Inflation spooks Treasuries and stocks

Rising inflation expectations and robust economic data mean the Fed will likely pause rate cuts for several months. Stocks reacted negatively, but gold seemed unfazed.

The US economy shows slow but steady growth, with total weekly hours worked growing at an annual rate of 1.0% compared to real GDP at 2.5% in 2024.

Real GDP & Total Hours Worked

Heavy truck sales, a reliable leading indicator, fell sharply in December but rebounded to a robust 44.5K in January.

Heavy Truck Sales

Another reliable leading indicator is employment in cyclical sectors, which also shows robust growth. In a recession, manufacturing, construction, and transportation & warehousing typically shed far more jobs than the rest of the economy.Employment in Cyclical Sectors: Manufacturing, Construction, and Transport & Warehousing

ISM Survey

ISM business surveys show continued expansion in the services sector in January.

ISM Services PMI

It was joined by a manufacturing recovery above 50% after 26 months of contraction.

ISM Manufacturing PMI

Labor Market

The labor market added a modest 143K jobs in January.

Employment Growth

However, the unemployment rate fell to 4.0% from 4.2% in November, possibly aided by a surge in deportations.

Unemployment

Average weekly hours worked fell to 34.1 for the first time since the 2020 pandemic. This typically serves as an early warning of increased layoffs. Employers first cut back hours before shedding staff.

Average Weekly Hours

Lower weekly hours is contradicted by the JOLTS report, which showed job openings exceeding unemployment in December.

Job Openings

Average Hourly Earnings

A sharp increase in average hourly earnings, showing 4.1% growth for the 12 months to January, will likely cause concern at the Fed.

Average Hourly Earnings

December earnings growth surprised, at close to 0.5% for the month or 5.7% annualized.

Average Hourly Earnings - Monthly

University of Michigan Survey

Consumer sentiment dipped slightly in February, with the 3-month moving average declining to 71. Sentiment remains below levels during the 2020 pandemic.

University of Michigan: Consumer Sentiment

The current economic conditions index declined to 68.7 in February, but the 3-month MA is still rising.

University of Michigan: Current Economic Conditions

Expectations are also falling, with the 3-month MA declining to 70.

University of Michigan: Consumer Expectations

Financial markets were spooked by the sharp jump in expected price increases in the next 12 months, which reached 4.3% in February, with the 3-month MA at 3.5%.

University of Michigan: 1-Year Inflation Expectations

Five-year inflation expectations are also rising, with the 3-month MA climbing to 3.2% in February.

University of Michigan: 5-Year Inflation Expectations

Treasury Market

Ten-year Treasury yields rallied in response to the stronger inflation outlook, testing resistance at 4.5%. Recovery above the descending trendline would warn of another advance.

10-Year Treasury Yield

Stocks

The S&P 500 fell sharply in response to the prospect of higher interest rates. Breach of 5850 would signal a test of primary support at 5800.

S&P 500

Dollar & Gold

The Dollar rallied, testing resistance at 108 in response to higher interest rates. Breakout would offer a short-term target of 110.

Dollar Index

Gold is retracing to test support at $2,850 per ounce. Respect would signal a test of $3,000.

Spot Gold

Silver broke its new support level at $32 per ounce, warning of retracement to test $30.

Spot Silver

Conclusion

Strong growth in average hourly earnings and rising consumer inflation expectations will likely cause the Fed to pause rate cuts until the current uptrend reverses. That could take more than six months.

10-year Treasury yields are expected to resume their uptrend. Recovery above 4.5% would confirm.

Rising long-term yields are bearish for stocks, with the S&P 500 likely to test primary support at 5800.

The Dollar Index is also expected to resume its uptrend. Breakout above 108 would signal another test of resistance at 110.

Gold is expected to continue its uptrend, with a breakout above $2,900 per ounce signaling a test of $3,000 for the first time. Rising inflation expectations and increased bullion holdings by foreign central banks will likely maintain a shortage of physical gold.

