The unemployment rate ticked down to 4.2%, as expected, from 4.3% in July.
Nonfarm payrolls rose by 142K in August, accelerating from the 89K added in July (which was revised down from +114K), but still lagging the +160K consensus,
“August #jobsreport is a touch better than July but not by much: the job market is clearly cooling,” said Daniel Zhao lead economist at jobs site Glassdoor in a post on X.
Wages gained more ground than expected in the month, with average hourly earnings climbing 0.4% vs. 0.3% consensus and 0.2% prior On a Y/Y basis, average hourly earnings rose 3.8% vs. 3.7% consensus and 3.6% prior.
“Wage growth moved up a bit to 3.8% from 3.6%, but not enough to get in the way of the Fed’s pre-announced rate cut later this month,” said Brian Coulton, Fitch Rating’s chief economist,
The labor force participation rate was unchanged at 62.7%, matching consensus.
There was a combined 86K downward revision for June and July.
With the weaker-than-expected jobs growth, traders have increased expectations for a 50 basis-point Fed rate cut on Sept. 18, bringing the probability to 47.0% from 40.0% on Thursday. The 25-bp cut probability dipped to 53.0% from 60.0% a day earlier, according to the CME FedWatch tool.
Broader markets are drifting, there’s really nothing in this payroll report that suggests the September swoon is over, I would stay on the sidelines and let the markets correct a little more.
A rate cut could be on the table as soon as September, if inflation continues to progress toward the Federal Reserve’s 2% goal, Federal Reserve Chair Jerome Powell said at his post-monetary policy decision press conference.
In the labor market, supply and demand have come into better balance and have returned to about where they were before the pandemic — “strong, but not overheated,” he said.
Earlier today, the central bank’s Federal Open Market Committee kept its benchmark rate at 5.25%-5.50%, a level that it has stayed at since July of last year.
The second quarter’s data has strengthened confidence that inflation is heading sustainably toward the Fed’s 2% goal, he added. It’s waiting for additional data to further strengthen that confidence before the FOMC reduces the federal funds rate target range.
“We have made no decisions about future meetings, and that includes the September meeting,” he said.
S&P 500 5,022 down 243 points, 4.6% from its all-time high of 5,265.
10-Year US Treasury 4.6%, possibly breaching its Oct 2023 high of 4.98%
There has been a lot of consternation regarding the market in the last two weeks, with the index dropping almost 5% and the 10-year jumping from 4.25 to a high of 4.67% because of the fear of higher for longer interest rates due to stubborn inflation and the reluctance of the Fed to cut rates till they put the inflation genie back in the bottle for good.
Let’s look at it chronologically from Oct 2023.
In late October 2023, when the 10-year was close to breaching 5% Janet Yellen signaled lower interest rates by borrowing $76Bn less than anticipated for the last quarter of 2023. A nod to the nasty run-up in rates, which if unfettered could have been harmful to the economy. The Feds had stopped raising interest rates after the last quarter-point raise in July, and by October, the consensus viewpoint was developing that the markets had done the Fed’s work with the 10-year treasury circling 5%.
Around the same time, multiple Fed officials had said rising Treasury yields are indicative that financial conditions are tightening, possibly making additional rate hikes unnecessary, when the 10-year Treasury yield topped 4.9% on Wednesday, a first since 2007. During this run-up in interest rates, the S&P 500 had dropped to 4,120 from its July high of 4,560.
Once the 10-year treasury topped out, and Q3 2023 earnings season also exceeded expectations it set up the S&P 500 for a furious run up from the October low of 4,120 to about 4,800 by Dec 2023. A massive gain of almost 700 points or about 17%! helped by the Dec dot plot indicating possibly 3 cuts in 2024
We had another positive run in Q1, to the all-time high of 5,265 – both on AI-related earnings and expectations of the 3 cuts materializing in 2024.
My takeaways
A drop of 4.6% compared to the rise from 4,120 in October to 5,265 (28%) is an overdue correction, not a reason to panic.
The earnings yield of the S&P 500 = $245/5,022 = 4.9%, which is just above the 10-year treasury yield of 4.6% – we’re getting just 0.3% higher for a riskier investment compared to a risk-free investment of a government security. That’s a very small risk premium, I would think the S&P 500 is likely to fall further to see some semblance of the historic and mean premium of at least 1 to 1.5%.
The same argument that the Fed used in October is likely to happen as the treasury inches towards 5% –
a) the market itself has made financial conditions worse, (done the Fed’s work – a 0.6% rise in the treasury is more than 2 quarter-point hikes!)
b) Buying a risk-free (US Government) long-duration bond paying 5% is a damn good yield and when funds start buying bonds, the yields fall. There will be buyers from all over the world for that kind of yield. Especially in the event of further turmoil in the Middle East – that’s the flight to quality and safety. I don’t see yields topping 5% – I would be shocked if it did.
