Written by Jim Welsh
Macro Tides Weekly Technical Review 10 May 2021
From Jay Powell’s perspective it didn’t matter if 1,000,000 jobs were created in April or the 266,000 that were added according to the Labor Department. Jay and the FOMC are committed to waiting for the unemployment rate to fall significantly and for core inflation to rise above 2.0%.
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I did an interview with Blake Morrow from FORX Analytix on Friday and discussed the employment report and the Fed’s potential reaction:
For decades the FOMC was guided by the Phillips Curve, which showed that inflation perked up once unemployment fell to a low level. This framework led the FOMC to begin increasing the federal funds rate whenever unemployment fell below what their Phillips Curve model indicated was the lower bound threshold in anticipation of rising inflation.
The FOMC abandoned the Phillips Curve ideology after unemployment fell below 4.0% and inflation failed to materialize in 2018 and 2019. In 2018 and 2019 the headline and Core PCE rates of inflation continued to drift lower and further away from the FOMC’s 2.0% inflation target. As a result the FOMC will wait for actual inflation to appear and for the unemployment rate to drop significantly before they even think about changing policy.
After the soft employment report the odds of the FOMC hiking the federal funds rate by the end of 2022 fell to 60% after hitting a high of 100% in March. The decline in the probability suggests markets had expected the FOMC to respond to incoming data. With the weak jobs report the FOMC has the leeway to postpone when they will tighten policy. If inflation and job growth jump as expected, the market will shift again and expect the FOMC to taper and raise rates in 2022 more aggressively.
If the FOMC’s resolve is as entrenched as I think likely, the market will be surprised by the FOMC’s stubbornness. The narrative will then shift to the FOMC being behind the inflation curve and markets would begin to price in not one but multiple rate increases in 2022. In coming months there will be members of the FOMC and more likely District presidents that will give speeches and express their concerns about inflation and the need for the FOMC to discuss tapering their $120 billion in monthly purchases. Dallas Fed President Robert Kaplan has already done so and I expect he will be joined by other presidents.
Monitoring the number of these speeches will provide guidance as to which meeting the real discussion will occur. It is not likely to happen at the June 16 meeting but more likely at the July meeting, after the next two employment report show strong job growth. The April inflation data will be released on Wednesday (CPI) and Thursday (PPI) and will be dismissed somewhat by markets due to the Base Effects. How the financial markets respond will be instructive.
The Labor Department reported that only 266,000 were created in April compared to estimates of 1,000,000 or more. There are a number of reasons why the number fell short by such a wide margin. The Labor Department’s seasonal adjustment process has been disrupted by the extreme volatility in the labor market due to the Pandemic and recovery. On an unadjusted basis the economy created more than 1 million new jobs in April for the third month in a row. This suggests job growth is stronger than the official adjusted numbers.
The vaccination progress has been stunning and there has been a big increase in the number of Help Wanted Signs. Applications are lagging but that is likely to change as more of the U.S. is fully opened. Job growth will more closely mirror the pace of reopening especially starting in June. California will be fully open in mid June and New York City has targeted July 1. As the most affected sectors, open job growth is going to soar.
From 2011 through 2019 an average of 2.0 million Baby Boomers retired each year with 1.5 million retiring in 2019. However, in 2020 3.2 million Boomers retired. Some of these people will reenter the labor market when herd immunity has been achieved and they feel safe, and after a few months of boredom. In the short term the excess number of Baby Boomer retirees will weigh on job growth.
Supply chain problems are also taking a toll. Auto manufacturers, who have idled assembly lines because of semiconductor shortages, cut jobs by 27,000 in April.
According to the Labor Department more than 16.1 million people received unemployment benefits in the week ended April 17, including gig workers and the self-employed who are typically not eligible for such payments. Under relief bills passed by Congress, those receiving jobless benefits get an additional $300 a week on top of regular state benefits, which average $318 a week. An unemployed worker receiving $618 a week is earning $16.07 an hour, and on an after tax basis if Congress Exempts unemployment benefits from federal taxes as in 2020. The federal unemployment benefits will end on September 4, 2021. In 2020 a University of Chicago study found 42% of those on benefits received more than they did from their prior jobs. The National Restaurant Association reported that in January, 7% of restaurant operators rated recruitment and retention of workforce as their top challenge and by April that number had risen to 57%. Paying workers not to work more than what they would earn is definitely keeping some workers from returning to work.