Acknowledgments

ASX 200 jumps to new high

A strong September jobs report boosted the ASX 200 to a new high of 8355, confirming our target of 8500 for this year.

Labor Market

The Australian economy added a seasonally adjusted 64,100 jobs in September, according to the latest Labour Report, well above expectations of 25,000.

Australia: Employment

The unemployment rate remained steady at 4.1%.

Australia: Unemployment

The surge in jobs was absorbed by an increase in the participation rate to a robust 67.2%.

Australia: Participation Rate

Aggregate hours worked also improved to 1,968 million in September, a 0.3% increase compared to the 0.2% average over the past 12 months.

Australia: Aggregate Hours Worked

Business

Strong labor conditions failed to inspire business confidence, with NAB business confidence (black below) declining to -6 pts in the third quarter.

NAB Business Confidence

Wage costs were the number#1 issue affecting business confidence:

Issues Affecting Business Confidence

The Mining industry (red below) recorded a sharp drop in confidence.

NAB Business Confidence by Industry

Stocks

The ASX 200 rallied through resistance at 8300, confirming our year-end target of 8500.

ASX 200 Index

The ASX 200 rally was led by a strong surge in Financials, which is headed for a test of resistance at 8600.

ASX 200 Financials Index

The ASX 300 Metals & Mining Index remains tentative, weighed down by falling demand from China. Breach of support at 5600 would warn of another test of long-term support at 5000.

ASX 300 Metals & Mining Index

On the other hand, the All Ordinaries Gold Index is testing its July 2020 high at 9500. Breakout would offer a long-term target of 14500. The soaring gold price and falling energy costs have boosted margins, with diesel a substantial cost in extraction and transportation.

All Ordinaries Gold Index

Conclusion

A strong jobs report boosted the ASX 200, which recorded a new high of 8355, confirming our target of 8500 for the year.

Strong employment growth suggests that the RBA is unlikely to cut interest rates before next year. Instead, the hawks will be keeping a beady eye on inflation.

Business confidence remains low, with Mining especially hard hit by sluggish demand from China.

The Financials sub-index is headed for a test of resistance at 8600. Breakout would offer a medium-term target of 9200. The All Ords Gold Index is also bullish, testing its 2020 high of 9500. Breakout would offer a long-term target of 14500. Metals & Mining, however, remain bearish.

Acknowledgments

Jobs and GDP growth

The view is often promoted that low GDP growth over the past decade is caused by low interest rates and balance sheet expansion (QE) by central banks. That is putting the cart before the horse. Central banks have tried to stimulate their economies, with massive QE and low interest rates, because of low GDP growth. Not the other way around.

The real cause of low GDP growth is low job growth, as the chart below illustrates.

Real GDP and Nonfarm Payroll Growth

[click here for full screen image]

Offshoring jobs means offshoring growth.

The last time that the US had employment growth above 5.0% is 1984 which also the last time that we saw real GDP growth at 7.5%. Since then, job growth has progressively weakened — and GDP with it.

In the last decade, employment growth peaked at 2.27% and GDP at 3.98% in Q1 of 2015.

Real GDP and Nonfarm Payroll Growth

We now expect job growth to fall to -20% in April, four times the -5% trough in 2009, and a sharp GDP contraction.

How long the recession/depression will continue is uncertain. But, in the long-term, it is unlikely that the US can achieve +5% real GDP growth unless employment growth recovers close to +3.0%.

ASX 200 diverges from fundamentals

Seasonally adjusted labour force estimates show a decline in October 2019:

  • Employment decreased by 19,000 to 12,919,200 people
    (full-time -10,300 and part-time -8,700).
  • Unemployment rate increased by 0.1 pts to 5.3%.
  • Monthly hours worked in all jobs decreased by 2.8 million hours to 1,783.9 million hours.

The leading indicator of employment has been predicting a down-turn in employment for some time, recording its sixteenth consecutive monthly fall in November.

Australia: Leading Employment Indicator

Job advertisements have also declined since late 2018.

