market so it’s specious to say the employment market is tight right now.

For more evidence, let’s look at the chart of job openings (JOLTS data) and unpack this a bit further. We are presently at 9.8m job openings according to this week’s data release…oh look at all those unfilled job openings! Doesn’t that mean the labor market is tight!? Well, no actually. We are now 2.8m openings above pre-pandemic levels and about 794k above trend. Notably, the number of openings is down from 12.1m in March of last year. Over the same period, payrolls have grown by 4.5m. This means, for every job posting removed, we hired 2.1 people!

And it’s not out of the ordinary to see openings running above trend. In fact, we were at 648k above trend in 2019, pre-pandemic. PCE inflation was 2% at that time when the jobs market was roughly in the exact same condition as it is today. It’s a mistake to argue that full employment equates to tight labor market conditions and therefore, somehow is inflationary.

Powell is a lawyer, not an economist. Let’s hope the staff of economists at the Fed are better than our meme of the week.

Still in Decline

Real time rental data continues to trend lower this week. The latest from Apartment List shows rent growth was flat on a year-over-year basis, a far cry from the official government data which is still showing gains of 8%+ as of the last CPI report.

Here is a graph of the year-over-year change for these measures since January 2015. Most of these measures are through May 2023, except CoreLogic is through April and Apartment List is through June 2023.

The CoreLogic measure is up 3.7% year-over-year in April, down from 4.3% in March, and down from a peak of 13.9% in April 2022.

The Zillow measure is up 4.8% year-over-year in May, down from 5.3% in April, and down from a peak of 17.0% in February 2022.

The Apartment List measure is flat at 0.0% year-over-year as of June, down from 1.0% in May, and down from a peak of 18.2% YoY November 2021.

With slow household formation, more supply comes on the market and a rising vacancy rate, rents will be under pressure all year. Although asking rents increased in June according to Apartment List, “rent growth is gradually declining at a time of the year when it’s normally picking up steam”.

Since rents increased sharply last year in July, asking rents will likely be down again year-over-year in the next Apartment List report.

How Long Before the Government’s Fiscal Problem Becomes the Fed’s Monetary Problem?

25% of all US government debt outstanding has been added since the beginning of 2020. And with higher debt levels and higher interest rates, debt servicing costs have increased from $1 billion per day in 2020 to almost $2 billion per day in 2023,. See the chart below for context into our growing fiscal problem. At some point, Congress and/or the White House will be giving Jerome a call to “discuss” this issue. A problem that lower interest rates could certainly at least extend to future administrations.

And, here’s another look at our growing national debt. Not only has 25% been added in the last 3 years, but 50% of our outstanding debt comes due in the next 0-3 years!!! Just wait for the skyrocketing interest expenses once we roll over all this debt at today’s prevailing higher rates!

Economic Funnies

A peek into the Government’s survey methodology…

Crazy Stat(s) of the Week

Here are this week(s) crazy stats!

There’s never been a bear market rally that’s lasted longer than the decline. By July 26th, we will have rallied 195 days which is longer than the -27% decline in the S&P 500 (which took 195 trading days) in 2022. This would seem to offer proof we may be in a bull market again.
Data from the US Bureau of Economic Analysis revealed that the Southeastern states of Florida, Georgia, Tennessee, Texas, and the Carolinas accounted for a larger share of national GDP (23.2%) than a group of Northeast and Mid-Atlantic states including Connecticut, DC, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont (22.7%) in 2021. This is the first time the Southeast has overtaken the Northeast in terms of contribution to aggregate GDP since the start of the data in the 1990’s.

Quote(s) of the Week

“No one ever made a difference by being like everyone else.”

-T. Barnum

Calendar of Events to Watch for the Week of July 10th

Next Friday’s Bank earnings reports will mark the unofficial kickoff to the Q2 earnings season with Citigroup, JP Morgan, and Wells Fargo reporting. On the US Economic Calendar, we get critical data readings on CPI and PPI next week with expectations for ongoing moderation as these indices get closer to the Fed’s target zone. These releases will be key as they set-up in front of the next Fed meeting scheduled for later this month. IF we see significant signs of moderation, as we expect to receive, then it may lessen the odds of the Fed taking additional action on interest rates.

Monday 7/10 – US Wholesale Inventories for May are expected to show a contraction of -0.10%, in-line with the prior month’s reading. Fed Vice Chair Barr is also scheduled to speak about Bank Capital giving the Fed yet another opportunity to repeat its hawkish rhetoric.

Tuesday 7/11 – The NFIB Small Business Index for June will be out and economists are expecting an uptick from last month’s 89.4 reading.

Wednesday 7/12 – The main event of the week will be the June Consumer Price Index (CPI). Due to strong tailwinds in the removal of high readings a year ago, the headline rate is expected to fall to 3.1% year-over-year and show a 0.25% month-over-month increase. The Core CPI (ex-Food/Energy), which contains a heavy 44% weight to the over-inflated housing component of inflation, is expected to remain stubbornly elevated at 5.0%, down from 5.3% last month. Any downside surprises would go a long way towards dissuading the Fed from taking on additional rate hikes from present levels.

Thursday 7/13 – Following up on the CPI release, today will be the release of the Producer Price Index (PPI). Here the headline rate is expected to fall to a paltry 0.40%, down from 1.1% last month (Deflation anyone). Yes, you read that right…0.4%. The Core PPI (Ex-Food/Energy) is expected to come in at 2.5%, down from 2.8% last month. In addition to data on inflation, the weekly jobless claim data will continue to get extra focus for signs of moderation in the employment market.

Friday 7/14 – US Export/Import Prices for June are expected to contract by -0.20% and -0.30% respectively. The Preliminary University of Michigan Consumer Sentiment Survey will also be out mid-morning with economists expecting a slight uptick to 65.5, up from 64.4.

Source: FactSet