Political Update: Stay Focused on Taxes, Not Impeachment

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Before getting into the market implications of the latest political headlines, I want to remind everyone that any political coverage I give in the Sevens Report is solely from the perspective of the markets, they don’t reflect my preference or lack of preference for any specific politician or party. My personal opinions are not important. What is important is giving you analysis that cuts through the steadily rising amount of sensationalist noise in the financial media (on both sides), and keeping you focused on what’s really moving markets.

That said, given the latest revelations on President Trump, I wanted to take a moment and push back on some of the sensationalism.

Specifically, I want to explain clearly that any talk of impeachment is not realistic in the near term. The reason is simple: Impeachment is a political process, not a legal process. The House of Representatives must start the impeachment process, and since it’s controlled by Republicans, short of having incredibly damning evidence against the president, that simply won’t happen.

In all likelihood, even if Robert Mueller’s commission finds that President Trump likely obstructed justice during the Russian investigation, the evidence would have to be unequivocally conclusive in order to cause the Republicans to impeach. That means we would have to have the equivalent of a video or audio tape of Trump telling someone to break the law.

Obstruction of justice, unlike perjury, is an opinion derived from conclusions; it’s not a hard and fast fact (i.e. you told the truth under oath, or you did not).

So, to be clear, impeachment of President Trump is very unlikely over the next 1.5 years, again because of political reasons, not legal ones (and to be fair to Republicans, Democrats wouldn’t impeach a president either without undeniable evidence).

Now, all this might change if the House changes hands in 2018, and frankly that’s more than possible. On average, the president’s party loses about 30 seats in the House in the first midterms, and the Republicans enjoy a 45 seat majority. So, if the average holds, it’ll be close. If the Democrats take control and this is still an issue, impeachment is a real risk… but that’s a problem for another day.

In the near term, the key is to stay focused on tax reform. Expectations are pretty low at this point, but the market does expect corporate tax cuts in 2018, and the ongoing Russia saga does continue to reduce the chances of that expectation being met.

The biggest risk to stocks continues to be if the market begins to factor in no tax reform in 2018. If that happens, it’ll be good for at least a mild pullback. Taxes, not Russia, remain the number one risk to this rally.

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Fed Takeaways: What the Hike Means for Markets, June 15, 2017

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FOMC Decision: The Fed increased the Fed Funds rate 25 basis points, as expected.

Wednesday’s Fed decision was not the dovish hike the market was expecting, although it wasn’t exactly a hawkish decision, either (even considering Yellen’s balance sheet surprise). Looking at the statement, the Fed wasn’t as dovish in its language as the consensus expected. The economic growth language remained good, and actually improved a bit from the May statement.

The inflation language, as expected, was downgraded, but the Fed refrained from changing the characterization of risks, and left them “roughly balanced.” That’s Fed speak for “any meeting is live for a rate hike.”

However, the Fed did note the undershooting of inflation recently, and explicitly said they are monitoring inflation, meaning if it continues to underperform they will react with easier policy. For now, the best way to characterize the statement is “steady as she goes,” with regard to the Fed’s current outlook.

Wildcard to Watch: Balance Sheet Reduction

We were right to make this our wildcard to watch, as the topic of the balance sheet provided the only real surprise in yesterday’s Fed meeting.

Importantly, the Fed gave guidance on all three major balance sheet related questions: When will it reduce the balance sheet? How will it reduce the balance sheet? What holdings will it reduce?

What will it reduce: The Fed revealed that it will simultaneously reduce holdings of both Treasuries and Mortgage Backed Securities, which was generally expected.

How will it reduce its balance sheet: The Fed will implement a rising monthly “cap” on principal reinvestments. What that means, practically, is the Fed will not reinvest the first $6 billion of Treasury principal and the first $4 billion of MBS principal, making it a total of $10 billion that it won’t reinvest each month, at least initially. That cap will rise by $10B every three months, so one year from the start date (which will likely be September), the Fed will no longer be reinvesting $50B worth of bond principal payments per month. That number and this escalation is not surprising, and was close to in line with most forecasts (i.e. this wasn’t “hawkish.”)