Until herd immunity is achieved there are some older workers who will continue to be reluctant to go back to work and risk infection. Younger workers though have a different perspective since they are far less worried about how sick they may become if they get infected, especially if they aren’t supporting a family. The opportunity to get paid more and do nothing is appealing for anyone in their 20’s. This factor certainly contributed to some of the weaker job growth in April and will continue to do so. Are generous unemployment benefits the only or major reason job growth was so weak in April? Probably not, but to dismiss it as President Biden did on Friday is a bit disingenuous:
“I want to remind everybody it was designed to help us over the course of a year, not 60 days,” adding that the small job growth is “a testament to our new strategy of growing this economy from the bottom up and the middle out” and underscores the need for more government stimulus. He also said there was no “measurable” data that people aren’t looking for jobs because it pays more not to work. The President has clearly not talked to many small business owners. The National Federation of Independent Business’s April survey of small business owners found a record-high 44% of owners reported that they have open positions they couldn’t fill, 22% higher than the 48-year historical average.
The primary reason for The Big Miss was due to seasonal adjustment factors, but other factors played a role. The April report doesn’t change the bigger picture: a surge of job growth in the next few months is almost sure to follow.
Dollar
As solid job growth and robust inflation materializes in the next two months, the narrative surrounding the FOMC about the timing of their tapering discussion and rate increases will change. The anticipated change in monetary policy by the financial markets could provide the foundation for an important low in the Dollar. As discussed in the last two WTR’s:
“The Dollar recorded a trading low on January 4 of 89.21 and rallied to a high of 93.44 on March 31. Since that high the Dollar has been decisively trending lower, which suggests that Wave 4 ended on March 31. Ultimately, the Dollar is expected to test and probably drop below the January 4 low, which could mark an important low.”
In January 2017 the Dollar topped at 103.82 and declined in 5 waves for about 14 months before bottoming in mid February 2018 at 88.25. (Wave A) The Dollar subsequently rallied in a choppy overlapping fashion, which looks nothing like the strong move down from the January 2017 high. (Wave B)
If all of this unfolds as described it suggests that the Dollar is nearing the end of the correction that began in January 2017 (Wave A 88.25 low, February 2018 – Wave B 102.99 high, – Wave C 87.50 – 89.20 low).
The coming low in the Dollar could set the stage for a large rally that is expected to last at least 14 months and could exceed the January 2017 high of 103.82. A rally of this magnitude would have a large impact on a number of markets.
Treasury Yields
The 10-year Treasury yield has been expected to drop below 1.52%. In the minutes after the employment report the 10-year Treasury yield fell to 1.471% before reversing and closing at 1.577%. It’s possible that Treasury yields have completed an a-b-c pattern from the 1.765% high to complete Wave 4. Although Treasury yields could rise in a B-wave and then fall below the low on Friday, the odds are not high. In the second half of this year the 10-year is expected surpass 2.0% and could reach 2.25%, before the FOMC intercedes with talk about Yield Curve Control (YCC)
The 30-year Treasury yield fell below the low of 2.207% as expected after the employment report disappointed. By the end of day the 30-year Treasury yield jumped from a low of 2.161% to 2.277%. The Treasury market will be tested this week as the Consumer Price Index (CPI) and Producer Price Index (PPI) are released on Wednesday and Thursday.
This will be the first test of how much the bond market believes Chair Powell will be correct in his assessment that the coming wave of inflation will be transitory. Investors want to believe he will be right so monetary policy can stay accommodative for longer, so the Base Effects argument could mute the reaction even if the CPI and PPI come in hot. We’ll see. Before year end the 30-year Treasury yield is expected to climb to 2.85% and could jump to 3.15%.
The Treasury bond ETF (TLT) was expected to rally to $142.00 – $143.00 and did in the minutes after the jobs report. On February 26 TLT traded up to $143.30 as the 30-year Treasury bond future contract reached 161.06. On Friday the T-bond future traded up to 160.47, or -0.37% below the February high. Had TLT been trading in the open market session it would have traded up to 142.75. After the post jobs report spike higher, Treasury bonds sold off sharply and by the time TLT open for trading in the regular session it only reached $140.60. Longer term TLT has the potential to decline to $125.00 and potentially as low as $110.00.
Gold
Gold was expected to rally to $1820 – $1840 and traded up to $1840 on Friday and $1843 on May 10. If the inflation news exceeds estimates Gold should rally a bit more before pulling back. As long as Gold holds above $1797.00, a rally above $1900 is expected, with a test of $1950 possible.
Silver
Silver was expected to rally to $27.40 and hit $27.78 before pulling back. As long as Silver holds above $25.80, Silver could test $30.00 in the summer as inflation concerns intensify. A close above $30.00 could lead to a rally to $33.00 – $36.00.
