Commodities

Shrimp on the Wage Inflation Barbie

It’s time to throw another shrimp on the wage inflation barbie.

Three trading days after the May jobs report revealed a 2.3% yoy increase in wages (over the Fed 2.2% target), and one day after record JOLTS (job openings) and the citing of difficulty finding adequate talent in the small business survey, the Employer Costs for Employee Compensation (ECEC) data came in surprisingly firm—Q1 ’15 ECEC rose 4.9% yoy, the same pace as Q4 ’14—again anecdotally implying we are seeing wage inflation start to accelerate.

In addition to the higher wage inflation implications, the ECEC staying at Q4 ’14 levels offers more proof that Q1 economic weakness is being overstated and was transitory and not a material shift in the economy. This is something that many analysts had thought to be the case, but now the jobs and wage inflation data is really starting to confirm initial intuitions.

From an investment standpoint, near term the evidence for wage inflation incrementally adds to the potential for a more “hawkish” Fed than currently expected, which is dollar positive/bond negative.

wage inflation

In terms of sectors, this also bolsters our “consumer” theme that retailers via Market Vectors Retail (RTH) are poised for a potential breakout if consumer spending rebounds (as it should given the positive fundamentals).

Beyond the near term, wage inflation begets real inflation.

So, this is positive inflation-hedged assets (stocks) and to a point gold, which was up decently yesterday (although despite the gold bugs’ beliefs, statistically gold is not the greatest inflation hedge—although it is obviously positively correlated).

Bottom line, wage inflation has started, and that should lead to an ultimate uptick in real inflation unless growth unexpectedly stalls.

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The Improving Labor Market

Last week, we received one of the best jobs reports we’ve seen in a very long time. On Tuesday, we saw more data suggesting an improving labor market. The April JOLTS, or job openings, number came in at a record high of 5.376 million, which is obviously positive for an improving labor market.

Meanwhile, the NFIB Small Business Optimism Survey rose to 98.3 vs. (E) 97.2. From a wage standpoint, the survey results were especially important. That’s because the survey of small businesses found that third on the list of “problems” small business faces (behind taxes and government regulation) was “No Qualified Applicants” for open positions.

improving labor market

More specifically, 45% of respondents to the survey said they planned on hiring or were trying to hire more workers in May (up 2% from April), but 47% of respondents said there were few or no qualified applicants for the open positions.

So, the practical takeaway from the improving labor market data is: A lot of job openings plus difficulty finding qualified workers to fill those openings is a great recipe for an acceleration in wage inflation—which if it continues, will put further “hawkish” pressure on the Fed.

It won’t change anything in the immediate term from a Fed outlook standpoint, but the anecdotal evidence of an improving labor market implies wages are accelerating higher. Wage inflation be-gets nominal inflation, and for a market that is still very dovish, that is notable.

From an investment standpoint, the improving labor market adds more credence to my “hawkish” scare pullback in stocks (despite Wednesday’s rally). It also is bearish bonds, a trend we have seen ramp up significantly over the past six weeks.

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May Jobs Report Preview

The key to the May jobs report, due out Friday morning, is whether it solidifies September as the date of Fed rate hike “lift off”, or whether it leaves open the consensus of a later than September rate hike (October/December/early ’16). Going into the May jobs report, December remains the slight consensus expectation, although a strong number Friday could shift that to September.

So, look at it this way:

“Too Hot” = Potential of a July hike

“Just Right” = September hike

“Too Cold” = October/December/2016 hike

The “Too Hot” Scenario (What It Takes to Put July on the Table)

> 250k Job Adds. It’ll take a pretty strong number to put a July hike on the table (there’s almost no chance of June), but a 250k or higher May jobs report would do it. 

< 5.4% Unemployment Rate, ≤ 10.9% U-6 Unemployment Rate. In the March statement the Fed lowered “NAIRU” to 5.0% and below, but if we continue to see both unemployment rates grind steadily lower, again in the context of a “fully dovish” expectation by the market, this will elicit a hawkish reaction because it’ll make a September hike more likely.

> 2.3% yoy wage increase. YOY wage gains again moderated a bit in the April report, but inflation metrics are clearly bottoming. If we see year over year wages move above the 2.2% target, expect calls for a small hike in July.