When will the Fed start Reducing the balance sheet: This was the surprise, as Fed Chair Yellen said balance sheet reduction could start “relatively soon.” That is sooner than expected, as the consensus was the Fed would hike rates again in September, and start to reduce the balance sheet in December. Now, that may be flipped.

Since reduction of the balance sheet is like the Fed hiking rates, this was taken as mildly hawkish, and the dollar bounced along with bond yields. However, this surprise is not a hawkish gamechanger, and won’t alter anyone’s outlook on Fed policy going forward.

Bottom line, for all the noise and production yesterday, the Fed outlook remains broadly the same: One more rate hike and balance sheet reduction in 2017, unless inflation metrics get much worse.

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Could The Fed Give a Hawkish Surprise Today?, June 14, 2017

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The simple answer is probably not, but there is a better chance than previous meetings because of one simple reason: Despite two rate hikes since December, in aggregate, “financial conditions” have gotten “looser” in 2017, so Fed rate hikes aren’t really working.

Financial conditions is a term that was coined (for all intents and purposes) after the financial crisis, so we could see financial conditions were getting very tight (i.e. less credit availability) and when liquidity was drying up.

Now, in a post-crisis world, multiple institutions keep “Financial Conditions Indices” that measure the level of interest rates, liquidity in the system, credit availability and other measures of whether the availability of money and credit is getting loose (i.e. more availability) or tight (less availability).

I watch three such indices: (withheld for subscribers—unlock with a free trial). All three have slightly different methodologies, but all generally try and accomplish the same objective, which is to see if financial conditions in the economy are “looser” (i.e. easier credit/more liquidity) or if they’re getting “tighter” (i.e. less credit and less liquidity).

Here’s the important takeaway: All three financial conditions indices have shown aggregate financial conditions getting looser since the start of the year. In fact, in aggregate, financial conditions have eased by the equivalent of a 25 basis point rate cut since 2017 started, despite two rate hikes.

The reasons for this are somewhat obvious: Liquidity remains ample; credit remains readily available, interest rates are down, the stock market and housing prices are up (so more ability to borrow).

From a Fed standpoint, the takeaway is this: The fact that the Fed’s “slow walk” in interest rates isn’t mopping up excess liquidity in the market may make the central bank more prone to get “hawkish,” which again would be positive for banks and cyclicals (i.e. the reflation trade), but negative for defensives and higher-yielding sectors (utilities, consumer staples, REITs).

Again, I’m not saying the Fed will be surprisingly hawkish today, but if I had to bet on a surprise based on these financial conditions indices, I’d bet hawkish over dovish (although I’m making the dangerous assumption the Fed is serious about getting rates back to normal levels).

Bigger picture, though, the takeaway here is that the Fed’s policies, so far, are not having the desired effect. And, if this continues, the Fed will have to “shock” markets with a substantial rate hike at some point if it wants to regain market related credibility—and that increases the risk of higher rates over the longer term (or, higher inflation if they don’t provide that shock).

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FOMC Preview and Projections plus the Wildcard to Watch, June 13, 2017

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The Fed meeting is more important than any other this year, for the simple reason that it could either exacerbate the glaring discrepancy between stocks and bond yields (which would be negative for risk assets medium term), or it could help close the gap (which would be positive for risk assets).

Specifically, the bond market has quietly been pricing in the expectation of a “dovish hike” for this meeting via the decline in yields. That “Dovish Hike” means the Fed does hike rates 25 basis points, but makes the statement dovish enough that it doesn’t cause longer-dated yields (i.e. 10- and 30-year Treasuries) to rise. If the Fed executes on that expectation, then we will see the 10-year yield dip and likely test the 2017 lows of 2.14%, and again that is a problem for stocks over the medium/ longer term.

Looking at the actual meeting itself, whether it meets expectations, is dovish, or is hawkish, will depend not only on the rate hike, but also the inflation commentary and any guidance regarding “normalization” of the balance sheet.

