Stocks and Bonds Celebrate Weaker Economy

Investors and consumers love a growing economy. It means better corporate earnings, rising wages and an appreciating stock market. The stimulus on steroids response to Covid by Governments and Central Banks revealed that too much of a good thing can become undesirable. With Fiscal and Monetary leaders vastly overestimating the pain of Covid mandates, they consequently underestimated the inflationary result that has brought us to a place where esteemed analysts and economists have never been more confused. Jay Powell has been resolute that his Fed will keep draining bank reserves and raising borrowing costs until it’s clear that their 2% core inflation rate is confidently within reach. Understandably, stock and bond investors were crushed in 2022 as the Fed embarked on the fastest rate hiking cycle in modern history that has dared home buyers with 7+% mortgage rates along with bank lending restrictions that historically coincide with a serious recession. Leading indicators and factory surveys all indicate that we should already be near the “end” of a deep GDP recession with high unemployment. Yet, the economy continues moving along at full employment, with resilient consumer spending and healthy business profits. Today’s sharp decline in the Job Openings report clearly indicates a weaker labor market and economy, to which investors cheered with sharply higher stock and bond prices. Another few months of declines  in unfilled jobs at the current pace and the over-heated labor market will reach a cool equilibrium. Anything below 7 million job openings will increase the risk of rising unemployment for the first time since Covid began.

Weaker labor conditions mean slowing consumer demand and reduced inflationary pressures. Stock indices rallied back above their 50 day moving averages today on the slower jobs report.

Bond investors cheered as well by assuming the jobs report was one big step closer to persuading the Fed to stop raising interest rates. The 10 Year treasury yield has fallen from 4.3% to 4.1% this past week. Below 4% will fire up the stock market Bulls who will assume the Fed will stop rate hikes and allow the economy to accelerate.

Expectations are more important than actual data. This latest labor forecast vastly underestimated the weaker job openings report. This provided an extra boost for stocks and bonds.

This year began with stock market uncertainty exacerbated by an isolated banking panic. Once the Fed ring fenced the potential contagion and Nvidia shocked the markets with a wave of investments surrounding Artificial Intelligence, investors flooded large cap tech and shifted money managers to an extreme overbought long side equity exposure by July. In our July 18th newsletter we targeted a Summer peak for stocks on July 28th. In early August our Seasonal forecast report indicated the first leg correction should bottom around August 25th or September 5th. Thus far July 28th was the peak and August 25th has been the correction low. With the weaker inflation data this week triggering a good bounce off the August 25th lows, we suspect any pullbacks will be short and shallow until the 2nd half of September. After the current market rebound falters (near mid September?), a final wave of seasonal downside pressure is scheduled to bottom in the September 24th to October 10th time frame. However, any retest of the August lows would likely signal a technical breakdown into the expected 2nd leg lower for this correction. The set up for new highs in stock indices before year end will depend upon further progress in gradually weakening the jobs market and lowering inflation to trigger the Fed to end their inflation battle.  When the inflation battle is perceived as over, investors will start worrying about a real recession. For now, it’s still a Bull market. The economy is slowing, but consumer spending along with better than consensus earnings reports continue to support stable market conditions this  year with no signs of an impending recession.

 

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