Earnings reports weren’t as impressive yesterday as they were the day before, which weighed on major market averages. We also got the daily dose of jaws from Fed Chair Loretta Mester, who reminded investors that interest rates will remain increase until inflation is brought under control. More importantly, there were justified concerns about the strength of this morning’s jobs report.
The consensus expects 258,000 job creations for the month of July, which would represent a net slowdown compared to the average this year, but not to the point of arousing fears of recession. We’ve seen weekly jobless claims rise, which shouldn’t be alarming either, given targeted layoff announcements in industries that are well-sized for the post-pandemic economy. A much stronger number will likely send stock prices south on fears of more aggressive Fed tightening, while a much weaker number will stoke recession fears. We really need the number close to the estimate to support the current rally. As with everything in the economy and the market, it can neither be too hot nor too cold.
I referred to the economy walking a fine line between growth and contraction, because we want just enough growth to avoid recession, but not enough to fuel inflation. Markets are walking the same tightrope but sending mixed messages. The rebound in equities points to growth ahead, while the bond market warns of the possibility of a recession with the growing inversion of the yield curve.
The difference between 2- and 10-year Treasury yields is now at a cycle high of 36 basis points. The 2-year yield represents the market’s expectations of where the fed funds rate will go in 6-12 months, while the 10-year yield represents the market’s view of the neutral rate, which is neither stimulative nor restrictive . Therefore, a reversal implies that the market thinks the Fed will be too restrictive and cause a recession. At least that’s how recession hawks see it.
In this case, I listen to the stock market instead of the bond market. Bonds are generally smarter than stocks, but the high-yield bond market doesn’t confirm what an inverted yield curve suggests. Instead, it points to a strengthening economy as spreads over Treasury yields in this market have tightened. I think the 10-year yield has fallen due to foreign demand for a very attractive yield. Another influence on lower yields was the strength of the dollar. This decline in yield should reverse if the dollar weakens and foreign central banks continue to raise interest rates, as expected, creating increased competition for longer-term Treasuries.
Today’s jobs report will be key in the near term, either providing the stock market with a reason to push higher or stopping the advance in its tracks to find support above the June lows. Regardless, investors will continue to judge incoming economic data as too hot, too cold, or fair. I still think the data balance will pave the way for a soft landing, whereby the S&P 500 recoups most of this year’s losses. This presents a significant advantage over current levels.
Many services offer investment ideas, but few offer a complete top-down investment strategy that helps you tactically shift your asset allocation between attack and defense. that is how The Portfolio Architect complements other services that focus on bottom-up analysis of REITs, CEFs, ETFs, dividend-paying stocks and other securities.