What’s Expected: A Dovish Hike. Probability (this is just my best guess) About 70%. Rates: It would be a pretty big shock if the Fed didn’t hike rates tomorrow, so a 25-basis-point hike to 1.25% is universally expected. Statement: In paragraph one, the Fed should include some additional soft language regarding inflation, noting that it’s been soft for a few months. However (and this is important), the Fed should still attribute sluggish inflation to “transitory factors,” implying Fed members are still confident they will hit their 2% inflation goal. Dots: No change to the 2017 dots (so, still showing three hikes as the median expectation). Likely Market Reaction: Withheld for Sevens Report subscribers. Unlock by starting your free trial today.

Dovish If: No Hike or a Very Dovish Hike. Probability (again, my best guess) About 10%. Rates: It’s widely expected that Fed will hike rates, but there’s always a possibility of a surprise. More likely, the Fed will hike 25 bps and accompany it with a very dovish statement. Statement: The Fed changes the characterization of risks from “balanced” to “tilted to the downside,” or some similar commentary, thereby signaling rate hikes are off the table again. This is a very unlikely, but possible change. More likely is the Fed adding considerable language regarding concerns about lower inflation. Dots: A reduction of the dots to reflect just two rate hikes in 2017. Likely Market Reaction: Withheld for Sevens Report subscribers. Unlock by starting your free trial today.

Hawkish If: We get a regular hike, not a “Dovish” Hike. Probability About 20%. Rates: The Fed Hikes Rates 25 basis points. Statement: The Fed does not add softer language regarding growth or inflation in the first paragraph, and instead just largely reprints the May statement, which was dismissive of the recent dip in inflation and growth. Dots: The dots remain the same or even increase one rate hike in 2017 (this is unlikely, but possible). Likely Market Reaction: Withheld for Sevens Report subscribers. Unlock by starting your free trial today.

Wild Card to Watch: The Fed Balance Sheet

The market fully expects the Fed to elaborate on when and how it intends to reduce its balance sheet (i.e. the holdings of Treasuries it has purchased over the years through the QE program).

I covered why the balance sheet is important back in April (a link to that report is here) but the bottom line is that when and how the Fed begins to reduce its balance sheet (the term “normalize” is just Fed speak for “reduce Treasury holdings”) could be a substantially hawkish influence on the bond market, regardless of rate hikes.

Specifically for tomorrow, the key detail the market will be looking for is at what level of interest rates does the Fed begin to reduce its Treasury holdings. The number to watch here is 1.5%. It’s widely expected that at 1.5% Fed funds, the Fed will begin to reduce its balance sheet. If we get one more rate hike this year, then that puts balance sheet reduction starting in early 2018 (likely March).

For a simple reference, if the Fed statement or Yellen at her press conference reveals the Fed will reduce holdings before 1.5%, that will be hawkish. If it’s revealed that the Fed will reduce holdings after rates hike 1.5% that will be dovish.

Bottom Line

This Fed meeting is likely the most important of the year (so far), not just because we will get updated guidance on expected rate hikes and the balance sheet, but also because it comes at a time when we are at a tipping point for bond yields (if they go much lower and the yield curve flattens, more people will start talking recession risk). We also are potentially seeing a shift in stock sector leadership (from defensives/income to cyclicals/ banks), so understanding what the Fed decision means for rates will be critically important going forward. You’ll have our full analysis, along with practical takeaways, first thing Thursday morning.

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Weekly Market Cheat Sheet, June 12, 2017

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Weekly Market Cheat Sheet

Last Week in Review:

There were only a few economic releases last week and the Fed circuit was silent ahead of this week’s Fed events.

The headline of the ISM Non-Manufacturing PMI was largely in line with expectations at 56.9 for May, and the details matched as well. The one outlier was a sharp dip in the prices category, which fell to 49.2 from 57.6. It was the first sub-50 reading in 13 months. And while the one number by itself is not very alarming, pairing it with other soft price data of late, including the weak unit labor cost on Monday, inflation data is beginning to gain some attention. For now, it is just something to monitor and will not have a material effect on Fed policy yet.

