Just when equity markets needed an extra boost, the US released yet another “Goldilocks” employment report. Strong jobs growth surely indicates a strong economy; great news for corporate profits that are being turbo-charged by the recent tax cuts and Dollar weakness. Wage growth remains stable, which is enough to keep everyone happy, and not too strong so that the Federal Reserve will panic in fear of being behind the curve.
It’s hard to be immediately bearish when faced with a Goldilocks employment report and also a new all-time high on the Nasdaq 100 index, as seen in chart 1 below. The Nasdaq index has led the recovery as all the other major indices remain below their late January highs. So, with a divergence between the major indices, it’s still a little too soon to sound the all clear, but as noted above, difficult to be immediately bearish.
Chart 1 – Daily Nasdaq 100 chart
Two weeks ago we said that we were looking for some short term improvement in bond markets. Since then, yields have basically tracked sideways, and after such a strong employment report, we would not be that surprised to see yields break higher again (price lower) as that appears to be the path of least resistance.
Chart 2 – Daily US 5 year yield chart
And this brings us back to something we have written about a lot. With such a heavily indebted system, higher rates will have an impact at some point. Recession may not begin this year, but 2019 could be very different, and markets will begin to adjust before economic strains are apparent. Simply put, we can easily see the scenario in which the Fed feels compelled to keep raising rates until it is too late, creating yet another policy error just as they have done during every rate rising cycle since WWII.
The Dollar is also important here. We are a little surprised that it did not perform better after the strong employment report, which may be a sign of underlying weakness (or a sign that reserve managers continue to diversify away from the Dollar). Chart 4 shows that trend from early 2017 remains down, but we are very much keeping an open mind on the Dollar. If weakness is seen, then that will likely be seen as a supportive factor for equities and a negative for bonds. However, a rally above the two trend lines drawn on the chart would indicate to us that a larger rally may be at hand, and this would be a negative to risk assets.
Chart 4 – Weekly US Dollar chart
So to wrap things up, it appears that the path of least resistance is for equities to move higher and bonds lower in the short term. That said, we are not predicting a straight line move, and it does not feel sensible to us to chase equity markets at the moment. We still think that both the economy and markets are very late cycle, and that a multi-month topping process has broadly begun.
Stewart Richardson RMG Wealth Management