After Friday’s disastrous employment report the markets continued the trend we had been monitoring since March in what looked to be a climax type of move with treasuries making new all time highs, closing both the 10YR and 30YR at record low yields (1.45% and 2.52% respectively) while the S&P cratered 2.50% by 30+ points to close right on top of 1278, a level we have been watching for some time as it represents a 10% corrective measured move against the 10% Nov 2011 correction.
After the news broke the financial media and punditry were all sounding the growth slowing alarm and calling for more stimulus from the Federal Reserve. This morning’s NYTimes went so far as to suggest they had not done enough and the jobs number implies they may be forced to act. We don’t know whether to laugh or cry. Done enough? How about they’ve done too much.
We got cautious in February due to the rising gas prices and subsequent effect on the “real” risk premium. You see the market is not stupid and despite interest rates being at record lows, risk premiums are not being floated off negative yields, you have to use inflation and rising gas prices represent one of the larger net changes on consumer prices.
in Gas Prices and the Real Equity Risk Premium (3/18):
Our concern with market valuation is that when looking at the current $3.88/gal it is consistent with much higher CPI run rate, closer to 4% rather than the 2.9% Feb print. This would tighten the current 400bps Real ERP to closer to 300bps and with stocks rallying on mostly multiple expansion into rising inflation the Real ERP can contract quickly. We aren’t anywhere close to the zero line even at 4% YOY CPI but if gas prices takeout the $4 level the inflation pressure on the multiple should start to kick in and defense is warranted.
But what do we have now? The exact causes of growth slowing in rising raw material prices are now waning and the dollar is rallying.
One of the other potential reasons for a spring slow down in growth is that the warm winter we had pulled forward some growth we would typically experience in the spring. The bears complained about this in February when the market was hitting new highs but they don’t want to discuss that today. We saw an interesting interpretation of Friday’s other big number in the May ISM manufacturing report.
In Bloomberg’s “chart of the day” Carlos Torres reported that the relationship between new orders and inventories.
The slowdown in U.S. manufacturing in May will probably be short-lived as orders climb and stockpiles are down down.
An increase in bookings paired with a drop in inventories pushed the spread between those measures to the highest level in two years.
Quoting Conrad DeQuadros, senior economist at RDQ Economics, The indication from orders and inventories is that production, and potentially employment, will pick up in the months ahead. The ability of companies to fill demand through inventories is being greatly reduced. The manufacturing sector is probably the strongest area of the economy, and the forward-looking indicators are encouraging with orders picking up and inventories very low.
Bradley Holcomb, chairman of ISM survey said on a CC with reporters, There’s a lot of strength in that combination of rising demand and fewer stockpiles. I suspect inventories will creep back up and that will continue to stimulate the pipeline.
So let’s not get too carried away with wiggles in the data. Unfortunately, the Fed’s campaign to manipulate the banking system is driving increased volatility in the economy and in the markets. We have to manage risk with this in mind but make no mistake, there is nothing unusual about the price action in stocks or a 10% correction after a 30% rally.
What is unusual is interpreting the price action in the bond market and the parabolic advance in the long end of the curve as somehow a reflection of real economic activity. We have been pointing to the potential for a short squeeze for months and that is exactly what is playing out. As we have said before, the Fed’s Bubble of Fear took the discount out of the discount rate long ago and it is nothing but a commodity from here, therefore subject only to the supply and demand of speculators who are getting squeezed and no doubt will soon be positioning for a QE 3 front run.
Thursday Bernanke speaks before a joint economic committee in Washington and the Fed has a June 20th meeting before Operation Twist ends on June 30th. With election rhetoric heating up it will be very interesting if he is compelled to come back in with yet another round of stimulus. We think despite European fears, recession fears, jobless fears and all other fears the Fed’s Bubble of Fear is encompassing, the economy is in pretty decent shape and just needs time to adjust to the massive credit bubble debacle caused by the Fed themselves. We are capitalists because we believe capitalism not only works but the free market is the best allocator of capital and resources, not central government planning. Mr. Bernanke we urge you to let capitalism work and reap the rewards of the free market. Simply throwing more debt and manipulation of money and with negative interest rates will only extend the pain, create more distortions and make the eventual exit that much more catastrophic. It would be like doing the same thing over and over again and expecting a different result.