Moment of Truth
This holiday shortened week was a volatility sandwich. Tuesday started with a bang as stocks sank and the VIX volatility index shot higher by more than 30%. Markets then calmed on Wednesday and Thursday before stocks sold off and volatility surged all over again on Friday. Tuesday’s sell-off was the worst since early August’s mini-meltdown, and Friday’s rout was broad based and accelerated into the close. Just as in the August sell-off, tech and the Nasdaq got hit the hardest while a plunge in Nvidia drove an outsized hit to chip makers.
Since the yen carry trade liquidations in August that briefly torched risk assets, it’s been all V-shaped recovery. As the market has been conditioned to do by Fed interventionists, dip buyers poured billions of dollars into stocks to take advantage of a rare pullback in booming stock prices. As the Wall Street Journal recently put it, “Even during the brief turmoil in early August, investors kept buying stocks. U.S. equity funds drew inflows for eight consecutive weeks through late August.” This week’s volatile sell-off is the first challenge to the market’s buy the dip obsession. Interestingly, it also comes with deteriorating market technicals in key market-leading stocks and sectors, and just as the 2s10s U.S. Treasury yield curve un-inverts.
The 2s10s curve managed its first un-inversion since it inverted on July 5th of 2022, for what ultimately amounts to a record 793 days of inversion. Now, while an inverted curve has preceded and predicted every single recession over the past 50 years, it’s the un-inversion after an inversion that really starts the clock ticking on the economic slump that follows.
Right on cue with that troubling signal from an un-inverting yield curve, evidence continues to mount that the labor market is weakening—and that weakening may be picking up steam.
According to the latest research from outplacement firm Challenger, Grey & Christmas, layoffs soared in August and hit their highest total for the month in 15 years. At the same time, Challenger also said year-to-date hiring is running at the lowest level in the 19-year history of their data.
According to Challenger, announced job cuts for August totaled 75,891, lurching 193% higher than July. On the hiring front, companies said they were adding just 6,101 new workers, up by nearly 2,500 since July, but down more than 21% from August 2023.
As Andrew Challenger, the firm’s senior vice president explained, “August’s surge in job cuts reflects growing economic uncertainty and shifting market dynamics… Companies are facing a variety of pressures, from rising operational costs to concerns about a potential economic slowdown, leading them to make tough decisions about workforce management.” In other words, in a stagflation-like dynamic of rising costs on flat or falling sales, after first responding by significantly slowing the pace of hiring, we may now be starting to see the outright firings.
Meanwhile this week, the JOLTS report tracking the number of U.S. job openings sang a similar tune. JOLTS missed all 29 estimates in Bloomberg’s survey. From June’s downwardly revised 7.910 million (previously reported 8.184 million), July nonfarm job openings dropped to 7.673 million. In so doing, they fell below 2019 pre-Covid levels for the first time post-Covid.
Then on Wednesday, payroll processing firm ADP reported that private companies added just 99,000 workers in August. The report badly missed estimates for a 145,000 increase in workers, and amounts to the smallest monthly gain in private payrolls since January of 2021. In keeping with the recent trend, the July increase of 122,000 was also revised lower to 111,000.
Then on Friday, non-farm payrolls came in weak as well. Employers in August added 142,000 net new positions, short of the consensus 165,000 expected by economists. Furthermore—you guessed it—job gains reported in June and July were also revised significantly lower (July numbers were revised from 114,000 to 89,000). Hiring on a trailing three-month basis is now averaging 116,000 per month. That’s the weakest pace since the middle of 2020 during the depths of the pandemic.
All told, given this week’s data along with the 30.1% negative revision to payroll data several weeks ago (for the trailing 12-month period through March), the “strong labor market” narrative and suggestions of a “booming” economy are now rapidly collapsing.
