Markets have been historically irrational, so it only makes sense that they continue to be irrational! What is good is bad, and what is bad is good. There are many drivers across the markets, and as the bulls and bears fight over market direction, little has changed to start the second quarter as market volatility as tracked by the VIX remains at or below typical levels.
The major catalyst of the markets has been the strength of the commodity sector, which has been largely dominated by global forces (namely China and India), with American job numbers setting the precedent for American interest rate expectations and thus setting the tone for the global market. The markets are also waking up to the looming national American elections this Fall, as the outcome will likely have myriad implications on not only the current policy, but through Supreme Court nominations-the policies of generations to come.
The economy continues to add jobs and is attempting to reach and surpass many pre-recession measures; major US equity indexes are at or near all-time highs, as the unemployment rate hovers around 5%. As inflation is still flat relative with the Fed’s target, the rally in commodity prices, the recovery of oil prices and the Non-Farm Payroll numbers become critical measurements of the economic pulse of America.
Job creation remains strong, but with 160,000 jobs added juxtaposed with the 202,000 expected, the market reacted with the rational of slowed growth, but the pause eventually dissipated as the bulls made the case that another Fed rate hike will be delayed. With the seemingly tenuous jobs report, economists-including those at Barclays and Merrill Lynch-have revised their rate hike expectations from two, down to one, which is largely anticipated by the market to occur in September. When you peel back, unearth the headline numbers and look at the quality of jobs that have been created in America since the Great Recession, they still leave much to be desired.
The trend in total compensation, a number which takes into account hours worked, salaries paid and benefits, is actually declining, and as individuals drop out of the labor pool in frustration, the headline numbers are skewed. Americans are simply leaving the labor force in large numbers, much of it to retirement and parenting, but it is important to point out that many Americans who have the ability to leave the labor force find that salaries and small business earnings are too low to make it worthwhile for them to stay in the labor market.
Total annual compensation of workers has dropped by 15% of the American GDP ($3 trillion) since 1970 and workers of the world have failed to unite to reverse the trend, as the old adage of “the rich get richer, while the poor get poorer” continues.
While the work force continues to be underemployed and underutilized, lower real term wages of workers benefit corporate earnings. With booming growth in the construction and service sectors, it would be rational to extrapolate that corporate earnings show healthily growth. As pointed out earlier, markets are not rational, and earnings from publicly traded companies have failed to impress Wall Street. The irrational markets continue to react to headlines, and have largely shrugged off the underlying message that contributes to those headlines.
Several sectors and companies have been winners, but some “blue chip” companies have had some set-backs, which could be a canary in the coal mine for the epic 2016 rally in equity and commodities. Disney and Apple are two American giants that have had recent reversals as quarterly earnings and guidance have disappointed investors. One of the major themes continues to be global struggles, as both companies point to weakness in China. However, optimism persists that American markets can overcome a global slowdown, as rebounding oil prices give hope that cause for a global recession is diminishing.
With negative rates, many central banks around the world are doing everything possible to pump money into the economy and spur growth. Even if the US hike rates one to two times in 2016, rates will still be historically and empirically low. By some measures, many of the fiscal and monetary policies are working as the world has not slipped into a re-cession. We keep a close eye on Brazil and Britain, as political uncertainty could create outcomes that either strengthen or weaken the world economy. With uncertainty, we remain flexible and hope for the best, but prepare for the worst.
As we march towards summer, the markets appear to be gaining momentum and are relatively healthy. Don’t fall victim to market and media hype, peel back the onion and take a hard look at the real story that the market and numbers that drive the market are saliently conveying. Good times appear to be here, but the question remains, are they?