Employment Bomb

PaulNolte-2“Well, here’s another nice mess you’ve gotten me into.” Janet Yellen will be giving a speech Monday evening, ostensibly to reiterate the Fed views that a rate hike would be appropriate “probably in the coming months”. Then the employment report was released with the worst showing in five years. Since the Fed has announced they are data dependent, the latest report has, for investors, formally pushed any possible rate increase off until July. As has been the case since the December hike, each economic report, both here and internationally, takes on greater significance than normal. Looking for signs of strength to justify increases, or additional weakness that further postpones the second increase, the Fed has talked themselves into a corner. The current “increase” cycle is already unique in that this marks the longest period between two rate increases in the history of the Fed. So, instead of discussing monetary policy and the likely rate
increase, Ms.Yellen will be discussing the latest employment report and how that changes monetary policy.

As if one report, that gets revised twice more, is THE report to decide when, how and by how much rates should change in the US.

Essentially unchanged on the week, the markets achieved that in a very interesting fashion. In each of the first three
trading days of the month, the markets opened lower and finished very near the high for the day. So, buying stocks after
about 30 min of trading and selling near the end of the day netted a nice return even though stocks essentially did nothing
all week. The SP500 has been trading within a 3% range, from roughly 2040 to 2100 this entire quarter. This is nearly the
exact same pattern the markets experienced last year. From February to August, stocks were stuck within a very narrow
range before the fall swoon, recovery, New Year swoon and the current recover. Will this time be different in that instead
of falling apart, stocks rally well beyond the 2100 level and establish a new bullish trend? From strictly a fundamental
perspective, earnings would need to begin showing signs of life as well as much better economic data. For now, both
seem to be rather mushy at best. The best and most well defined trend has been sideways – a little up, a little down with a
few scary parts tossed in, but essentially little headway in two years. The same has been true of the economic data, just
when you think things are getting better the next report contradicts it and we are all back into the nice mess.

The bond market seems to have things figured out, as interest rates continue to plod ever lower, expecting the Fed to
have to wait to raise rates until well past the summer. The bond model is still pointing to lower rates ahead, even as
commodity prices and short-term rates have bumped up a bit. Certainly the rally in energy and along with higher prices at
the pump has boosted inflation rates a bit, but still well below the Fed’s target of 2%. Bond investors have feared a rate
increase cycle similar to those of past cycles: a steadily higher fed funds rates being boosted regularly by the Fed. We are
in very different times, global rates are below zero in many parts of the world, deflationary pressures are at work in many
countries and although the US looks good by comparison, it does not justify regularly increases of interest rates. Will we
ever see negative rates here? Never say never as stranger things have happened just within the last eight years.

Bond and stock returns are essentially the same so far this year. We are beginning to see some improvements from long
suffering parts of the global markets. From small US to emerging markets, something other than the SP500 is winning the
performance race this year. But when we look over a longer time horizon, the current performance masks the much longer
negative trends for many of these asset classes. Emerging markets, a very inexpensive asset class, has been performing
poorly compared to the SP500 since 2011. The recent good performance barely registers on a longer term chart. Small
US stocks have not suffered as much, but are essentially at the same spot they were in 2011. They perform well for 9-12
months and then poorly for the next 9-12 months. They are valued even more richly than the large US stocks, so risks to
earnings could hurt this group much more than the SP500. Commodity prices and larger international stocks have been
suffering since the market bottom in ’09 relative to the SP500. We have been patiently waiting for something to change,
but it looks as though we will have to wait some more to see whether these recent “pops” can last beyond a quarter or

The SP500 has been playing cat and mouse with the 2100 level for the past few weeks. While we think investors will
eventually push stocks beyond 2100, valuations and economic fundamentals still warrant a cautious stance for the long term.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information
that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or
future financial market conditions.