Looking overseas, the EBC decision was the big event last week. As expected, rates were left unchanged and there were no changes in the QE program. The ECB changed their risk assessment to “balanced” and also removed the potential for lower interest rates going forward. Overall, the meeting was anti-climactic as a step was taken towards eventually ending QE, but no update on the timeframe was offered.

This Week’s Preview:

Focus will be on central banks this week as the Fed takes center stage Wednesday, the BOE is Thursday and the BOJ is Friday. The Fed will obviously attract the most attention as a rate hike is expected, but the outlook for future policy has grown cloudier. The market will be looking for any clues as to the number of rate hikes remaining in 2017, or whether the committee’s sentiment towards the economy has changed in recent months. We will have our full FOMC Preview in tomorrow’s Report.

As far as economic data goes, CPI and Retail Sales will both be released pre-market ahead of the FOMC on Wednesday (which we will provide a preview for, as always).

Later in the week we get the first look at June data from the Philly Fed Business Outlook Survey and the Empire State Manufacturing Survey as well as Industrial Production data for May. The latter will be important to see if the recent bounce in manufacturing data has continued at all in Q2 or not. Lastly on Friday, Housing Starts data for May will provide the latest update on the housing market.

Overseas, there are some important releases to watch beginning on Tuesday night with Chinese Fixed Asset Investment, Industrial Production, and Retail Sales all due at 10:00 p.m. ET. There are several second-tiered reports that may move market modestly if there are any surprises, but the only other report overseas really worth watching is the Eurozone HICP (their CPI) to see if inflation is firming at all or actually rolling over as some individual European country reports have shown (German CPI was -0.2 vs. E: -0.1% in May).

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ECB Rate Decision, June 9, 2017

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The ECB Decision left rates unchanged, and made no changes to the QE program, as expected.

ecb rate decision

ECB Rate Decision Takeaway

The ECB met expectations Thursday, as they changed the risk assessment to “balanced,” and also removed the potential for lower interest rates going forward.

Overall, it was an anticlimactic meeting as the committee took another step towards the eventual end of QE, but gave no indication that the end of QE or rate hikes would occur sooner than was currently expected. As a result, the market largely yawned at the decision.

The euro dipped slightly on the news, despite it being a technical “hawkish” shift, and that’s because this result was already priced into the euro above 1.12. Thus, we saw a classic sell-the-news reaction.

Going forward, with the euro at current levels, whether the rally continues will depend more on US and EU economic data than anything else, as central bank policies for both the Fed and ECB are well known (the Fed should hike next week, and stick to the current guidance of three hikes for 2017).

From a bond standpoint, German bund yields dipped slightly following the statement, again a sell-the-news reaction. However, Treasury yields bounced slightly, mainly due to how short-term oversold they are. Bottom line, the ECB interest rate decision did not provide any sur-prises, and it will not cause Treasury yields to embark on a rally. Whether yields can rally from here will depend on economic data.

From an equity standpoint, I do not view this decision as negative for European stocks, and I remain bullish on European stocks via HEDJ and EZU. It’ll take a material uptick in US economic data for the euro to begin to weaken materially vs. the dollar over the next few months, but even if that doesn’t happen, the positive economic growth and continued QE should continue to put a tailwind behind EU stocks.

UK General Elections — What the Outcome Could Mean for US Markets, June 8, 2017

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The focus on this event is magnified because of Brexit, but the bottom line is that it’s unlikely to move global markets. Still, I wanted to provide a basic primer so no one is blindsided if there is election-inspired volatility.

Today’s election will be for the House of Commons. Polls and most betting sites have the Conservatives (the Tories) holding an outright majority over the second-largest party, Labour.

Positive If: Conservatives increase their majority. Magic number: 330 seats. If the Conservatives win more than 330 seats, their majority should expand and it will give the Conservatives a clear mandate on Brexit negotiations, and on economic and monetary policy. Since markets like continuity, this is likely the most positive outcome for stocks near term (although to be clear, I don’t expect a big Tory victory to cause a legit global rally).

