Fasten Those Seat Belts 4/27/18

It is supposed to be a big week for tech – looks to be a big week for international relations as well. It will be interesting to see how all this shapes up. And oh yea, we have an ECB meeting in the middle of it all.

Well it does seem like the 10 year yield is beginning to get a bit nervous. This time around it seems as though the inflation mongers are really banging their drums. As the crude oil price has been beginning to climb so has the 10 year yield. This time around it isn’t that panic spike higher in rates we saw at the end of January. This time around it has been a slow march higher and with the aid of some higher metals prices the inflation fears are there. Some of the economic news has also been a bit better than expected and with the earnings this week we should get a big picture idea of how corporate America is doing. I still say that things ‘feel’ like they are getting better but I want more proof. I am not trying to be a Debbie Downer here but I still have some outstanding questions that need to be answered. The first issue being that the employment rate is at 4.1% and projected to go even lower. Remember when the pundits all said that 5.0% was full employment? I sure do. The labor market is supposedly tight but how come wages are only rising slightly? These are the tough questions that no one wants to answer because you know why? The simple truth is that they can’t. Period. We can make up excuses, and most usually do, about part time jobs and low paying jobs but at the end of the day we just aren’t really producing anything. Just take a look at GDP. If things were so great, how come we can’t get to that elusive 3.0% level? Yes, tax cuts will help and a huge budget spend will too but to what extent? There still seems to be something wrong. We have changed the psyche but the car engine is still the same. We can’t celebrate a low unemployment rate if the economy is stagnating. We have had tremendous gains in the stock market and corporate America ‘seems’ to be doing well but what are we making? What are we producing? One of the key factors in our dilemma is the Labor Force Participation Rate. It has not really moved since Trump took office. IT has hovered around 63% for the last 3 years and really hasn’t gotten back to the pre crash levels of just over 66%. That is a stickler. We just can’t seem to budge that number. The quicker we get that number up the better our GDP numbers will be. I think this is one of the single most important numbers now but it hardly gets any airtime.

I think you can see where I am going with all of this. After the fanfare and the feel-good factor have settled down, there is still some real work that needs to be done. We have seen a decent return on assets in the equity market – but that is what equity markets are there to do – forecast the conditions six months out. What we need now is to have GDP and the Labor Force Participation Rate to kick in and come support the equity move. So far, year to date, the Dow and the S&P are both lower on the year. They are not lower by much, but it must be a shock to the ‘buy the dip’ crowd. And if you ask me, a year spent going sideways might be one of the most painless and healthiest corrections the market could have. Just like in the past we have said that there were a lot of traders that had never seen a rate rise before, there are a lot of investors that think that equities only go up. It’s a Rodney Dangerfield market that only needs just a little respect.

To that point, over time and maybe it happens this year, we may see a decent rotation out of equities or at least the dividend yielding stocks to other safer instruments that are backed by the government and compete on a yield basis. If you are an older investor this has got to be part of your game plan this year. Especially after the outsized gains we have seen over the last few years.

As far as threats to the market, nothing has changed. We still see the geopolitical landscape as unchanged and dangerous. How the market navigates this is anybody’s guess but it is important to know that nothing has fundamentally changed. The movers that are garnering the headlines now are the products that are supposed to give us a view of inflation. The first being crude oil. Yes, we have some Mideast tensions. It was just over a week ago we bombed Syria. We also have OPEC to deal with as they put the clamps on production as well. And lastly, we have seen our own stockpiles dwindle all giving crude oil the chance to pierce that $70 level. I think we will go and have a little peek at it, but my long-term feeling is that there is a lot of oil around. In the short term though it will give the ‘inflation bugs’ something to talk about and a reason to sell bonds. We have seen the 10-year yield run up to that 3% level and it will interesting to see how the equity market reacts to $70 oil and a 3% 10-year yield at the same time. I think we would have to admit that with the Dow and the S&P off around 1% for the year they have held up well. Their work is cut out for them as we have added a lot of volatility to the mix, lowered their multiples and put some roadblocks in their way. It’s going to be a story that plays out all year. My only true advice would be to fasten those seatbelts.

About Scott Shellady

Mr. Shellady has a broad and strong range of technical and trade experience in both commodities and financial products in the three main geographies of North America, Europe and Asia.