It’s not just the labor market showing a clear trend towards weakening, however. Recall that the U.S. economy is 70% consumer spending driven. Through the start of the third quarter, the spread of real personal income less transfers over real consumer spending has slumped to 5% of the record $1.447 trillion reached amid Covid lockdowns and stimulus in the second-quarter of 2020. Now at just $71.4 billion, the rapid decline from the second quarter’s $130.2 billion and the first quarter’s $206.7 billion is noteworthy. It’s particularly noteworthy now that the primary source of personal income (the labor market) looks to be rolling over as well. To put the current $71.4 billion in perspective, it’s the lowest spread since the $105.3 billion seen in 2009’s second quarter—just after the consumer had been battered by the Great Recession.
Now, just as stock market risks appear to be growing meaningfully, this week, the Wall Street Journal reported that U.S. households’ allocations to stocks as a percentage of total financial assets has just reached a new all-time high. In 1968 the ratio peaked at 30%. In the 2000 dot.com bubble, the ratio set a new record at 38.4%. Now, as of Q2 2024, we have a fresh all-time high of 42.2%. In short, if the labor market rolls over further and the ratio of income to spending continues it’s nosedive, then it’s up to both the housing and stock markets to keep the consumer—and by extension the economy—in the game.
Unfortunately, with the National Association of Realtors Pending Homes Index and UMich’s Home Buying Conditions Index both at record lows in data back to 2000, unless Powell cuts rates aggressively we may not want to bank on the housing market to keep the consumer afloat.
Needless to say, the economic narrative of a soft or no-landing scenario is starting to face increased challenges. The Fed narrative is starting to shift as well. As Fed Governor Christopher Waller said Friday, “The current batch of data no longer requires patience, it requires action.”
This precarious economic position brings us back to Jay Powell. The Fed Chair is widely expected to begin the next rate cutting cycle later this month. The question on the collective mind of the market is, how aggressive will Powell be?
In 2003, speaking at the International Monetary Conference in Berlin, then-Fed Chair Alan Greenspan made it crystal clear that deflationary forces are the primary nemesis of the Federal Reserve. As Greenspan put it, “there is a tendency, so far as policy is concerned, to be extraordinarily cautious. We’re far more unclear on the issue of deflation [as opposed to inflation], and, as a consequence, we need a wider firebreak, in logging and forestry terms, because we know so little about it [deflation]. So, we lean over backwards to make certain that we contain deflationary forces.” Greenspan’s comments left little doubt as to the Fed’s policy predisposition. The Fed would run an inflationary policy regime to minimize the apparent real risk: a deflationary disaster.
Of course, conditions were different then. Inflation was largely kept in check by the era of globalization that followed the fall of the Soviet Union and the 2001 introduction of China into the World trade Organization. Now we have the opposite. We have a new secular trend of deglobalization in place and a new secular tailwind for inflation right along with it.
On September 18th, when Powell and the FOMC choose between a 25 basis-point Fed funds rate cut and a larger 50-point slash, we’ll get our first indication of whether Powell seems likely to cave to pressure to reiterate the Greenspan doctrine of 2003 or chart a new course more in line with the reality of increased inflationary tail winds. One thing is clear, however: an absolutely critical year for Powell, the Fed, and the policy trajectory of the Western world starts on September 18th. That’s the Western world’s moment of truth. In HAI’s view, regardless of whether Powell becomes Greenspan 2.0 or turns Man of Steel (cautious on inflation and intent on breaking the addiction to ever-easier monetary policy whatever the consequence), the precious metals sector, and eventually hard assets more broadly, stand to significantly outperform the stock market secularly in either outcome.
Weekly performance: The S&P 500 was down 4.29%. Gold was down 0.12%, silver was off 3.29%. Platinum was down 1.45%, and palladium was down 6.68%. The HUI gold miners index was off 6.30%. The IFRA iShares US Infrastructure ETF was down 3.94%. Energy commodities were volatile and mixed on the week. WTI crude oil was off 7.99%, while natural gas was up 6.96%. The CRB Commodity Index was down 3.67%. Copper was off 3.28%. The Dow Jones US Specialty Real Estate Investment Trust Index was up 0.90%. The Vanguard Utilities ETF was down 0.55%. The dollar index was down 0.47% to close the week at 101.14. The yield on the 10-yr U.S. Treasury was down 19 bps to close at 3.313%.
Have a wonderful weekend!
Best Regards,
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
