The guest commentary below was written by Joseph Y. Calhoun, III of Alhambra Investments on 11/8/21. This piece does not necessarily reflect the opinions of Hedgeye.
Almost all the economic data released last week was better than expected.
ISM manufacturing PMI, Redbook retail sales, ISM non-manufacturing PMI (an all-time high), factory orders (headline and ex-transportation), ADP employment, jobless claims (new post-COVID low), non-farm payrolls, the unemployment rate, manufacturing employment, all better than expected.
There were some disappointing reports: construction spending was down 0.5%, the trade deficit was slightly more than expected, unit labor costs were hot at +8.3% and productivity was awful at -5%, the worst since 1980.
But the negatives were largely expected and the only one that was a significant disappointment relative to expectations was productivity. But given a big slowdown in output in Q3 and continued hiring, it wasn’t exactly a shocker.
As always, there are negative aspects to some of the positive reports but they were mostly offset by positive details. For instance, new orders in the ISM report were down from 66.7 to 59.8 (still high), but employment rose to 52 from 50.
And the non-manufacturing ISM showed a big jump in new orders to 69.7 from an already hot 63.5. Both those moves are consistent with the dominant narrative of a rebound in growth post-Delta.
So with the Q4 rebound on track and services picking up to offset some of the expected slowdown in goods spending and the announcement by Pfizer of an effective anti-viral for COVID, why did bonds rally? Why did interest rates fall so hard on Friday after the payroll report?
I heard numerous explanations, most of them related to the Fed’s taper announcement on Wednesday. Some said that the rally in bonds was evidence that the Fed is making a mistake and tightening into a slowdown. Others posited that the Fed’s announcement was so dovish that the market had to factor in a longer timeline for raising rates.
I see several problems with both of those arguments starting with the idea that tapering is tightening. I’ve said it before and I’ll say it again – if anything, tapering is a loosening of monetary policy.
I don’t intend to go into that here because the sides have already been chosen in this debate and it is a waste of time to rehash the arguments. Suffice it to say that, at best, QE does nothing – for the economy – so stopping it does nothing as well.
Another problem is that bonds didn’t really move on the tapering announcement. In fact, rates were higher Wednesday after the announcement; the rally in bonds mostly happened on Thursday and Friday. 10-year TIPS yields fell 16 basis points over those two days while the nominal 10-year fell 13. So whatever drove bond yields south was something that happened on Thursday or Friday. I don’t see any evidence that the rally in bonds was related to the tapering announcement.
My colleague Jeff Snider didn’t directly address Friday’s drop in rates but did offer that the household report was weaker than the establishment survey. I agree with that since it’s true, but as a driver of rates in the short term, it seems a little doubtful.
There was nothing in the Friday household survey that was different than the existing trends. Besides, only econ nerds (like Jeff and I) pay any attention to the household vs establishment survey. Most people don’t have any idea that the unemployment rate has nothing to do with the “number” everyone waits for on jobs Friday.
The number of new jobs comes from the establishment survey while the unemployment rate comes from the household report. The HH and establishment surveys tend to even out over time anyway, although differences can provide insight at turning points. This doesn’t seem like one.
The only other thing I can think of that changed over those two days was the passage of the infrastructure bill by the House. I suppose that could be seen as a negative in any number of ways but the most logical is that it makes Biden’s bigger spending bill less likely to pass.
Of course, that requires one to believe that government spending has a positive impact on economic growth, a position that places hope way above experience.
Or maybe, since they’ve been talking about reinstating the SALT deduction, a defeat of that bill is seen as killing a tax cut because that’s exactly what restoring the SALT deduction would do. Ironic isn’t it?
Tax the rich! No, not those rich! I mean those rich folks over there, the ones behind the tree, the ones not in my state. Do they really think we’re that stupid? Yes. Yes, they do.
Whatever the cause, I always take these things at face value. If bond yields are falling then nominal growth expectations are falling. And since TIPS yields fell too, real growth expectations are falling. Why? Well, my guess is that while analysts were looking for 450,000 jobs last Friday, the market had factored in a much bigger number.
This was the first clean jobs report after the extended unemployment benefits ended and I think there was an expectation that those who lost benefits would rush back into the labor force. In case you missed the headlines about the Great Resignation, that isn’t happening.
Why it isn’t happening isn’t anything we can know directly and as investors, it doesn’t matter (as citizens it is a different story altogether). The bond market told us last week that expectations of a rapid rebound from the Q3 slowdown were too aggressive and had to come down. That’s it. And don’t get too comfortable with that because, as I said last week, it can change quickly.
We still have a lot to learn about the post-COVID economy and I don’t think there is any way to know yet what the long-term growth rate will be. Kierkegaard said that “life can only be understood backwards but it must be lived forwards”.
Economics is so complex and unpredictable that economists can’t even understand the past; they’re still arguing about the Great Depression nearly 100 years later. The bond market, the wisdom of crowds, is the best we can do over the near term and it’s telling us to cool our jets.
The only group that didn’t seem to get the memo on the pace of economic growth was stock traders. All major US stock indexes made new highs last week.
The S&P 500 and NASDAQ have been up for 5 straight weeks and the Russell 2000 for 4. Sentiment is wildly bullish with call buying volume swamping put volume. Small-company stocks – generally considered riskier than large caps – broke out of a year-long consolidation to new highs. Tesla is up 50% in the last month (and a big part of the orgy of call buying) and it was outrageously expensive before that. And that is true of the market as a whole as well if not to the same degree.
Of course, that isn’t exactly news but sentiment now points to some kind of correction. I have no idea what the catalyst will be or how big it will be but it’s coming and probably soon.
More generally, I am more than a little distressed by the rampant speculation in our economy, from meme stocks to bitcoin to NFTs to anything you can lay a bet on. Movie stars and retired sports stars are pimping crypto trading and exchanges on national TV. The mayors of NYC and Miami have both pledged recently to take their salaries in bitcoin.
I don’t watch nearly as much sports as I once did, but I watched the World Series this year because I’m a lifelong Braves fan. Imagine my shock when one of the announcers casually mentioned that if one so desired, a certain website would be glad to take your bet on whether the next batter would hit a home run.
Gambling was once held in low regard for good reason. To borrow a phrase from The Animals, it has been the ruin of many a poor boy and the odds haven’t changed. We will long regret allowing gambling to become acceptable in polite company.
As for bitcoin and the crypto market, it might be instructive to remember when Giselle Bundchen thumbed her nose at dollars and demanded that she be paid only in Euros.
She nailed the bottom on the dollar almost perfectly and I wouldn’t be surprised at all if Eric Adams (NYC), Francis Suarez (Miami), David Ortiz (Big Papi and FTX promoter), and Matt Damon (Hollywood bigshot and also FTX promoter) do the same with bitcoin and other cryptos.
As I said above, I don’t know what form a correction might take. A correction to the 125-day moving average (which would be comparable to the September correction) would take about 7.5% off the index.
A drop to the 50-week moving average (another popular measure) would be about 13% below current levels. If I was concerned about a bigger economic slowdown (and I’m not yet), then a drop to the 50-month moving average would be normal and logical. That’s 45% down from here. A really bad bear market that took us down to the 200 month MA would be a 60% haircut.
But, again, I wouldn’t expect anything like that without a lot more economic stress.
10% corrections are normal stock market behavior and are always a risk and we are way, way overdue. Invest accordingly.
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Joe Calhoun is the President of Alhambra Investments, an SEC-registered Investment Advisory firm doing business since 2006. Joe developed Alhambra's unique all-weather, multiple asset class portfolios. This piece does not necessarily reflect the opinions of Hedgeye.