posted on 07 August 2016
by Lance Roberts, Clarity Financial
Several weeks ago, I commented on the fact that if I were Janet Yellen I would have hiked rates in July by .50 bps.
Here was my reasoning at that time:
Chart updated through Friday's open.
Of course, she didn't do it. As expected. I bring this up because Friday's employment report which showed a 255,000 job increase for July, combined with upward revisions to the prior two months, puts Ms. Yellen in a very tough spot to NOT raise rates in September.
But here is what is interesting.
While Ms. Yellen is being pushed into a corner of hiking rates, thereby further tightening monetary policy, the rest of the world is flushing the system liquidity. The latest participant in the QE process was the Bank of England (BOE) this past week which lowered interest rates, announced a bigger than expected QE program and loosened restrictions on bank lending.
This follows the European Central Bank and Bank of Japan all doing the same thing. With global economic growth shrinking rapidly, BOE reduced economic growth expectations from 2.3% to just 0.8% for 2017, Ms. Yellen is banking on stronger economic growth in the future to support higher rates.
However, the "bond market ain't buyin' it."
As shown in the chart below, interest rates are a function of economic growth, wages, and inflation. Therefore, interest rates are confirming the low inflation/low growth environment in the U.S. and will unlikely be able to withstand a further tightening of monetary policy at this juncture.
The black line is a composite index of the annual rate of wage growth, GDP, and inflation. With this metric on the decline, interest rates are set to decline further.
Ms. Yellen is likely going to "punt" again on raising rates in September given the proximity to the Presidential election cycle, however, she shouldn't. The market and seasonal bounces in the economic data are giving her temporary cover to make her move, it is questionable whether she will have the same opportunity after the election.
This is a gamble she could well lose.
Employment Not A Strong As Reported
Back to the employment data for a moment. The large number in July of 255,000 defies the payroll tax collection data. Remember, the BLS takes a phone survey of individuals asking them what their employment status is, or is not. The corporate tax receipt data is an actual measure of the amount of payroll taxes being paid for all employees. (Which do you think is a more accurate measure?)
As Nick Colas of Convergex recently noted:
But then there is also the ongoing seasonal adjust "fudgery" going on with the employment data this week as well.
Southbay Research also blasted today's seasonal adjustment factor, this is how the seasonal adjustments look like relative to history.
The +85k unadjusted number also confirms the trends of fixed and non-private residential investment. Businesses hire against the demand for their products and services. This is why, as shown in the chart below, the historical relationship between employment and fixed investment is extremely high....until now.
Importantly, there are two takeaways from this data:
For now, we are not at the second point as of yet. Therefore, the bullish bias remains intact as long as Central Bankers remain accommodative and keeps interest rates suppressed. Of course, the ongoing liquidity push is distorting market dynamics to a point that will lead to some very bad things in the future.
So enjoy the party for now. Just don't be the last guy out of the door when the cops show up.
1-in-1200 Year Event
Jesse Felder wrote a great piece on Friday picking up this point of liquidity driven exuberance.
But that doesn't mean it will end today.
Or next month.
Just understand that the emotionally driven bias of the herd can keep stocks detached from underlying realities far longer than logic would deem possible.
But it does end.
It ends badly.
And it ends when you aren't paying attention.
Still Waiting On A Correction
So, am I buying equities to move portfolios to the current target allocation?
Three weeks ago, when the market broke out of its 18-month consolidation process, I laid out the case to increase equity exposure in portfolios. I am repeating that case here for new readers of this missive.
The consolidation over the past two weeks DID pull the deviation back from 3-standard deviations above the 50-dma to just 2-standard deviations. This didn't solve much of the problem as of yet.
Importantly, the market is now trading at one of its highest levels of deviations from the 200-day moving average that we have seen over the last couple of years. As I have explained in the past, like a rubber band, prices can only be stretched so far from the moving averages until they eventually "snap back."
Lastly, my friend Dana Lyons recently made some excellent comments the very low levels of inverse ETF volume which has historically denoted short-term market peaks. To wit:
All the data points to some sort of corrective action over the next two months (as discussed last week) which will provide a better risk/reward setup for increasing equity exposure. This is, of course, provided that important technical supports are not violated in the process returning the market back to its previous consolidation channel.
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