After buying the initial 50% in the Gold ETF IAU at $17.23 on February 23 and the second 50% position at $16.09, the cost basis is $16.66. Sell half of the position at $17.60 and use a stop of $17.14. Traders took a 50% position in the Silver ETF (SLV) when SLV dropped to $23.25 on March 23. Sell half of the position at $25.80 and use a stop of $24.60.
Gold Stocks
Traders were recommended to take a 33% long position if GDX closed below $32.00, and on February 26 GDX closed at $31.13. Two weeks ago traders were advised to add 33% to the GDX position on a pullback to $32.75. GDX fell below $32.75 on March 23, so the cost basis was $31.94. The stop of $34.70 was hit on April 29 as end of month selling caused GDX to weaken more than expected. The trade gained 8.6%.
A rally to $37.50 was expected and GDX reached $38.22 on May 10. Sell half at $38.25 (if you still own GDX) and use $35.20 as a stop.
Stocks
As noted last week:
“The shallowness of the recent pullback suggests that the S&P 500 will complete 5 waves up from the March 4 low by rallying above 4219 before a more significant top forms.”
The S&P 500 traded above 4220 on May 7 and reached 4238. After some early strength this morning, the S&P 500 reversed and closed at 4188 as selling in the Mega Cap stocks pulled it down. The Nasdaq 100 lost -2.53% and the Russell 2000 shed -2.59%. A Close below 4118 would likely lead to additional selling and a drop to the blue trend line near 4030.
The NYSE Advance – Decline line continues to make new highs so a test of 4238 or a new high is likely after any pullback.
As noted last week:
“As long as the Russell 2000 holds above 2250 it has the potential to test the all time high of 2360. It would be negative if the Russell 2000 closed below 2210 after having reversed higher one day after closing below that level.”
The Russell 2000 closed below 2250 on May 4 and continues to show poor relative strength versus the S&P 500 (top panel.) The Russell 2000 closed at 2212 on May 10 and it looks like a decline to 2110 is coming
Sector Analysis and recommendations
In the February 22, 2021 WTR I recommended buying Industrials (XLI), Basic Materials (XLB), and the Financials (XLF). In each case I suggested to buy the sector on weakness and the market accommodated. On February 22, the S&P 500 closed at 3876 but traded down to 3806 on February 23 and 3790 on February 26.
In the April 12 WTR I recommended price levels to sell half of each position. In the May 3 WTR I provided the following instructions:
“The remaining 50% should be sold when the S&P 500 trades above 4220.”
The S&P 500 traded above 4220 at 6:50am on May 7. The price for each ETF is the price it was trading at 6:50am on May 7. The S&P 500 closed at 3876 on February 22 and up was up 8.9% when it reached 4220. The gains for each ETF would have been larger had one purchased them on the subsequent weakness as advised.
Industrials
On February 22 Industrials XLI closed at $91.27 and on February 23 traded down to $90.19. Sell half of the position at $101.10. XLI traded up to $101.10 on April 14. XLI was trading at $106.10 on May 7 at 6:50am. The average sell price was $103.60. The gain from the February 22 close was 13.4%
Basic Materials
On February 22 the Basic Materials XLB closed at $75.34 and on February 26 traded down to $73.07. Sell half of the position at $81.10. On April 15 XLB traded up to $81.10. XLB was trading at $87.38 on May 7 at 6:50am. The average sell price was $84.24. The gain from the February 22 close was 11.8%
Financials
On February 22 the Financials XLF closed at $32.71 and on February 26 traded down to $32.19. Sell half of the position at $35.40. XLF traded up to $35.40 on April 14. XLF was trading at $37.57 on May 7 at 6:50am. The average sell price was $36.48. The gain from the February 22 close was 11.5%
Materials
On February 22 the Materials XME closed at $38.35 and on February 26 traded down to $35.83. Use a stop at $38.60. Sell 50% of XME on the opening of May 4, and the remainder when the S&P 500 trades above 4220. XME opened at $42.48 on May 4. XLB was trading at $45.36 on May 7 at 6:50am. The average sell price was $43.92. The gain from the February 22 close was 14.5%, and could have been larger if one had bought XME on the dip after February 22.
Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking
The MTI generated a Bear Market Rally (BMR) buy signal when it crossed above the red moving average on April 16, 2020 as the S&P 500 closed at 2800. A new bull market was confirmed on June 4, 2020 when the WTI rose above the green horizontal line.
The S&P 500 was expected to push to a new high above 4220 and it did. We will have to wait for the NYSE Advance – Decline to show more weakness and for the S&P 500 to fall below a prior low, before getting more cautious. Until then the trend is higher until Treasury yields reverse higher and the Dollar bottoms.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
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