Neutral If: Conservatives hold an outright majority. Magic number: 325 seats (technically they need about 322 seats, as most people expect five seats in Parliament to remain vacant as they will be won by Sinn Féin in Northern Ireland, and they don’t exactly like to participate in British rule). This would be a step backwards, and make negotiating Brexit and implementing post-Brexit policy more difficult (but it wouldn’t be a bearish game changer for UK stocks).

Negative If: The Conservatives can’t secure an outright majority. Magic number: <322. This outcome would lead to a very weak majority government from either the Conservatives or Labour, and it would not be positive near term as there would be no mandate for Brexit negotiations or the implementation of economic policy. In this outcome (which is a low probability), the pound would likely get hit hard, as would UK stocks, although I don’t expect that it would be a global headwind beyond the very short term.

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Why Bond Yields Are Important (A Plain-English Primer), June 7, 2017

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For more than two months, I’ve been talking about the increasingly concerning macro signals being sent by the bond market. During that time, stocks have traded great, hitting new highs amidst minimal volatility.

So, it’s logical to ask why I and many other analysts continue to point out these signs of non-confirmation of the rally from the bond market. After all, it hasn’t caused a problem in stocks, yet. But, I guarantee it will cause a problem (and potentially a painful one) if bond yields keep falling… it’s just a question of when.

Given that, I wanted to take a moment and explain more fully, and in plain English, why I’m watching the bond market so closely, and exactly what the bond market is saying about future economic growth and inflation.

First, I watch the bond market because it’s a better predictor of future 1) economic growth, 2) inflation, and 3) interest rate levels, compared to stocks or most economists estimates. Case in point, the bond market told us the financial crisis was coming when the yield curve inverted over a year before the turmoil, and well before Fed Chair Bernanke said subprime was “well contained.”

The joke is that bonds are more accurate because the smartest people on Wall Street always end up on the fixed-income desks (it’s why we call it the “smart market”). And while that may be true (and I can say that as I was an equities guy), in reality bonds are better forecasters of these variables because A) The bond market is much larger and more liquid then the stock market, and B) Stock prices, at their core, are just discounted estimates of corporate cash flows, and there are a lot of variables that go into those future cash flows that are very company specific.

Conversely, in the bond market, everything trades off a spread to Treasuries, and Treasuries price off expectations for 1) growth, 2) inflation and 3) future interest rate levels. Point being, there are less variables in the bond market, and the market is more liquid. That equals more efficiency.

Right now, that more efficient market is screaming that future economic growth and inflation will be disappointing, and that the Fed is going to hike rates, regardless.

The disappointing economic growth and inflation can be extrapolated from the decline in the 10- and 30-year Treasury yields. They fall because markets expect lower longer-term economic growth and inflation, which equates to a lower rise in interest rates over the longer term. After a brief bump in late ’16, the 10- and 30-year yields are telling us that the slow-growth economy is here to stay (so around 2% GDP growth).

However, in the short term, 2-Year Treasury yields are the best bond proxy for bond market expectations for the Fed funds rate, and that keeps rising (the 2-Year Treasury yield has risen from 1.2% to 1.32%). So, what the long end of the curve is saying is that rates may not go as high as we thought at the start of 2017 because of poor growth and low inflation. However, the short end of the curve (2-year yields) are saying that right now, the Fed will continue to hike rates.

More specifically, maybe Fed funds will be 1.5% in a year (so 2-year yields rise) but it’ll only get to 3% over the next four years (so 10- and 30-year rates fall). I’m making those numbers up, but you get the point.

Why does this matter to stocks? Because the short term aside, neither you nor I want to be overweight stocks at 18X earnings in a slow-growth and rising rate environment.

Think of it this way: From 2015 to 2016, earnings growth was flat and stocks went nowhere and volatility was high. Then, last year, earnings growth started to be revised higher, and stocks have rallied.

If the bond market is right about economic growth prospects and interest rate hikes, then that will hit expected earnings growth, and stocks will fall.

From a “how to play it” standpoint, the blueprint is clear. Defensive, higher-yielding equities like consumer staples (XLP) and utilities (XLU) (two of the best-performing sectors in 2017). Additionally, international exposure (Europe via HEDJ, EUZ) and emerging markets (IEMG).