The “Just Right” Scenario (September Rate Hike)

150k—250k Job Adds/ 5.4% Unemployment Rate, ≤ 2.2% YOY wage increase. There’s the chance we could see a “hawkish” reaction by markets to this type of May jobs report, but this is closest to expectations.

The “Too Cold” Scenario (December or early 2016)

< 150k Job Adds/≤ 2.2% yoy wage increase. This May jobs report number will be technically “dovish” but it’s not a positive for stocks or the economy, so fade any material rally on a number this weak. The Fed wants to get at least one hike in, and if the job market starts to soften and we see two sub-150k job prints in the last three months, that’s not going to be good for risk assets. 

I continue to believe that clarity on the state of the economy and on the timing of the first Fed rate hike is the key to materially higher stock prices, so I am hoping for a strong number tomorrow—but I’m also ready for any surprises in the May jobs report.

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Oil Prices and the Next OPEC Meeting

Oil trading was subdued yesterday as futures traded range bound following Friday’s steep rally. Oil prices finished the Monday session down just 0.18%. In addition to the “normal” weekly data releases including API supply data due out later today, EIA inventory figures released tomorrow morning, and Baker Hughes rig counts on Friday, traders are focused on the June OPEC meeting on Friday, which will likely move oil prices.

Many traders, foreign and domestic, are still “licking their wounds” after OPEC members were surprisingly disjointed at the November meeting when they refused to cut production targets.

That “surprise,” which led oil prices to fall over 5% while most Americans were eating Thanksgiving dinner, is largely to thank for Friday’s surge in oil prices, as shorts rushed to cover positions ahead of the June meeting this week.

oil prices

Most analysts are forecasting that OPEC will keep target output levels constant as the Saudis remain dead set on defending market share even if it means weathering further price weakness in the near term. However, leaving output levels near all-time highs has put serious economic pressure on smaller OPEC members with a higher cost of production amid the lower oil prices globally.

Bottom line: crude oil prices continue to drift sideways around $60/barrel where they have been for about six weeks now. The key drivers of the market have been the dollar, and equally as important, weekly inventory numbers. Production statistics within those releases are in focus as traders look for a clear trend and see if lower prices and declining rig counts have actually influenced a pullback in production in the US. And, so far the answer to that question is “no.”

This week, expect some additional volatility in oil prices as OPEC is in focus. If the meeting is a “non-event” as most analysts are anticipating, expect oil prices to remain range bound with a bias to the downside as the technicals currently favor the bears. Additionally, the reverse correlation with the dollar is very much intact, so if we see a material reaction out of the greenback to the May jobs report on Friday; expect a move of comparable magnitude in the opposite direction in oil prices.

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The Busiest Data Week of the Year

This is by far the busiest data week, and the most important, of 2015. From an economic and Fed outlook standpoint, several key questions will be closer to being answered:

1) Is the US economy rebounding in Q2, as expected?

2) Is inflation continuing to bottom?

3) Is global growth stabilizing?

4) Is European inflation bottoming?

All of these questions matter because ultimately they will determine whether a September rate hike is more likely than current expectations, and that matters because if it is more likely, then we will probably see that sharp, short pullback that I and others have been waiting for.

Turning to this busiest data week of the year, there are a lot of reports, but two are more important than everything else: the Jobs Report Friday, and the Personal Income and Expenditures report this morning.

The jobs report is important for obvious reasons, and we will get the normal “Jobs week” drip of reports from ADP Wednesday and claims Thursday. We will offer our “Jobs Report Preview” as we get closer to Friday, but clearly if we see another strong jobs print (above 200k), then the chance of a September hike will go up.

Turning to the Personal Income and Expenditures report out early Monday, this is important because it contains the Core PCE Price Index, which is the Fed’s preferred measure of inflation. This is important in the context of a series of indicators that shows inflation is bottoming, the latest of which was the hotter-than-expected core CPI report of two weeks ago.

The stock market basically has stalled since that report hit the wires 10 days ago, and while it wasn’t solely responsible for the market drifting lower last week, it did help the dollar rally, and that has weighed on stocks. So, inflation matters once again, and if the core PCE Price Index also runs “hot” this morning markets will react.

