APOLOGIES. I HAVE BEEN IN TRANSIT CROSS COUNTRY LAST TWO DAYS, HENCE NO VIDEOS AND FEWER UPDATES.
PLEASE READ THIS PRE-WEEKEND ANALYSIS CAREFULLY… VIDEO ON SUNDAY
A tumultuous week like this is rare (understatement). A week where equities gain strongly during and post-FOMC (Fed) meeting, and then suddenly tank over next 2 days and a jobs report that changes market narrative to “recession now base case, Fed needs to cut now!” And this has bludgeoned risk assets, from equities, to rates, to currencies.
- Top of mind is whether this week’s reversal signals a change:
– in the economic outlook (“recession is here”), or
– a change in equities (the “top is in”) or
– a change in the risk regime (“bad news is now bad”) or risk premia - Our thoughts on all of these are still formulating and we will have more analyses by Sunday. But to close out the week, our thinking is unchanged, even as the market took many gut punches:
– base case remains a “soft landing”
– inflation is falling like a rock
– lots of pent-up demand due to low debt/service ratio (consumers)
– lots of pent-up corporate demand due to cautious outlooks (low capex), lack of M&A, and little distressed debt
– Fed has lots of room to cut
– Fed cuts make a difference because of recession conditions in durables, auto sales and housing sales - You might wonder — didn’t this “jobs report miss” change the outlook? Especially considering July ISM manufacturing tanked to 43.4 this week (it was 45 a year ago, so about same).
– the answer is “no” because the “massive” miss could be due to Texas
– there are 3 reasons we believe this is the case - First, one of our macro clients mentioned their fund was positioned for a “material jobs miss” (July) due to Hurricane Beryl. They saw poor seasonal adjustment in the claims data, so this gave them conviction would be not properly adjusted in the July jobs report.
- The BLS in the report specifically stated that Beryl had no discernible impact on the data and the response rates were within the normal ranges. This sort of defies logic:
– more than 1.3 million homes impacted by power outages last a week or more
– this was early July and even two weeks later, many businesses without power - Second, the state of Texas weekly claims which nearly doubled in July versus June. Granted, these are not “seasonally adjusted” but one can see the surge in July vs the past 12 months.
– TX weekly claims nearly double in July
– Ex-TX, US weekly claims are flat/down in July vs June
– the outlier of TX in July is very visible - Third, there was a massive surge in “have a job, but not working due to bad weather” based on data from the BLS Current Population Survey. Take a look at 2 numbers:
– Usually full-time but part-time due to weather:
– July 1.079 million
– July range 2014 to 2023: 73k to 229k
– Has a job, but not at work due to bad weather:
– July 436,000
– July range 2014 to 2023: 10k to 60k - Both figures are massive outliers for July 2024 compared to the last 10 years. How would this not impact the employment report? To me, it shows there was a major distortion due to weather. By the way, hot weather similarly impacts jobs for those working outdoors and TX is prone to these weather impacts. The full tables are below.
- So, taking all 3 above points into account, this makes me wonder if July employment was really bad. Or was this poor adjustments due to the Hurricane? The fact is 1.3 million homes and businesses without power for two weeks will also hurt the economy marginally and likely impact even the ISM manufacturing.
- The August jobs report should be the “counter” to this and show a major upside surprise. That is, those not working in July will be back to work. Thus, August jobs report will be a deciding factor here.
- Let’s say the counter point is: Doesn’t matter, the economy seems to be slowing. My counter is that it seems like consensus had a bigger “rethink” especially due to jobs (and jobless claims). At a minimum, doesn’t it seem like there should be some doubt whether this was true?
HANDHOLDING 101: 7 catalysts/events why investors should not lose hope
We understand why the dramatic declines this week would cause many to become cautious and even outright bearish (when facts change, so can minds. But when price changes, many minds change).
There has been technical damage to equities. I spent a lot of time with Mark Newton, our head of Technical Strategy, and he is currently inclined to view this current sell-off not as the start of a larger breakdown:
- Per Mark: “I’m reluctant to give much credence to the idea that a larger market peak is upon us. While the “Tech Wreck” has proven violent, most of other parts of the broader market remain in good shape.”
- Per Mark: “Key issues seem to be the severity of the USDJPY and 2-Year yield declines, while the US Dollar began a meaningful decline given Friday’s weakness. Economic data seems to have precipitated this recent severe drop in US Dollar and Treasury yields… Small-caps underperformed sharply this past week, but I feel that Small-caps should remain an area of focus between now and mid-September.
- Per Mark: “Interestingly enough, three separate sectors rose to new all-time highs in the last week: Industrials and Financials on an Equal-weighted basis, while Healthcare’s XLV just made its own all-time high.”
We see several upcoming catalysts and events. I will not discuss all of these in detail, but want to list them:
- 8/5 Monday: July ISM services report and could provide balance to ISM manufacturing form this week.
- 8/5 to 8/10: Next week is multiple Fed speak including Chicago Austin Goolsbee on CNBC 8/5 8:30am ET. Fed speak likely shows Fed now committed to rate cuts and do not see them as arriving too late
- 8/22-8/24: Fed Jackson Hole Economic Symposium and Fed Chair Powell can “soothsay” markets concerned about a policy error.
- NOW: 2Y and 10Y fell dramatically this week. This will lead to lower mortgage and business lending rates.
– last time rates fell this sharply was Oct 2023 to Dec 2023
– 30Y mortgage fell from 7.8% to 6.6%
– Oct to Dec 2023 was positive for equities.
– 30Y mortgage now 6.7% and could drop 50bp to 100bp
– depending on if markets “believe” Fed committed to Sept
– spread of mortgages to 10Y could narrow to historical 175bp from 275bp now - NOW: The market’s tantrum to data and FOMC is a wake up call to Fed to get off “data dependence” and even former Fed officials are calling on the Fed to get off data dependence and look forward. Even this was broached by Claudia Sahm today on CNBC.
- NOW: VIX surged +65% in 3D to >25.
– 9 times since 1990
– 4 times S&P 500 bottomed within 4 days, higher 3M 100% time
– 5 times S&P 500 bottomed 28 to 66 days later, higher 3M later 75% time
– the difference? whether larger crisis underway
– but 3M returns positive anyways ~7% - NOW: Sell-offs like this often reverse higher
– Small-caps IWM 0.34% rose 12% (30D) then fell -7%
– since 1979, only 9 times
– 8 similar instances during “bull markets”
– 1 instance was March 2000, start of “bear”
– 1M, 3M, 6M returns 6%, 13%, 24%, respectively
On that last point, notice something. A 12% gain followed by a strong sell-off is bull market behavior. They say bull markets “take the escalator up and elevator down.” And to us, this is the case with the Russell 2000.
That’s it for now, we will have further analysis Sunday evening.
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42 SMID Granny Shot Ideas: We performed our quarterly rebalance on 7/16. Full stock list here -> Click here
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