Conversely, this set up will be very bad for banks, and the current selling is just the beginning if yields correctly forecast slowing growth. Finally, while they’ve held up well, it’s unlikely tech will be able to continue to rally longer term.

Bottom line, the signals in the bond market are important because they are telling us lower growth and inflation are coming, but with higher interest rates. That is a very bad set up for stocks at such stretched valuations, and that’s why we’re watching the bond market so closely.

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Three Momentum Indicators to Watch, June 6, 2017

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In Monday’s Sevens Report, we talked about how momentum, more so than anything else, is driving this rally in stocks. And while momentum is clearly a powerful force, it can also be fickle. When momentum dissipates, there are usually air pockets underneath the market (see August 2015).

The trick to outperforming, then, is knowing when momentum is waning, and we want to identify three momentum indicators we’re watching to stay ahead of that move. Those momentum indicators are: Two tech sub-sectors (FDN and SOXX), the NYSE Advance/ Decline Line, and Market Sentiment.

Momentum Indicator #1: Sentiment Indicators.

Starting with the latter, it’s important to realize that momentum and sentiment, while related, are different. Momentum refers to a state of market psychology where higher prices themselves become the biggest bullish force, as underinvested people and portfolio managers chase stocks higher and aggressively buy any dip out of fear of underperforming. Unlike sentiment, strong momentum is not, by itself, a contrarian indicator (like overly bullish or bearish sentiment indicators).

That said, in today’s market, a very bullish sentiment indicator could be a sign of an impending loss of momentum, as the bullish reading implies that everyone is “all in” on stocks, leaving a lack of capital on the sidelines that can “chase” stocks higher.

Right now, despite new highs in stocks, there are few signs that sentiment is near the highs. In fact, sentiment remains remarkably depressed for how strong the market has been in 2017.

The AAII Investors Sentiment Survey showed just 26.9% bulls vs. the historical average of 38.5%. The TMI Group Market Sentiment Index revealed just 49.8% bulls (the scale goes to 100) while the Citi Panic/Euphoria Model remains comfortably in “Neutral” range.

Point being, if bullish sentiment is a sign of an impending loss of momentum in stocks, we’ve got a long way to go.

Momentum Indicator #2: FDN & SOXX.

One of the reasons I look at sector trading every single day is because every rally is driven by a few sectors, or what I and others call “leadership” sectors. When these leadership sectors falter, that usually implies an impending loss of momentum.

Since late 2016, semiconductors have been the biggest leadership sector in the markets. They rallied big during the Q4 ’16 rally, and they are up big so far in 2017 (SOXX up 22%). While other sector leadership shifted from late ’16 to ’17 (banks and small caps to utilities, consumer staples and super-cap internet) semiconductors have continued to scream higher.

Similarly, as I and others have noted, nearly half of the 2017 S&P 500 rally can be attributed to just a few stocks: AAPL, AMZN, MSFT, FB, GOOGL. Those stocks are heavily weighted in the super-cap internet ETF FDN, and as such, that is also a leadership sector in 2017.

So, these are two important sectors to watch as any possible breakdown will imply a loss of momentum. It happened in the spring of ’14 when the then leadership sector biotech broke down and caused a pullback. It also happened before the pullback in August ’15 when the “FANG” stocks (leaders at the time) topped out in July— a month before the stock market fell.

Right now, the uptrends in FDN and SOXX are in good shape, but we will be looking for a violation of those uptrends as a clue the market may be about to lose momentum.

Momentum Indicator #3: NYSE Advance/Decline Line.

I’m not a huge fan of multiple measures of market breadth, but I do watch the advance/decline line, as it gives insight into buyer enthusiasm (i.e. the level of momentum). And, it has been an accurate leading indicator in these types of markets (the A/D Line topped out in April 2015, a month before the market topped in May).

Right now, the A/D line just hit a new high. But, once again, we’re looking for any signs of a trend break as a sign that momentum is waning.

Bottom Line

You’ll never hear me say that fundamentals don’t matter, because they do over the medium/longer term, and that’s what most of us are focused on. Yet we’re also judged in the short term by our clients and our competition, so getting both right is important.