After those two reports, the global manufacturing and composite PMIs are the next most important numbers. In the US, the manufacturing PMIs (this morning) and service sector PMIs (out Wednesday) will give us much better insight into the state of growth of the US economy in May—and whether the Q2 rebound is materializing.

Globally, the busiest data week includes two numbers to watch, and they are the composite PMIs (out Wednesday) and the EMU flash HICP (their CPI), which is released tomorrow. Bottom line, global growth needs to stabilize and start to move higher following some stagnation in April and initially in May.

China, especially, needs to show some stabilization of the slowing of momentum in growth metrics, otherwise concerns about a Chinese “hard landing’ will get louder and eventually become a bigger headwind on global risk assets. In Europe, there are several signs that inflation is bottoming, and if HICP continues to show that, it will be a positive for our various “Long Europe” ETFs.

Bottom line, this is the busiest data week of the year, and the data will give us more clarity on when the Fed will raise rates.

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The Death of Dovish and Hawkish

Since about 2008, we’ve all been conditioned that dovish and hawkish Fed policy is a key determining factor for equity prices. Dovish Fed policy, meaning no interest rate hikes and more QE, is positive for stocks, and for nearly seven years that’s been correct. However, we have been asserting since March that this idea is dead. Dovish is dead, and hawkish is dead too, for that matter—at least with regards to the next material move in stocks.

That’s because the date of the first interest rate hike, which will be a major influence on stocks, bonds and the dollar, now is almost entirely a function of US economic data. Higher interest rates are no longer “bad” for stocks beyond the very short term, and perma-zero interest rates are no longer “good” for stocks.

Instead of still reading dovish or hawkish tea leaves, we need to think of the timing of the first rate increase as an “if/then” function of the economy.

If economic data is good, then rates will rise. That’s good for stocks, corporate earnings, wages, the deficit, the debt and everything else beyond the very short term, because it’s all based on a growing economy.

dovish and hawkish

If economic data is soft, then rates will stay at 0%. Not because the Fed still wants 0% rates in the face of accelerating growth, but instead because the economy is so feeble that it can’t stomach a 25-basis-point increase. That is not a good scenario for stocks, especially given valuations.

This is why we continue to say dovish is not good for stocks and hawkish is, beyond the very short term.

With regards to the seminal event of 2015, the first rate hike in nearly 10 years, dovish and hawkish no longer apply in the traditional sense—and that’s an important distinction we think a lot of people are missing.

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The ‘Why’ Makes us Neutral on Stocks

Stocks again rallied to new highs last week, and clearly, trying to stand in front of this lift in stocks has been a fool’s errand. Yet despite the impressive resilience of markets, we remain neutral on stocks, because while we are impressed with the price action, “why” markets have rallied continues to make us nervous.

Put simply—it’s the “why” that makes us neutral on stocks.

Markets have risen these last three weeks because of two reasons: 1) A return of “dovish” stock buying following disappointing economic data, and 2) Too bearish positioning causing the “pain trade” to turn higher in the very short term. We view neither as the type of catalyst that will ignite the next material leg higher in stocks.

Markets have moved to new highs despite neutral (at best) April quarter-end earnings, consistently disappointing Q2 economic data, a surprising rise in interest rates, and historically high volatility in currency and bond markets.

neutral on stocks

There are those making the case that stocks are just climbing the proverbial “wall of worry,” but I disagree—I don’t think we’ve hit the wall of worry yet, because stocks have never really declined despite a somewhat negative turn in fundamentals and rich valuations.

Bottom line, interest rates have been at 0% for nearly eight years, and we do not see a few additional months of 0% rates (which will be the direct result of the economy being too weak to stomach a rate hike) as being a legitimate reason for stocks to rally significantly.

As a result, we continue to be neutral on stocks in the broad domestic market, and prefer international exposure, specifically Europe and Japan. And, it looks like that strategy may be back “on” in the short term, as HEDJ and DXJ both outperformed the S&P 500 last week.

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Why the Fed Minutes Matter

Yesterday’s release of the Fed Minutes from the April FOMC meeting did not reveal much; however, the market reacted in a slightly dovish manner as the dollar fell back from the highs and stocks rallied modestly.

The Fed Minutes showed that most FOMC members thought that it would be premature to raise interest rates in June, which according to Fed Funds Futures, the market was already expecting.

