Weekly Thoughts: 4/8/2024

Markets suffered a rare down week as the S&P 500 fell 0.95%, despite a solid 1.11% pop on Friday after a strong jobs report. At the lows of the week, the market experienced its first 2%+ decline since October. Nonetheless, the real story was the bond market. After writing last week how bond volatility had plummeted near its lowest level in two years, your author jinxed himself as treasuries sold off hard on Monday and ended the week with the 10-year yielding 4.40%, up from 4.20% at Q1 end.

The move in rates had a significant impact on other asset classes. Small Cap stocks fell more than the S&P, -2.87%. A part of the bullish case on small caps was the belief the Fed would aggressively cut and coupled with a valuation discount greater than historic gap to large equities. Small Caps lagged in the Q1 as investors came to grips short rates would be higher for longer and when they do start to fall, the magnitude would be modest. The dollar index has not retrenched YTD [+2.92%] as predicted, as stronger rates have supported the currency.

Interestingly, the narrative is that higher rates are a negative for Gold and the precious metal’s bullish move this year has been predicated on the perception lower rates. However, narratives about correlations are often wrong. The 5-day return for the flagship gold ETF, GLD, was up a stellar 4.58%, bringing the YTD rise to 12.54% Commodities are starting to come to life, after a small gain in Q1, the Barclays Commodity index rose 3.47% for the week. Energy led the way as WTI Crude for May delivery climbed as high as $87.63. Geopolitical tensions deteriorating in the Middle East was a driver last week. The Israel-Hamas War has the Biden Administration tied up between US support for Israel as a long-standing ally but negative press on civilian casualties and severe push back from his party’s left flank makes policy navigation a challenge, especially when mixing in election year strategy. Iran sabre rattling after an Israeli strike on Iran’s consulate in Syria killed two Iranian generals & five officers raised concerns. It is well known that Iran funds and supports both Hamas and Hezbollah in Lebanon but worries about more direct Iranian involvement in the conflict are growing.

The geopolitics of the region will be an overhang for quite some time. Russian ships moving to the Red Sea, Houthis attacks on western shipping interests and all the countries listed above mean the roster of participants is growing, increasing the odds for the conflict to spread. Investors must keep a level head as we believe a significant negative market reaction would need a catalyst such as western countries getting drawn in militarily. Keep in mind that the S&P is up well over 20% since the October 7th terrorist attack.

While the rate moves began immediately last week, the main event was the Friday jobs report. In what is a monthly miss, consensus estimates fell short again as non-farm payrolls rose +303,000 versus an expected +214,000. Additionally, Jan and Feb were revised higher by a total of 22,000. The unemployment rate ticked down to 3.8% from February’s 3.9%. Great focus was on average hourly earnings which were in line with expectations, +0.3% and +4.1% versus a year ago. The strength in labor, while great for workers, is bad news for investors hoping for aggressive rate cuts. The labor force grew by 469,000 in March, raising the participation rate back up to 62.7%. Average weekly hours increased to 34.4 from 34.3 and total hours worked rose 0.5% for the month. Adding it all up, a robust labor market remains in force.

Per usual with economic data, it is essential to comb through to read possible trends. The core measure of employment [excluding government + leisure & hospitality + education and health services which all possess less economic cycle sensitivity] rose a more modest 95,000 in March as was up only 61,000 per month for the past year.

The separate household survey shows full-time employment down in the past year according to First Trust’s Brian Wesbury which usually only happens around recessions. Yes, this cycle has some strange responses to economic stimuli and despite the mentioned negative signals, now, the labor market at the top line remains strong and we are expecting high 2’s GDP for Q1.

The conclusion is higher for longer is the expectation after three and a half months of stubborn inflation and strong labor markets. It is hard to see the Fed being aggressively dovish when the strength of the economy is allowing them to move slowly. Multiple Fed speakers last week were uniform in making clear patience is warranted. Of course, those that still believe recession later this year is possible, while a dwindling number note that higher for longer could hurt the economy more as the lag effects of rates kick in.? We expect this debate to be with investors for most of the year. The coming week’s release of March CPI & PPI will go a long way towards directing near term market sentiment.