MorningWord 7/8/16: Spoos and Twos

by Dan July 8, 2016 11:09 am • Commentary

Is this morning’s June non-farm payrolls print of 287,000 as much of an anomaly as last month’s May print of 38,000?  Probably, which is why forecasters and pundits smooth out the data. In the first quarter of 2016 the change in nfp’s was about 196,000 (vs 229,000 in Q1 of 2015), while the second quarter averaged 147,000, which some view as a slowdown as the unemployment rate is below the Federal Reserve’s target of 5%. May’s prints all but demolished any real chance for the Fed to raise rates at their upcoming FOMC meeting on July 27th, but as expected Fed Fund futures are now pricing a 12% chance of a hike at the September 21st and November 2nd meetings, up from 2% yesterday.  This morning you already starting to hear some Fed-heads like the WSJ’s John Hilsenrath suggest that this morning’s data “increases the chances of a Fed rate hike in September but officials are likely to remain in a wait-and-see mode until then, and will likely pass on moving in July“.  Umm ok, seems like some wasted ink there.

Let me start by stating the obvious: U.S. stocks like the good data. Good news is good news and a new high in the S&P 500 (SPX) seems in the offing. It’s been my view for more than a year that the SPX’s inability to establish a new range above the May 2015 high was a warning sign to committing new capital to equities. The market has been rejected on more than a few occasions below the prior all time highs. The SPX ‘s best upward momentums followed sharp declines. But these V reversals have all run out of steam right where they should:

SPX 1yr chart from Bloomberg
SPX 1yr chart from Bloomberg

But as we head into Q2 earnings season over the next few weeks, there is a very strong possibility that the path of least resistance changes. It’s possible that with its sharp drops of about 10% since Q4 2014 all having been bought, the SPX has merely been forming a base for a the next leg higher, despite its inability to this point. Given the recent volatility in most major asset classes the world over since the Brexit vote on June 23rd, the likelihood of a period of calm increases for the Summer, especially if there are no major red flags in U.S. corporate earnings, nothing unexpected out of China, and a European banking crisis is averted.

Those are all kind of big ifs. But we could be in for a sort of “goldilocks” period as the SPX benefits on a relative basis to other major equity indices around the world where far greater uncertainty reigns, and an FOMC that is still sitting on its hand because of the rest of the world.

And on that matter of interest rates here. They are still positive (above zero). And just above the all time lows for the 10 year Treasury yield. But this is what you want to keep an eye on to gauge the risk environment. The higher USTs go the more nervous we should all get about the chance of a global recession, which would likely increase the chance of a sharp decline in the SPX.  Look no further than the countries /regions where trillions of dollars of sovereign debt have negative yields, the Euro Stoxx 50 and Japan’s Nikkei are both 20% below their 52 week highs.  At some point there will be a breaking point for U.S. risk assets where the benefits of low yields start to outweigh the long term structural risks and reflect the impotence of the U.S. Fed.

So maybe we have a breakout on this Goldilocks set-up. Maybe we rip up 3 to 5% from current levels. But if the SPX fails to establish a new range above the May 2015 highs then I’d be careful how quickly I raise that Mission Accomplished banner. Because not being able to might be the most bearish sign for the SPX.

Which brings me to a funny tweet from The Reformed Broker and my response which was not meant to be a joke. There’s no need to choose between stocks and bonds. But I think it is important to recognize that there are some very unnatural forces at play that have propelled one asset class and kept the other one bid:


This trade has been consistent and seems only emboldened the more we see economic crises somewhere else. But for equities it’s also been dependent on those crises consistently rolling from one locale to the next.