Patience, Curveballs, and Golden Gifts – December 8, 2023

Wealth Management • Dec 09 2023
Patience, Curveballs, and Golden Gifts – December 8, 2023
Morgan Lewis Posted on December 9, 2023

Patience, Curveballs, and Golden Gifts

Many moons ago, Ben Franklin famously said that in this world nothing is certain “except death and taxes.” Perhaps true, but speaking of the comfy confines of financial markets, HAI would add two additional truisms—patience is a virtue, and markets throw curveballs. This week, both market-centric observations are relevant.

Despite a very volatile week of headline-grabbing cross-asset price moves, nothing really changed in the big-picture structural perspective detailed in last week’s missive. In HAI’s view, the events of the week really amount to little more than a stiff and reinforcing shot of evidence that patience is in fact a virtue, and that Mr. Market does indeed have a penchant for tossing curveballs with Koufax-like bite.

Now, given that it’s the magical month of December, snow flurries are flying, and this author is clutching a piping-hot mug of delicious holiday-themed “Gingerbread Joy” tea, let’s also take a quick moment to visit the ghost of HAI past.

To review, HAI’s working thesis is that global financial markets are in the late stages of a massive confidence bubble. In HAI’s view, after decades of activist policy reinforcement, that confidence is primarily tethered to an unquestioned expectation that government policy makers will continue to conjure, by hook, crook, or alchemy, a perpetual Goldilocks environment that will facilitate an endless expansion of the economy and an everlasting increase in financial asset prices.

But, to borrow from last week’s HAI: “the closer one looks into the perpetual Goldilocks thesis, the more it crumbles. We have increasing evidence of compromised monetary policy, similar evidence of compromised Treasury functioning, and major risks to growth, government solvency, and inflation. Like the game Whac-A-Mole, policy makers can try to apply their diminishing ‘tool-kit’ to address one area of concern, but only by exacerbating other key problems. Far from a plausible outlook for perpetual Goldilocks, realistically, it appears instead that the sand in the hourglass is running out as the walls close in on a thesis that was never much more than a pipe dream.”

Again, the eventful happenings of this week did nothing to alter HAI’s thesis. Rather, they reinforced the timeless need to exercise patience and identify curveballs. Now, after a big sip of Gingerbread Joy, let’s dig in for a brief update on the key themes of the week.

A flood of employment data and a failed (for now) breakout attempt in the precious metals sector defined this first full week of December for markets and the economy.

Without question, from a data perspective, the week was all about employment. We had updates from the JOLTS survey, ADP private payrolls, Challenger job cuts, and non-farm payrolls on Friday. That said, despite abundant new data, the overall labor market picture remains very much the same as HAI has discussed previously. In short, aggregate employment remains positive, but employment growth is way past peak, is slowing into a pronounced downtrend (now substantially below the 10-year trend-rate of growth), and the leading employment indicators paint a portrait of further weakening to come.

Job openings, as reported in the Labor Department’s latest monthly JOLTS report out on Tuesday, came in significantly below expectations. Openings fell to 8.73 million from 9.35 million (a number that was also significantly revised lower from 9.55 million) openings in September. The decline of 617,000 or 6.6% after the previous month’s downward revision (the drop from the pre-revision number was even worse) marks the lowest level of job openings since March of 2021. The eliminated job openings were widespread across industries, well below the market’s 9.4 million estimate, and provided further evidence of weakening in what has been a tight labor market post-Covid.

Singing the same tune, private-sector payrolls processor ADP confirms that the U.S. labor market lost significant momentum last month. Wednesday, ADP said that 103,000 jobs were created in November. The data significantly missed expectations as economists were looking for job gains of around 130,000. At the same time October’s employment data was revised lower to 106,000 jobs, and wage growth continued to slow to the slowest pace since 2021.

A day later, in a further sign that the labor market is weakening, Challenger, Gray & Christmas reported that U.S. employers increased their announced job cuts in November by 24% over October levels. The November update also brings the year-to-date tally of job cuts to the highest level since the Covid crash of 2020.

Friday’s non-farm payrolls report, on the other hand, was a relative bright spot for the week. U.S. job growth accelerated from 150,000 in October to 199,000 in November (better than the 180,000 expected) according to the Bureau of Labor Statistics (BLS). The report was indeed better than expected, but the positives were muted by the fact that much of the overall increase in jobs came from workers returning from strikes. 25,300 jobs came from members of the United Auto Workers union returning to the job, while another 16,000 of the job “gains” were actors returning to work.

Meanwhile, the major leading employment variables also showed a continued negative trajectory deeper into contraction this week. After the labor market data dump, EPB Macro’s Leading Employment Index maintained its negative growth trajectory with a 2.8% contraction. The Leading Employment Index has now been in contraction for four consecutive months, and for 11 of the last 13 months.

Furthermore, employment breadth continues to deteriorate, meaning that labor gains are emanating from an increasingly narrow portion of the economy. Looking at the cyclical economy, breadth has weakened substantially from about 95% of cyclical components in employment expansion as recently as 2022 to under 45% and down-trending sharply today. In fact, looking at the ADP private payroll report, we can see the same tendency toward cyclical weakness. Job gains in the ADP report were disproportionately from the non-cyclical and lagging portions of the economy. Employment gains were most notable in utilities, education, and health services. Job losses, however, bled out from the most cyclical and leading segments of the economy as private payrolls contracted in professional and business services, leisure and hospitality, construction, and manufacturing.

Again, to sum it up, the story remains the same. Despite aggregate employment remaining positive for now, employment growth peaked long ago and is continuing to downtrend while already substantially below the 10-year trend rate of growth. Further, leading employment indicators paint a portrait of more weakening to come.

