Mixed Signals in Equity Markets, Consumer Stocks, and Employment Trends


Mixed Signals in Equity Markets, Consumer Stocks, and Employment Trends

Monday, June 6, 2023 By Vincent David-Robin

The theme continues in having equity markets looking at economic prospects and the glass half full as opposed to anything that could derail the progress. The earnings releases we had in the US last week were not that good as far as consumer stocks are concerned. Especially the ones for Distribution, and Food and Beverage.

Consumer Caution and Slowdown in Spending

We know that Macy's wasn't very good. Dollar General wasn't very good. Costco wasn't very good. We have a series of earnings reports that were very lacklustre. Those stocks went down, which shows that the consumer in the US is starting to be just a bit careful.

Between them, these three companies cater to a very wide category of consumers – from the upper quartile to the bottom one. So it's quite relevant. Walmart did a bit better.

Employment Strength Despite Consumer Concerns

By the same token, employment is still going extremely strong. NFP was much, much stronger than expected. The only reason why unemployment rate from went from 3.5% to 3.6% is just because the participation rate went from 68.5% to 68.6%. So we still have full employment in the US.

Maybe some rotation; maybe the lower jobs are not as good as before. But with professionals, there's all demand. If you dig into unemployment the one statistic you want to look at is not so much the headline unemployment, but U-6; and U-6 is not moving at all. So it's still extremely good as well.

The Fed's Dilemma: Managing Inflation in a Strong Economy

This is complicating the job of the Fed for sure, because you have an economy still doing very well, barring a few sectors (mostly consumer related) where they're not doing as well as before. But overall, very strong.

The Fed is going to wonder, "How are we going to remove inflation?"; because under these circumstances, it's hard to see inflation disappearing. It may slow down a little bit and calm down just a bit, but very unlikely to disappear. PCE index that was released last week, as a matter of fact, was completely flat. It's not moving down at all. You can expect CPI to be likewise. So it's a tricky job for the Fed.

The rate market is pricing less rate cuts. We're down to 25 to 30 basis points (bp) by the end of this year. But I expect these to be taken out soon enough. We've seen a decent repricing across the treasury curve in less than a month. Treasury yields have sold off by 60 bp, more or less; from two-year to five-year; a little less. In the back end, we are looking at 20 to 30 basis points, but there's a decent repricing.

Diverging Market Reactions: Equities vs. Fixed Income

But what is very interesting is that there's a disconnect between equity markets and fixed income markets, which we didn't have at the start of the year. At the time the consensus was the Fed needs to hike to dampen inflation which may kill the economy; a threat for equities The same dilemma is still present; fixed income has sold off from the yield's lows seen in March but equities have rallied further.

The Fed needs to hike. They're gonna kill the economy and equities. We are reacting badly to it, and now we're getting back to fairly similar things. There are still rate cuts priced in 24 and 25 basis points. Maybe that's why equities are still doing fine, but everything that is 23 and early 24 doesn't seem to have much impact on equities for now.

It is a bit of a disconnect. That doesn't happen very often, but I suspect the fact that there's still plenty of liquidity in the system, that the Fed's balance sheet is still very high and there's still a lot money flowing into the system. Maybe that helps equities, even with rates being higher.

To put it into perspective, we are still dealing with negative real rates in America. It's still pretty stimulating. I suspect you would need 10-year treasuries to go to 4.5% just to invert that. But at the moment, at 3.7%, you are dealing with, real rates that are marginally negative. So it's not like financial conditions are really, really tight.

They've tightened, and since then they've loosened quite dramatically be it with the performance of equities or the fact that the back end of the treasury curve hasn't sold off as much as the front end.

Debt Ceiling Deal Does Not Do Much to Change Fiscal Outlook

I think the debt ceiling in itself was a non-event. At the moment, the mood is that anything that is good gives a boost to equities. In itself, that should have been totally neutral. Looking at the savings put together over for the next couple of years: frankly, it's pretty marginal.

The forecast that it may reduce the debt by 1 trillion over 10 years is already doubtful anyway. But it's not a lot. So there's no fiscal tightening as far as the White House is concerned. Or if there's a tightening to be done, it'll have to be done by the Fed. That renders the job of the Fed even more complicated because maybe they were hoping for a serious fiscal tightening, but they're not getting it. It's really tricky from a positioning standpoint.

It's clear that equity markets are on a tear. Overbought from a technical standpoint. But into a new range. So maybe the overbought doesn't matter because they're at new levels. But it's a bit tricky to go along equities here. But that's what I said last week. I had mentioned that I didn't see a catalyst for equities to just go down hard. It seems to me that it is still the same story.

So we could have a pushback, obviously; because the levels are really high. I mean, NVIDIA is now a trillion-dollar company. It's trading at 200 times! AI may be something for the future, but it's not something for today. We may see a pushback at some point. That's highly possible. But it's a hard one to navigate, for sure.

Global Market Overview: Asian and European Equities

As far as the other markets are concerned: Asian markets are not doing too well. Japan may be a bit better, but in Japan we had a push, but I think now that's it. It's a cheap market from a P/E standpoint, but it's not a cheap market once you look at its idiosyncrasies. I don't see China going anywhere. Korea has a few issues at the moment.

Europe benefited from the rally in the US. Although, I don't think there should be a rally in Europe, frankly. There are too many issues. Inflation came down on Friday, to 6.1%. But still, inflation is quite high. The market is pricing less rate hikes than before, but the economies are slowing down in Europe. So I would tend to be more negative on European equities than on US equities. European equities are at the all-time high and the US equities are not.

Impact of Dollar Strength on Commodities

The dollar index could rally a bit further if fixed income continues to set off in the US. Will it rally too much further? Maybe not. But it certainly could go a bit further. That means commodities and precious metals could come under a bit of pressure. It's what I had said last week. As a matter of fact, since then it hasn't rallied. Gold was at 1980. Now it's at 1960. I see commodities plateauing at best; or coming back down.

OPEC+ Influence on Oil Prices

Oil may be a bit different, because Saudi Arabia and OPEC+ are likely to take further measures to limit production. The volatility in oil has been quite high. I think they will try to push very, very hard to make sure that it's floored at around 75. So they could reduce production further.

Potential Rebound in Soft Commodities

With regard to soft commodities, everybody is short; or at least the CTAs are. Could we have a rebound? Possibly. The Ukraine-Russia deal now has another month and a half to go. Will Russia renew it then? It's not that obvious. It's touch and go on that one.

I think soft commodities could rebound a bit because of the positioning. But hard commodities: I don't see them go up that much, since the Asian growth is not that strong there; other than an oil where maybe OPEC will push very hard for a reduction in production to lend support to the price.

Persistent Themes and Extremes in the Market

So on the whole, it's pretty much a continuation of the same things that we have had over the last few weeks. Things are the same, but more extreme. Nothing new other than pushing boundaries.

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