Momentum in stocks remains higher still, but getting the break right, before our competition, will be the key to outperforming. With stocks this extended, a sharp, nasty and painful pullback is lurking somewhere out there. We’re focused on making sure you avoid it, and we’ll update you when any of these momentum indicators begin to break down.

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Weekly Market Cheat Sheet, June 5, 2017

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Last Week in Review:

Until Friday’s jobs report, the economic data last week was mildly encouraging, as multiple economic reports showed a mild bounce in activity during May. Unfortunately, that momentum was lost thanks to Friday’s jobs report, which missed estimates on virtually every level.

As we start a new week, the outlook on the economy remains as it’s been for two months. The absolute levels of activity are generally “ok,” but there is a decided lack of positive momentum. And though stocks continue to hit all-time highs, they are now well beyond any sort of fundamental foundation (i.e., this is not the same quality rally we saw in Q4 ’16/Q1 ’17) and that is a growing concern.

From a Fed standpoint, it’s unlikely that Friday’s jobs report will result in no hike at the June 15 meeting, although the issue is a bit more in doubt. Nonetheless, the expectation is still for a 25-basis-point rate hike.

Looking more specifically at last week’s data, the jobs report was the big (negative) surprise. Every measure of the jobs report missed expectations. May job adds were 138k vs. (E) 195k, and the unemployment rate fell to 4.3% vs. (E) 4.4% (but that was because of a 0.2% drop in the labor participation rate). Average hourly wages rose 2.5% vs. (E) 2.6% yoy, and the revisions were negative at -66k.

So, like most recent data, while the absolute level of employment remains “ok” (138k isn’t a bad number) the momentum and direction remain a concern… especially with markets so stretched on a valuation basis.

Looking outside of the jobs report, as mentioned, last week’s data was mildly encouraging. May ISM Manufacturing PMI (54.9 vs. (E) 54.6), May Auto Sales (16.7M vs. (E) 16.9M), and March Core PCE Price Index (0.2% vs. (E) 0.1%) all basically met or slightly beat expectations, implying
initially that there was some bounce back in both inflation and economic growth (which is critical to a continued reflation rally).

Unfortunately, that data was undermined by the jobs report, and as we start June legitimate doubts still linger about whether the economy is starting to lose momentum. Those doubts are not big enough to hit stocks yet, but I’ll remind everyone that stocks had a delayed reaction to the uptick in economic growth during the late summer/early fall of 2016.

This Week’s Preview:

As is typically the case for the week following PMIs and the jobs report, the economic calendar will be mostly quiet except for a few releases this week.

First, today’s global composite PMIs are already out, and the big number of the week domestically will come at 10:00 a.m. via the ISM Non-Manufacturing PMI. Again, given the sour taste the jobs report left at the end of last week (at least from an economic standpoint), a “beat”
here will be welcomed.

Outside of that ISM Non-Manufacturing PMI, the next most important event will be Thursday’s ECB meeting, where the central bank is widely expected to give a mildly hawkish signal by saying that risks to growth and inflation appear “balanced.” In Fed speak, that statement means a rate hike is coming, but in ECB speak it just means that the ECB is beginning to prep the market for tapering of QE, which should begin in early 2018.

Normally, the ECB meeting wouldn’t move US markets, but if the ECB surprises hawkishly or dovishly it will impact Treasury yields, which will improve or make worse the gap between yields and stocks.

Finally, the latest Chinese data comes Thursday night via CPI and PPI. China remains out on the relative macroeconomic back burner, but trends there aren’t encouraging. The May Caixin Manufacturing PMI dropped below 50 for the first time in months, joining a nowgrowing
list of other disappointing economic data.

Meanwhile, the Chinese yuan is starting to experience volatility again, as it has surged in the last few weeks to a multimonth high vs. the dollar (adding a bigger headwind to the Chinese economy). To be clear, China is not a macro risk that warrants caution, yet. However, the trend isn’t going in the right direction, and we will continue to watch that region for you.

 

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