- The May Employment report was surprisingly strong. Labor force participation rose by 400,000 and average hourly earnings climbed to 2.3% year-over-year, so there is no way to put an asterisk on the report. Bonds were weak leading up to the report and continued to sell-off thereafter. It increases the pressure on the Federal Reserve to raise rates sooner rather than later.
- Bonds continue to struggle. Over the last three weeks it has been the middle of the yield curve that has borne the brunt of the selling. This indicates the market fears rate tightening more than it fears actual inflation, but at this moment it fears both. While I believe to some extent that we are seeing leveraged long positions getting forcibly liquidated, support has not held and at this point buyers may be catching the proverbial falling knife. Floating rate bonds have done well relatively to all but the shortest duration bonds. While I don’t find their risk/reward especially compelling, they will probably be the bond sector of choice in the short run. Consider holding more cash.
- The dollar jumped sharply last Friday, but has not been able to build on that spike. September is the consensus month for the first rate hike, but the “no hike” minority gained steam until Friday. Last Wednesday, Doubleline’s Jeffrey Gundlach said he didn’t think the Fed would move at all in 2015. Today I would suggest that October is the very latest the Fed would move.
- Dollar strength is bad for those investing overseas in the short run, but good in the intermediate term. Since May 21 we have seen a nearly -3.3% correction in the EAFE in dollar terms (the S&P 500 has given back just -1.6%). This will ultimately benefit foreign companies that export and hurt domestic companies that do, so I wouldn’t be worried about one’s foreign stock positions. It remains a good idea to have part of this exposure currency hedged. See Chart 1 below.
- Roughly, two weeks ago I wrote about the three phases of the market cycle. If this quarter’s action marks the end of the cyclical bond bull market, we have entered into the excess phase where high quality bonds are sold for stocks and high yield/floating rate bonds. REITs broke through their 200 day moving average in May, bounced back above it for two weeks, then plunged decisively below it last week. The Dow Jones Utility and Transportation Averages have also broken below their 200 moving averages recently. Though the broad market remains solidly in “bull” territory, the “early warning” indicators are flashing.
- Good economic news is bad market news now. The bull market was built and extended on very low interest rates and the belief that the Fed was investor friendly. Gradually, this is no longer becoming the case. Save for perhaps the Materials, Mining, and Energy sectors, history suggests this is a headwind for stocks. Bull markets top out when investors begin to take profits on rallies (versus buying on dips, which has strongly characterized the environment since the Autumn of 2001). Failure to build on Wednesday’s 238 point rally (which did not take us to a new high) is not an encouraging sign either. However, it is summer and liquidity is traditionally lighter, so I have to try not to read too much in to these numbers.
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