Australia: Job Ads & Vacancies

Falling employment has a knock-on effect in other areas of the economy:

According to Tony Weber, chief executive of the FCAI, new vehicles have now seen the nineteenth consecutive month of decreasing sales in the Australian market, with October 2019 sales down 9.1% compared to October 2018.

“Year to date sales of new motor vehicles in 2019 are almost 78,000 units (eight per cent) lower than the same period in 2018…”

Retail sales are also soft:

In volume terms, the seasonally adjusted estimate for the September quarter 2019 fell 0.1%. This follows a 0.1% rise in the June quarter 2019, and a 0.1% fall in the March quarter 2019.

But the ASX 200, seemingly unperturbed, is testing resistance at 6800. Breakout would signal a primary advance with a target of 7200. Breach of support at 6400 seems unlikely but would warn of a decline with a target of 5400.

ASX 200

There are, however, signs of weakness in the largest two sectors.

ASX 300 Banks index penetrated its rising trendline, warning of a correction. Declining peaks on the Trend Index indicate secondary selling pressure. Follow-through of the index below 7600 would strengthen the bear signal.

ASX 300 Banks

A hanging man candlestick warns the ASX 300 Metals & Mining index is likely to again test support at 4100 ( the neckline of a large head-and-shoulders reversal pattern ). A Trend Index peak near zero would indicate continued selling pressure.

ASX 300 Metals & Mining

Iron ore continues its primary decline, since breaking support at 90. Our long-term target is 65.

Iron Ore

We maintain low exposure to Australian equities, with a focus on defensive and contra-cyclical stocks, because of our bearish outlook. But ASX 200 breakout above 6800 would force us to re-examine our outlook.

Australia: Leading Index of Employment in 16th month of decline

The Department of Employment, Skills, Small and Family Business released their Monthly Leading Indicator of Employment for September 2019, recording its 16th straight month of decline.

Hat tip to Macrobusiness, this is a peach of an indicator, predicting Australia’s economic performance.

I have added % retracement in the ASX 200 to the graph below. Each of the significant past troughs in the Leading Index coincides with a drawdown of more than 20% in the ASX 200.

Leading Index of Employment

Is the current fall in the Leading Index a false alarm, as in the 2005/2006 raging commodities bull market, or are we in for another retracement?

Leading Index of Employment - Components

My money is on the retracement.

Australian residential construction to decline until 2021 | ABC

One of Australia’s largest cement and construction materials producers, Adelaide Brighton Ltd (ABC), announced their half year results today. The media statement contains a decidedly bearish outlook for the housing market.

ABC logo

Operational Review

Demand for construction materials slowed further during the period. Australian residential construction approvals declined more than 25% on seasonally adjusted terms for the six months to June 2019 and residential construction is forecast to continue to decline until 2021, until it returns to growth. However, the Company expects both mining and infrastructure to increase demand for construction materials in the near term. Capacity expansion in iron ore and gold production, along with the reopening of nickel capacity, will increase the demand for both cement and lime in Western Australia and the Northern Territory.

Outlook

For the balance of 2019, Adelaide Brighton expects demand for construction materials to:

  • Weaken in east coast markets and South Australia, until the commencement of further planned infrastructure projects;
  • Remain stable in the Northern Territory and Western Australia;
  • Improve in the lime business as a result of increased gold and nickel production in Western Australia; and
  • Increase in concrete and aggregates due to more available work days, seasonality and volumes generated via Scotchy Pocket quarry.

Auction clearance rates in Sydney and Melbourne have improved but sales volumes remain low. We have witnessed recent improvement in consumer attitudes towards housing investment but whether this translates into increased activity will depend on:

    • APRA’s macro-prudential controls on bank lending;

Australia Housing Credit

  • The global economy;
  • Impact of the trade war on China’s economy; and
  • Domestic employment prospects.

