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Conclusion confusion! Stocks and bonds slipped on Friday as investors became concerned that a big rate cut may not come in July, after all. A stronger than expected employment report caused investors to question the likelihood of Fed easing.
MY TWO CENTS
- The wacky, wacky world of stock investing. On Friday, the Bureau of Labor Statistics reported that 224K new jobs were created in June. The number was far better than the expected +160k and last month’s tepid +72k revised figure. The unemployment rate ticked up to 3.7% from 3.6% because more people are actively seeking work. No one could argue that the report was a healthy one. A strong economy is good for companies, which should in theory, be good for stocks, right? Nope. The market’s obsession with monetary easing is so heavily baked into the market, that good news is now bad news. The justification goes like this: higher interest rates on bonds compete with stock returns, so if rates are expected to fall at a slower pace, then stocks are less attractive. The S&P 500 trailing twelve month dividend yield is 1.88% compared to the Fed Funds rate of 2.5% and 3-month T-bill rate of 2.21%. The P/E multiple of the S&P 500 is currently 19.65, making stocks a bit on the rich side. Earnings season is starting to rev up and expectations for earnings growth are flat, so stock investors are looking for any good news to keep the market going up, and the Fed has been that good news. According to Fed Funds futures, there is a 100% chance of a 25 basis point rate cut in July. Last Wednesday, the probability for a 50 basis point cut was around 29% and on Friday that probability went to 5.4%. This morning, the probability stands at just 3.9%.
- The challenging world of bond investing. Bonds sold off a bit on Friday after the probability for a big rate cut went down in the wake of a strong jobs number. The move caused yields to go up slightly but they are still quite low with the 10-year yielding 2.03%. What is an investor supposed to do at these levels? Is it possible for bonds to continue rallying bringing rates even lower? While there doesn’t seem to be much room on the upside, if we expand our focus to the global stage we can see that Japan, Germany, France, Netherlands, and Switzerland all have negative yields on their 10-year sovereign debt. That makes 2.03% for US Government guaranteed debt look pretty good. Not enough for you? You can buy a AAA-rated corporate bond and get an extra +14 basis points for the risk. If you still want more, you can drop down to a BBB-rated bond and get almost +1.5% additional yield. If you expect a recession to come within the next 2 years, as many economists are predicting, it is probably good to stick to lower maturity treasuries and higher quality corporate bonds in the 3-5 year maturity range.
THE MARKETS
Stocks sold off on Friday after a better than expected jobs number lessened the likelihood for a 50 basis point rate cut later this month. Though they closed off of their session lows, stocks still closed in the red with the S&P 500 closing off by -0.18%, the Dow Jones Industrial Average trading down by -0.16%, the Russell 2000 advancing by +0.22%, and the NASDAQ 100 falling by -0.21%. Bonds also fell and 10-year treasury yields climbed by +8 basis points to 2.03%. The 3-month / 10-year yield curve still remains inverted at -18 basis points, despite the move in bond yields.
WHAT’S NXT
- Consumer credit is expected to have grown by +$17 billion compared to last month’s +$17.497 growth.
- The week ahead will bring Job Openings, Consumer Price Index, Producer Price Index, and the Empire Manufacturing Index. On Wednesday, the Fed will release the minutes from its June FOMC meeting which is highly anticipated. There will be lots of Fed speak this week including a 2-day stint on Capital Hill for Chairman Jerome Powell. Last Friday’s number will cause traders to heavily focus on the speeches and testimony. Corporate earnings will start to bubble in this week with the season starting in earnest next week. Please refer to the attached earnings and economic calendars for details.
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