The financial media spun the Fed Minutes as “dovish” with multiple headlines stating “June is off the table.” Well, June was never “on” the table from a market expectation standpoint, so that is nothing new.

But, why June is off the table is what made these Fed Minutes matter.

Most FOMC members had June off the table because there wouldn’t be enough time for data to conclusively show that it is ok to raise interest rates. It was a time issue, and not one of concern for the economy. In fact, the FOMC seemed to agree that the reasons behind the economic weakness were transitory, and that they collectively expected a solid “bounce back” in Q2 after the Q1 weakness.

Point being, there is plenty of time and data for a September hike, even though it’s only considered a remote chance by the market. If we see two strong jobs report, maybe even a July hike—although admittedly that’s a long shot.

Bottom line: yesterday’s Fed Minutes release was largely in line with market expectations, but the reiteration of “data dependent policy making” will cause investors to continue to watch economic data very carefully going forward—notably the CPI number released Friday morning.

Also, given that yesterday’s Fed Minutes were pretty stale coming from the April meeting, Fed Chair Yellen’s speech at 1:00 p.m. Friday will be closely watched as market participants look for further clues and updated Fed commentary on the state of the economy and when the first rate hike may potentially happen.

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Natural Gas is Heating Up

Natural gas futures are heating up, and on Thursday the energy commodity rallied sharply on inventory data. The gains in nat gas helped push the benchmark commodity tracking index ETF, the PowerShares DB Commodity Tracking ETF (DBC), up 0.60% on the day. DBC now is hovering just below its recently established 2015 high.

Natural gas was, in fact, the big mover in the commodity space Thursday, rallying about 2.5% in the session to break through the $3 mark as the Energy Information Agency (EIA) reported a smaller-than-expected supply build of 111 Bcf vs. (E) 121 Bcf in the weekly nat gas inventory report.

The smaller supply build carried natural gas prices to their highest level since mid February, and futures now have officially entered bull market territory as they’ve traded just over 23% higher since the late-April lows.

natural gas

UNG is the benchmark natural gas ETF

Natural gas futures have benefited from a crowded short side of the market being forced to buy back positions as the market gained upside momentum, as well as a hotter-than-expected start to summer leading to increased natural gas power demand thanks to heightened air conditioner usage across much of the East Coast.

Bottom line: the fundamentals of natural gas are difficult to read out for much more than about two weeks, as the extended weather forecasts are driving the market from a demand standpoint. However, natural gas futures have established a well-defined uptrend that could see futures rally as high as $3.50 in coming weeks. But, keep in mind the move is largely all about weather right now, so if you are a buyer beware of the “Mother Nature” factor.

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Are Gold Futures Becoming Oversold?

Precious metals have been a very boring sub-sector of the commodity markets to watch over the past six weeks, and Monday was no exception as gold futures drifted sideways to close the day almost perfectly unchanged. But, looking past the tight range of the daily chart that has had gold futures corralled between $1,180 and $1,210ish for weeks now, there has been an underlying development in a key, concurrent indicator—the Commitment of Traders Report published by the CFTC.

When looking at the “COTs,” the Net Long Positions held by Money Managers on gold futures are a concurrent indicator that generally rise when the price of gold rises, and fall when the price of gold falls—and usually with pretty high correlation.

But, gold futures Net Longs held by Money Managers can also begin to offer gold futures traders with a contrarian signal when relatively high levels or low levels are reached, as they begin to forecast overbought or oversold market conditions.

gold futuresRight now, Net Longs on gold futures are approaching the low end of the spectrum at just 22,857 (suggesting futures may be potentially oversold). To put this in perspective, during the early 2015 gold rally that saw prices reach $1,300, Net Longs rapidly rose to 153,237, which is towards the high end of the range of recent years (suggesting the market may potentially be overbought).

Now, the way the indicator works is primarily based on the trend of the COTs, so just because Net Longs are currently low, it does not mean you should go out and buy gold. Rather, when net longs reverse direction and begin to move higher it is a signal that a new uptrend is potentially in the early stages of forming.

Bottom line: based on the internal indications that the COT report provides us with, gold futures are nearing “oversold” conditions and we will continue to watch the weekly report to stay ahead of a potential move developing in the near term.

If we see an uptick in gold futures net longs, and the technicals of the gold market agree, we will be inclined to initiate a long position in gold.

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