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Meet the New Year, Same as the Old Year

The Days Ahead: More Fed speakers should echo Powell’s comments. Inflation numbers out.

One-Minute Summary: We're always suspicious of market moves over prolonged holidays. Many traders and investors are away and some markets, like Japan, were only open for three days in nearly two weeks of business.  Europe checks out for nearly 10 days. So “small news makes big impact” or “worst day since last one” are headlines you see a lot. This is what we think is going on:

  1. Economy weaker but not stopped and not near recession.

  2. The inverted yield curve story is overdone but that doesn't stop people talking about it.

  3. Volatility is normal. But if you haven’t seen it in a while it feels awkward.

  4. The government shutdown, impasse and partisanship should not be a major problem.

  5. 2018 was a bad year for multi-asset investors. The only markets not in correction or bear territory are Brazil and India.

  6. Earnings and dividends are both likely to continue to grow 10%. There are no major profit warnings.

  7. U.S. Treasuries have done well but they may be too pessimistic about a recession.

  8. Trade and China are the very big elephants in the room. And will remain so.

1.     The Fed moved the markets again. The last time was in December when the market fell 12% peak to trough. Many thought the weaker signs in the economy, such as trade, industrials, government shutdowns and the general tightening of financial markets, should have meant the Fed passed on its fourth hike of the year. We didn't. It’s not the Fed’s job to bail out the stock market and there were no signs of credit stress.

 But Chairman Powell came through on Friday when he announced that the Fed intends to be patient when coming to further increases and will respond as needed. That was the equivalent of throwing a massive bone to a very hungry market. It means they're going to take into account things like China trade deals, profit warnings, the global economy and any housing softness.

 We're somewhat nervous that one announcement can make such a difference. But markets are feeding off headline risk right now. They were down 7% in the days before Christmas on nothing more than a few throwaway headlines and they're now up 3.5% on not much more than soothing noises. But that’s the way markets play out at this end of the cycle.

 Meanwhile, government bonds have been on a tear and are due for a correction. They’re clearly anticipating a recession but they may have overdone it. That move down in the chart is equivalent to a 5% price gain on a 10-Year Treasury.

2.     How were the jobs numbers?  Great. No, really great. After a disappointing December, the market was all about a slowing economy and employment growth. There was plenty of news to support the view: trade, slower industrial production, and some weaker Fed surveys. But the 315,000 new jobs announced Friday were the best since the launch of the tax cuts last February and the third best in the last five years. Here’s the chart:

By now, you’ll know that we take a rather jaundiced view of the labor market. Sure, the numbers are there but things like labor participation, the underemployed rate (the black line) and part-time work are all not what we would expect. Yes, the nature of the labor force has changed: lower participation by women, marginalized workers and demographics but we'd cork the champagne before declaring it the best jobs market ever. Some points worth looking at:

  1. The labor force grew by 419,000. That’s more than the growth in the population.

  2. The number of employed rose by 142,000 while the number unemployed rose 276,000. We'd suggest that’s a good sign that more people are coming back into the work force.

  3. Average hourly earnings rose by 3.1%. This may be distorted. People out of work in prior months because of hurricanes and California fires will have reentered. Their wages thus came back on stream and changed the underlying trend.

  4. Average weekly hours didn't change.

  5. There was a net loss of jobs for those with a college education and they’re 57% of the workforce and 67% of the over 25-year-old workforce.

This all puts the Fed in a bit of a quandary. They recognize the stressed financial conditions of the last two months and see weaker growth numbers. But they also watch wages very closely. There’s a very clear link between the Fed Funds rate and wage growth (h/t Pantheon):

The Fed won't move for now. But if the wages keep growing, then they’ll probably hike in June.

3.     How important was the announcement by Apple? Not very. The fourth quarter is a big quarter for Apple. They typically realize one third of their annual revenue between September and December. They revised sales down by 8% and margins to 38%, which is exactly what they've been for five years. The problem with Apple in the short term is China, which is 18% of sales, and the iPhone price point and saturation. Even after the price drop, Apple sells at a 20% discount to the market and 50% discount to Microsoft. As in the past, if it falls below 10x, it seems like a very good buy.


 Bottom Line. Trade related headlines will keep traders on their toes. We feel confident with the Fed’s obvious patience with the data and willingness to listen to the markets. Any breakthrough on trade will push the market higher very quickly.

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