posted on 05 June 2016
by Lance Roberts, Clarity Financial
On Thursday, the market briefly peaked above 2100 giving the "bulls" a glimpse at all time highs.
Here is the interesting part.
While the short-term market dynamics are improving, it has been primarily based on "hopes" the Fed will NOT raise rates in July.
With the Labor Department's job report on Friday showing that non-farm payrolls grew by just 38,000 in May, much less than expected, this should not have been a real surprise. Nor should the backward revision to March's data from 160,000 to 123,000.
The weakness in hiring trends has been clearly evident in the Federal Reserve's own Labor Market Conditions Index, which is supposed to be driving their policy decisions, over the last several months.
This decline in employment, combined with "global uncertainty" due to the potential exit from the Eurozone by Britain (Brexit), is being viewed as plenty of reason for the Federal Reserve to keep rate hikes on hold in July.
One additional point on the employment report. Despite all of the talk about a "tight labor market," such is hardly the case given such a small percentage of the working age population actually working.
It is only "tight" because so many are no longer counted. When you have 1-in-5 families that have ZERO employed, that is hardly the case of a tight labor market.
Furthermore, the deviation in employment for long-term trends also clearly indicate the demographic and structural shift in employment. The deviation from the trend is clear evidence of that shift which will continue to weigh on the long-term economic dynamics in the future.
Of course, it is NOT just the employment data keeping the Fed on hold.
As I addressed earlier this year, the "seasonal adjustment anomaly" due to the exceptionally warm winter was due to be reversed. As I stated:
This realignment of the seasonal adjustments with reality is what we are witnessing now. As shown in the chart below, if we compare the Economic Output Cycle Index (EOCI) above to both GDP and the Leading Economic Indicator Index, we see a clearer picture of what is currently happening in the economy.
Not surprisingly, the EOCI has bottomed coincident with Central Bank interventions which drag forward future consumption. Unfortunately, when you "drag forward" future consumption today, you leave a "void" in the future that must be filled.
That future "void" continues to expand each time activity is dragged forward until, inevitably, it can not be filled. This is currently being witnessed in the overall data trends which are being reflected in the deterioration in corporate earnings and revenues.
While the media continues to "protest too much," the reality is that earnings and revenue are a direct reflection of real economic activity.
The only question for investors is whether the ongoing delay of rate hikes by the Federal Reserve, and continued accommodative policy, can continue to support asset prices long enough for the economic cycle to catch up.
Historically, such is a feat that has never been accomplished.
RECESSION INDICATORS TICKING UP
Following the release of the employment data, and other rather dismal economic data, JP Morgan issued a note (courtesy of ZeroHedge) suggesting the probability of a recession beginning within 12 months has moved from 30% on May 5th, to 36% today. To wit:
I disagree with JP Morgan's view on the unemployment rate. Actually, I would agree IF the unemployment rate was falling due to actual increases in employment. However, such is not the case today as shown by the data below.
Here is the point. These statistics all suggest the REAL economy is operating at far weaker levels than espoused by the mainstream media, economists or analysts.
But don't take my word for it, just look at the charts above. Or any of the litany of charts I recently produced in "The Economy In Pictures" and decide for yourself.
This divergence between price and reality will be resolved at some point and likely not to the satisfaction of those with a bullish bias.
With the risk/reward ratio for equities still tilted to the negative, the current rally is likely one that investors should continue to 'sell into' particularly as we head deeper into the seasonally weak period of the year.
Yes, there is a bullish argument to be made if the market can break out to new highs, and if that occurs I will certainly reassess the risk/reward of increasing equity exposure further at that point. But that is not today.
Unfortunately, and frustratingly so, we remain confined this week to wait and see what happens next. As I stated, the only certainty is this consolidation/topping process will end.
When? How? Those are the questions that must be answered which will determine the consequences of our actions.
S&P Flashes A Warning Sign
One of biggest peeves is when people tell me they are a "long-term investor" and then proceed to tell me how much their portfolio made or lost the previous day.
The reality is that we are all speculators. We are all trying to take what "shekels" we can scrape together in hopes that somehow buying ethereal pieces of paper can magically grow in price like Jack's "bean sprouts" to fund our retirement goals. The problem is that along the way we forget two very important things:
I have written many articles in the past discussing the fallacy of benchmarking portfolios, long-term investing and the importance of "duration matching." However, Rob Isbitts also took note of the problem with "long-term investing."
Rob is absolutely correct. The 30% advance seen in 2013 was a rare anomaly for investors that marked the beginning of substantially lower future returns. This was a point I discussed in detail previously, but here is the important chart.
Historically, you will note that huge market surge years of 30% or more, are generally followed by much lower returns in the future until a reversion cycle is generally complete. The near 30% surge in 2013 is likely the beginning of the same such cycle. As Rob notes, much of the price action suggests a more important long-term topping process remains underway.
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