Correlation is Key
Low correlation of prices, earnings, and inflation are evidence of tight fiscal and monetary policy, as is weak demand for labor
If You Tax Something, You Get Less of It
A week after the employment revisions shock, equities are marginally higher, the dollar is marginally lower and Treasuries are little changed despite sloppy auctions for 3s, 10s and 30s. The US, China and Taiwan released trade data, 200 days into the second Trump Administration’s efforts to reshape global supply chains global trade imbalances are not contracting, but there are signs China’s excess capacity is shifting to Europe. The impact of increased import taxes, reduced government spending and the Fed’s restrictive rate policy for floating rate borrowers (small banks and their small business customers) has led to a sharp deceleration in demand for goods, services, labor and capital. The artificial investment boom is masking the impact of the detox from the addiction to government spending on the stock market. Since the early April low the S&P 500 has gained 27%, but the gains are highly concentrated with tech up 50% and communication services gaining 33%, no other sector is meaningfully outperforming the index. Earnings season is winding down and the concentration is evident, revenues and margins for consumer discretionary and staples companies are under pressure, healthcare is struggling, the profitability dichotomy between large and small banks remains wide, and what looks like decent earnings growth is highly concentrated in the same two sectors, tech and communication services.
The response from FOMC participants to the unequivocal evidence their solid labor market narrative was incorrect was muted, but the market is priced for a virtual certainty of restarting of the policy rate normalization process in September. Despite the repricing of the Fed policy path, small bank stocks did not respond favorably, underscoring how late the Fed is to recognize the deterioration in the labor market. The Bureau of Labor Statistics is complicit; we have three areas of concern. First, as we’ve discussed at length over the last year, the birth/death model overestimation of small business employment and job openings. Second, the annual population control adjustment to the size of the labor force did not capture the largest surge in immigration in US history until this January, which appears to have reduced the unemployment rate. Third, seasonal adjustment factors for the 16-24 age group appear to have been corrupted by the closing of schools and limited seasonal employment in ‘20 and ‘21. A surge in participation last September was a major contributor to the surprisingly strong report just before the election that raised questions about the FOMC’s 50bp cut, a move we thought was appropriate.
Of course, as has been discussed widely, the BLS collection methodology is primitive. The issues with the BLS were obvious, FOMC participants who took the data at face value are also complicit. As we will discuss later, the count of FOMC participants who have spoken since last week’s report who are hanging to the labor market is solid narrative is 5 of 10.
After last Friday’s report we concluded that the deterioration in the growth outlook was likely to lead to a modest pullback in the equity market, this week’s price action was mixed, the equal weight S&P 500, financials, energy and midcaps slipped but the relentless rally in the artificial intelligence beneficiaries marched on. In this week’s note we preview next week’s inflation reports, update our Fed views and wrap up earnings season.