Australia Unemployment & Underemployment

ASX: Dead cat bounce

The ASX 200 found support at 6450/6500 followed by a hesitant rally: a candle with a long tail followed by a short-bodied evening star. This resembles a typical dead cat bounce. Breach of 6450 is likely and would warn of a decline to test support at 6000.

ASX 200

Gerard Minack in a recent report suggested that Australia is likely to go into recession if the saving ratio increases. For the past few years, consumption has been growing at a faster rate than disposable income as households dig into savings to maintain their lifestyle.

Australia: Consumption, Disposable Income & Saving

Households may continue this behavior because of the wealth-effect (they feel asset-rich but cash-poor) but are likely to reverse sharply if housing and equity prices fall. Which is what we are witnessing at present.

Australia: Housing Prices

In our view, the housing decline is likely to continue despite the RBA cutting rates. While rates may be attractive, job prospects are looking shaky. Loan approvals are falling.

Australia: Housing Loans

Business investment is falling.

Australia: Business Investment

Job ads are about to go over a cliff. Trade tensions with China will add to our woes.

Australia: Job Ads

Public funded infrastructure construction is slumping.

Australia: Public Construction

Credit and broad money supply growth are approaching 2009 GFC lows.

Australia: Credit & Broad Money

And our iron ore tailwind is dying fast. Iron ore spot prices have fallen off a cliff. Breach of support at 95 is likely and would warn of another decline to test support at 80.

Iron Ore

I plan to further increase the level of cash in our Australian Growth portfolio.

Employment lifts but S&P 500 tentative

Growth in total non-farm payrolls ticked up to 1.76% for the 12 months to April 2019, supporting Fed reluctance to cut interest rates.

Payroll Growth

The Philadelphia Fed Leading Index has been revised upwards, above a comfortable 1.0%.

Leading Index

Real GDP growth came in at a healthy 3.2% for the 12 months ended 31 March 2019 but growth in total hours worked sagged to 1.47%, suggesting that GDP growth is likely to slow.

Real GDP and Total Hours Worked

Growth in average hourly earnings came in at 3.23% (total private), suggesting that inflationary pressures remain under control. Little chance of a Fed rate hike either.

Average Hourly Earnings

The S&P 500 retracement respected support at 2900. Rising Money Flow indicates buying pressure but gains seem tentative.

S&P 500

US growth looks to continue but commodity prices warn that global growth is slowing.

Nymex crude penetrated its lower trend channel, warning of a correction. Despite the supply impact of increasing sanctions on Iran and Venezuela, and the threat of supply disruption in Libya.

Nymex Light Crude

A similar correction on DJ-UBS Commodities index reinforces that global demand is slowing.

DJ-UBS Commodities Index

Australia: Job gains

ABS June figures reflect solid gains for the labor market. Justin Smirk at Westpac writes:

“….The annual pace of employment growth has lifted from 0.9%yr in February to 2.0%yr in May and it held that pace in June. In the year to Feb there was a 106.9k gain in employment; in the year to June this has lifted to 240.2k. The Australian labour market went through a soft patch in 2016 that was particularly pronounced through August to November when the average gain in employment per month was a paltry 2.2k. We have clearly bounced out of this soft patch and now holding a firmer trend.”

My favorite measure, monthly hours worked, jumped (year-on-year) by 3.1%.

Monthly Hours Worked

Infrastructure spending, particularly in NSW and Victoria, is doing its best to offset weakness in other areas.

Wage rate growth remains subdued, indicating little pressure on the RBA to lift rates.

Monthly Hours Worked

Australia’s economic growth is slowing.

Employment and Participation rates are falling.

Australia Employment & Participation Rates

Wage rate growth is slowing.

Australia Wage Rates

Slowing wage rate growth and inflation confirm that the economy is faltering.

Australia Underlying Inflation

The RBA, with one eye on the housing bubble, has indicated its reluctance to cut rates further. Increased infrastructure spending by Federal and State governments seems the only viable alternative.

With the motor industry winding down and apartment construction headed for a cliff, this is becoming increasingly urgent.