The Days Ahead: The market is inflation sensitive right now. Tuesday’s CPI number will be important
One Minute Summary: Mixed economic numbers. Blow-out job numbers (but yes, some caveats). The trade deficit widened, although there may be some relief on the oil side in coming months. Productivity stalled. The Fed’s Beige Book, a report that lives up to its title, was mostly more of the same “modest to moderate” (mentioned 193 times in a 32-page document) growth from the 12 districts. There were some reports of compensation increases but we put that down to state minimum wage increases coming into effect in January. Some 29 states have minimum wages above the Federal level (which is unchanged for nine years) and 18 of them raised them for 2018.
The week started with major concerns on the Administration’s policies but markets settled down mid-week. We're not out of the woods, of course. Thursday’s decision to limit steel tariffs to non-NAFTA partners means those issues now become part of the NAFTA discussions. The ECB said it would keep buying bonds for “as long as necessary.” That weakened the Euro.
Bonds were flat. Stocks liked the jobs number. The S&P 500 and European stocks were up around 3% to 3.5%. We're still 3% down from the market peak on January 26, but up 7% from the lows. The dollar took a round trip…down and then up.
1. Blow-out job numbers. We've been cautious on the jobs market for a while. Yes, good headline numbers but low labor force participation, low wage growth and high growth in low wage and part-time jobs. This month was different.
The headline number was the best since November 2014 and the third biggest since 2000. The unemployment rate was flat because the participation rate ticked up to 63%, which is good, but the same as a year ago. And the types of jobs? Construction, specialty trades did well but there were still the same mix of temporary and low-level service jobs. No argument or change there.
The last set of job numbers set up a storm about Average Hourly Earnings, which showed a big jump and had all the “here comes wage inflation” experts humming. But it proved another false start. Earnings growth slowed to 0.1% from 0.4%. Hours worked increased.
What’s it all mean? There is more labor slack in the market than assumed. More sidelined workers are coming into work. This is good for activity and the economy. Wages are not growing. Which is good for stocks. Mind you, this is only one month of data. So, you know, lest we get carried away.
2. How are the steel companies doing? Quite well, thank you. Steel production peaked in the early 1970s, halved in the next decade and has been flat since 1988. As stocks, you would think they’d be hammered as old industrials but they've actually done quite well. Here’s a composite of the 10 largest steel companies in the S&P 1500.
In the last three years, the top five steel stocks have outperformed the S&P 500 by a whopping 31% and by 5% in the last year. The long-term results of 20 and 30 years are equally impressive. Of course, they are highly cyclical stocks so an investor would have had to stomach a 70% loss in the 2008 recession. But, basically, they're in good shape and for the 134,000 employees in the steel industry, wages are about 35% higher than the national average.
So what does all that mean? Well, the tariffs were not really about steel or aluminum. The U.S. did not accuse any country of dumping, which will get you a hearing at the WTO. Instead, the Department of Commerce used the national security argument (pretext?...hey, I’m not a lawyer). That opens up all sorts of retaliation opportunities because it's a spurious and hard-to-prove rationale.
Meanwhile the Fed’s Beige Book mentioned that “Four Districts saw a marked increase in steel prices, due in part to a decline in foreign competition.” And the survey was taken mid-February. So, you know, barn door…horses.
If the purpose of the tariff was to “stick it to the foreigners” and send a strongman message, then job done. But if this escalates into tit-for-tat, then we’re in serious trouble. As of midweek, the market was leaning to the former.
Bottom Line: The trade issues are going to be lurking for a while. We don't know what policy will come down the road. It's somewhere between speak softly…big stick and improv. We don't think this is a game changer yet. We hold Treasuries for a risk-off market. We'll increase our growth exposure in international and Emerging Markets. We're lightening up on real estate and looking at some downside protection on the S&P 500. It was a good week.
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