A slowing labor market is touted by many financial commentators and media mouthpieces as “good news” for both the Federal Reserve’s war on inflation and for the hopes of an economic soft landing. According to their reasoning, softening labor data improves Fed credibility and, by extension, buttresses the confidence bubble. HAI disagrees, and would suggest being very careful with such an interpretation.

Recall that the leading employment indicators continue to contract. They suggest that further labor market weakening—very possibly substantial weakening—still lies ahead. If the negative labor market momentum flagged by the leading indicators eventually pushes the labor market over a cliff, it will ensure the overall economy’s deep recessionary fate. That’s a serious problem for policy makers, Goldilocks, soft-landing hopes, and the confidence bubble.

The U.S. government has made a Herculean effort via deficit spending to prop up U.S. headline GDP growth, offset otherwise flailing global growth numbers, and forestall recession. Despite that fact, the economy is still decelerating, the labor market is still slowing, tax receipts are still negative year-over-year, and the road to recession still looms.

That’s because a policy of both colossal spending to support growth and high interest rates to combat inflation is fundamentally untenable. Though the government shells out trillions it doesn’t have, it accounts for only 25% of domestic GDP. The interest rate-sensitive private sector that is hurt by higher rates makes up the difference. As this 75% of GDP stalls, tax receipts drop. The policy is inherently unsustainable because massively increased spending amid falling tax receipts on top of $34 trillion in already-existing government debt is the fast track to insolvency, not perpetual Goldilocks. If policy makers cut spending, we’ll have a budget busting recession even if the Fed cuts interest rates. And if interest rates are cut while spending continues, we’ll have inflation.

This concerned view isn’t unique to HAI. The government’s current deficit spending “miracle” helping to temporarily support growth is what former Trump administration Chief Economist Joe Lavorgna just described as a spending binge growing “unsustainably” at “one of the fastest rates in decades.” Adding to his theme of untenable and unsustainable policy, Lavorgna added that the current deficit spending bonanza also “works at cross purpose with monetary policy [in other words, the inflation fight] objectives.”

Lavorgna’s observation over current policy unsustainability hits the same notes as HAI’s Whac-A-Mole comment from last week. At this stage of diminished optionality, government policy makers can attempt to address one area of concern, but only by exacerbating other key problems. In this case, U.S. policy makers can choose to goose GDP growth and offset a problematic global growth downturn, but only temporarily, and only at the cost of unleashing a fiscal crisis, restoking inflation, and one way or another killing policy maker credibility and, by extension, the ultimate confidence bubble.

To reiterate, the closer one looks into the perpetual Goldilocks thesis, the more it crumbles. And make no mistake, if the perpetual Goldilocks thesis crumbles, the confidence bubble bursts. If the confidence bubble bursts, that’s good for gold as the only time-tested, counterparty risk-free financial insurance in the system, but very likely almost nothing else.

Now, outside the labor market, the big story of the week was a seemingly failed breakout in the price of gold. Sure enough, after breaking to new all-time highs late last week and continuing higher into uncharted territory during Sunday night futures trading, the price of gold then suddenly and decisively broke down back below breakout levels this week. While many gold bulls were heartbroken and sucker punched by the seemingly cruel turn of fate, HAI will return to the two market truisms stated at the onset—patience is a virtue, and markets throw curveballs.

With perpetual Goldilocks set to crumble, the fallout looks all too likely to put a match to the powder keg and a pin to the confidence bubble. Given gold’s time-tested role as financial insurance, HAI advises patience with the yellow metal, and furthermore suggests that time will attest that selling gold amid this week’s curveball will ultimately prove an epic swing and miss.

Heading into the breakout, bullish positioning among speculative hot-money traders was massive and excessive. Similarly, short-term technicals were overbought and overcooked. Given positioning and technicals amid the breakout, a fairly violent shakeout was a certainty at some point. The curveball was that it arrived so soon. Nevertheless, the fundamental set-up for gold post-shakeout remains overwhelmingly positive.

Even the shorter-term technical picture is now lining-up bullish. As Steven Hochberg of Elliot Wave Financial Forecast observed Friday when discussing gold, “The selloff should be substantially complete. There may be another near-term drop Sunday night or early next week, but if so, it should be the final subwave [correction] of wave (ii).” He continued that as long as price remains above $1,931.55, the next imminent wave up “will be a strong gold advance that carries prices toward $2,350 and likely higher.”

HAI holds high conviction that ultimately, despite curveballs, patience with gold’s breakout will prove a virtue amply rewarded. If Steven Hochberg is correct, yellow metal enthusiasts can expect Santa to deliver a golden gift in Elliot Wave wrapping by the time the advent calendar marks The Night Before Christmas. HAI suspect that, for gold bugs, Gingerbread won’t be the only Joy had this holiday season.

Weekly performance: The S&P 500 gained 0.21%. Gold corrected by (3.60%). Silver was clubbed, down 9.98%. Platinum was lower by 1.74%, and palladium was hit by 5.82%. The HUI gold miners index was crushed by 6.42%. The IFRA iShares US Infrastructure ETF was nearly flat, off 0.03%. Energy commodities were volatile and lower on the week. WTI crude oil was down 3.83%, while natural gas was off 8.32%. The CRB Commodity Index was lower by 2.94%, and copper was down 2.54%. The Dow Jones US Specialty Real Estate Investment Trust Index was off 1.16%. The Vanguard Utilities ETF was nearly flat, down 0.02%. The dollar index was up 0.76% to close the week at 103.98. The yield on the 10-yr U.S. Treasury gained 1 bp to end the week at 4.23%.

Have a wonderful weekend!

Best Regards,

Morgan Lewis
Investment Strategist & Co-Portfolio Manager

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