“Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.”
Legendary global macro investor George Soros needs no introduction; nor does the aforementioned quote require any contextualization. So we will provide neither. It’s also Jobs Day so we don’t want to take up too much of your time with lengthy prose.
Back to the Global Macro Grind...
If nothing else, recent labor market strength is indicative of the #LateCycle nature of the current economic expansion insomuch as any trending deterioration from such strength would likely foreshadow the start of the next recession. Contrary to consensus across the investment community, there will be a next recession.
With respect to the “r” word, our analysis shows that a recession is not an imminent threat to the U.S. economy and the financial markets that underpin it. That said, however, the purpose of our macroeconomic analysis is to help investors “discount the obvious and bet on the unexpected”. In light of that, the following bullets contextualize the #LateCycle nature of the domestic labor market in order of leading to lagging:
- Over the previous three economic cycles, the 3MMA of the YoY % Change in Nonfarm Payrolls peaked an average of 22 months prior to the onset of recession.
- Over the previous three economic cycles, the 3MMA of Average Weekly Hours Worked peaked an average of 8 months prior to the onset of recession.
- Over the previous three economic cycles, the 3MMA of MoM Nominal Change in Initial Jobless Claims troughed an average of 7 months prior to the onset of recession.
- Over the previous three economic cycles, the 3MMA of the MoM Nominal Change in Nonfarm Payrolls peaked an average of 7 months prior to the onset of recession.
- Over the previous three economic cycles, the 3MMA of the Unemployment Rate toughed an average of 6 months prior to the onset of recession.
- Over the previous three economic cycles, the 3MMA of YoY % Change in Wage Growth peaked an average of 1 month prior to the onset of recession.
- Over the previous three economic cycles, the 3MMA of Total Employees on Nonfarm Payrolls peaked an average of 0 months prior to the onset of recession.
What this data should tell you is that if you’re anchoring on the trending deceleration in annualized employment growth, you’re likely way too early in expecting the economy to be in the latter innings of an economic expansion. Conversely, if you’re one of the many investors who are anticipating wage growth to accelerate fervently from here, you’ll likely be way too late in getting out of the way.
As such, the key indicators for investors to focus on with respect to the business cycle would be: average hours worked, initial jobless claims, sequential nonfarm payrolls growth, as well as the unemployment rate. Trends across each of these indicators prospectively signal the top in the economic cycle 2-3 quarters out, on average.
Of each of these, the indicator that is probably the most consistent is Initial Jobless Claims. Specifically, the rolling six-month average in this series has oscillated in a band of ~300k to ~600k over the previous three economic cycles. Even more consistent is its signaling capability as it relates to timing the onset of recession. Specifically, a recession has commenced 18 months, 19 months and 20 months after this indicator has breached 300k to the downside and/or toughed as it did at 305k in April of 2006.
For reference, June ’15 represented the eighth consecutive month the rolling six-month average of Initial Jobless Claims has been below the critical threshold of 300k. Additionally, the latest monthly average reading of 285k is the lowest since April of 2000 on a delta-adjusted basis (i.e. still trending down).
For the record, April of 2000 proved to be a difficult time for an equity investor to celebrate #LateCycle labor market strength as many are doing now, given that the stock market (S&P 500) was in the very early innings of a multi-year, (49.2%) correction.
Also for the record, April of 2006 proved to be a good time for an equity investor to celebrate #LateCycle labor market strength, given that the stock market (S&P 500) rallied +19.4% from 4/30/06 though its 10/9/07 all-time closing high.
All that being said, investors need to decide whether or not the current #LateCycle labor market strength is more indicative of April ’00 or April ’06 because the expected outcomes are extremely binary in financial market terms.
Going back to the aforementioned quote, if Soros’ investment framework is indeed appropriate, then investors need to “discount the obvious and bet on the unexpected” with respect to the labor, economic and financial market cycles.
This we know:
- Per a recent Bloomberg article, sell-side strategists expect the S&P 500 to shake off its worst first half since 2010 and rise +8.2% by year-end.
- The article summarizes consensus sentiment as: “The economy is too strong for the second-longest rally since 1950 to end now.”
- The FOMC – with its infamous “dot plot” projecting interest rate hikes beyond 2017 – is implicitly forecasting the 2nd longest economic expansion in U.S. history.
It’s “obvious” that consensus remains bulled up on each of the aforementioned cycles and, while we are not calling for an immediate inflection in either, we do think “bet[ting] on the unexpected” requires distancing oneself from the herd of near-universal bullishness. In financial market terms specifically, we offered our latest asset allocation thoughts in the following video: http://app.hedgeye.com/m/ZG+/aQXNs6/consumerslowing-again.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.19-2.49%
Oil (WTI) 57.80-61.20
Best of luck out there and enjoy the long weekend with your friends and family – I sure will!