The Vix (Volatility Index) or the fear gauge as it is known has shot up to 18-19, after being dormant to steady in the 12 to 14 range through Q1-2024. Computerized trading desks or CTA’s, trade based on volatility which will cause sudden drops and a lot of choppiness, which scares investors. Zero-day options are not helping either. For example, if I see a 1% down day, my first reaction is to lower my buying limits.
Earnings season should be good, but misses are likely to be hammered disproportionately given the weakness in the market. Semiconductor monopoly ASML, which missed bookings but assured the same full-year guidance and a great 2025, dropped 8% today.
The graph below is a good contrarian indicator and makes me shake my head at supposedly professional investors. Fund managers have record low cash levels – they’re overextended at only 4.2% cash. When they need the money to pick up bargains, they don’t have it! Some professionals! This won’t help the market recover easily.
This is another good chart.
If Q1 has risen more than 10%, on every occasion except 1987 (the year of the Black Monday crash) it has closed the year higher. That doesn’t preclude drawdowns and the average pullback in the years was 11%, with a low of 3%.
I feel the best way to play this uncertainty is patience and lower limits – the first quarter was exceptional and unlikely to be replicated.
THE LONG-TERM STORY FOR QUALITY STOCKS IS VERY MUCH INTACT, but we would be better off getting good prices. The first to recover will be the high-level quality stocks – see how steady Microsoft is compared to the rest.
In the last 15 days, my buy trades and recommendations have been limited as you may have noticed and strictly averaging lower with lower limits. I intend to keep it that way.
The 2% Fed target is a myth and highly unlikely to be achieved. Historical CPI has been closer to 3%, and given the move away from globalization, and China decoupling in the past 3-4 years, that era of persistent disinflation is likely to be over. You saw Japan’s move.
That said – At least, I believe that beyond a certain point Fed induced higher interest rates will not name inflation, a lot of US inflation is fiscal, not monetary, the Feds know that and will cut for sure as insurance – nobody wants to derail the economy. I still think the three cuts of 25% each in 2024 are achievable. But to your point, yes, I don’t think we’ll go below a 3.5% treasury for a long, long time. I agree with energy stocks doing better in 2024, they will take up more space in the index.
The 10 year treasury dropped from a high of 4.195 on 1/25 to 3.942 today, 01/31 – the day the Feds and Chair Powell was clearly signaling no chances of a rate cut at the March Fed meeting.
Intuitively the yields should have gone up – is there something else at play.
I believe Yellen’s dovish nod on 1/29 was the main catalyst for the drop in rates and clearly that seems to be overriding Chair Powell’s comments after the FOMC meeting.
Simply, if the government decides it needs to borrow more, it doesn’t get to borrow at cheap rates; the private sector will naturally charge more, which means interest rates go up. Now if Powell’s boss signals that borrowing will be a) less than anticipated this quarter b) borrowing intervals and amounts will be regularly spaced out, it’s a clear dovish signal that the government doesn’t want interest rates going up in an election year.
From 2017 to 2021, Upstart grew at a frenetic pace of 70%, before higher interest rates, funding constraints and higher defaults led to a massive decline in revenue.
Upstart was supposed to be an agnostic “Fintech” marketplace without credit exposure, but they made the mistake of taking auto loans on their books, which completely negated the buying/bullish case.
Upstart has boosted its capital but even at its latest earnings call, management stated Upstart’s ability to approve borrowers is constrained due to a macroeconomic environment of low consumer savings and high credit default rates.
Right now revenue growth forecasts are low and there are no clear indications of a turnaround – sure lower interest rates and better participation from banks and other financial institutions could be tailwinds in the second half.
Interestingly, while researching this one, I looked at Sofi Technologies (SOFI) and Pagaya (PGY), which are in much better shape, much more resilient and could be winners. Pagaya has executed well in the high interest rate downturn. Both are on the riskier side, and I will update later today.
Inflation has eased from its highs without a significant increase in unemployment— “that is very good news,” Federal Reserve Chair Jerome Powell said Wednesday after the central bank kept its policy rate unchanged for the fourth straight meeting. But he followed that up with inflation still remains above the Fed’s 2% goal. “We need more evidence to confirm what we think we’re seeing,” Powell said.
It will likely be appropriate to dial back the Fed’s policy rate at some point this year, he said.
Powell repeats that the Fed will move “carefully” in considering when to cut rates. He doesn’t think that the FOMC is likely to cut at the March meeting.
While he sees some risk that inflation reaccelerates, “the greater risk is that inflation will stabilize at a rate over 2%.”
He declined to say the economy has achieved a soft landing. “We’re not declaring victory at this point. We have a ways to go.”
“There was no proposal to cut rates,” Powell said. Some members did discuss their rate path. Also, he said there was a broad range of views.
“If we saw an unexpected weakening in the labor market, that would weigh on cutting sooner.”
