Nolte Notes 5.10.21

May 10, 2021

“Jobs, jobs everywhere and not one to be had”. With apologies to Samuel Coleridge, the jobs report on Friday was in stark contrast to the news earlier in the week of large drops in weekly jobless claims. Employment reports embedded in various survey data also indicated that payroll gains would be close to 1 million, not just a quarter of that guess. Given the huge whiff, it would not be a surprise to see stocks take a header and drop a few percentages. However, they rose nearly 1% as investors feel the monetary spigots will remain wide open, fueling further stock gains and potentially higher inflation along the way. Excuses for the miss abound, from lingering fears about covid while heading back to work, schools still in hybrid and parents needing to hang around the house while kids are home. Finally, some point to the generous unemployment programs that are keeping potential employees at home until at least September, when the benefits are set to expire. Of course, the weaker report emboldened others to push for even more benefits.

The economy is in a strange place. Manufacturing is running full out and having trouble finding “stuff” needed to make their “stuff” (hence the rising prices on various inputs like steel, copper, grains, etc.). Services are beginning to come online as restrictions ease. Yet they are having trouble finding workers and still have capacity restrictions and higher prices for their needs (like jet fuel and foodstuffs). Housing is booming as many are leaving the larger cities and heading to the ‘burbs. Lack of building (and higher lumber/copper prices) has pushed up home prices at a pace last seen in ’07. GDP growth was over 6%, yet the calls for more stimulus and keeping the Fed’s rate policy in place were heard following the report. The key question is whether the combination of the enormous stimulus package (as well as the one proposed) and higher input prices for all sorts of goods will indeed be “transitory” or much more lasting than is presently assumed. Inflation in the financial markets have been deemed a good thing, however now that it is spilling over into the “real economy”, it could pose problems for officials.

Bond investors cheered the poor employment report, as they believe the easy monetary policy will continue for longer than expected. Since hitting 1.74% in mid-March, the 10-year Treasury yield has eased to 1.60%, trading in a very narrow range. If the bond market is indeed worried about inflation, it is not yet showing up in yields. Even the spread between short and long-term bonds has contracted when it would be expected to expand as the economy heats up. Investors in low-grade corporate bonds are not worried either, as high yield rates are their closest to Treasury yields ever, meaning the margin of default risk has never been lower.

Even with the much lower-than-expected job growth last month, the “re-opening” trade in the market continues to lead the way. Small US stocks and large US value have been out in front much of the year and have regained their leadership roll over the past two weeks. The dollar has weakened as well, allowing international investments to lead their US counterparts. A concentrated portfolio of US technology stocks has been the big winner over the past decade, starting in the depths of the financial crises of 2008 and (likely) culminating with the rollout of the vaccine late last year. Investors are paying a hefty premium for growth, as the average price to earnings for growth is 30x, 50% higher than that for value stocks. Both are at historically high levels, but for those that need to always be fully invested, the near historical difference between the two would argue that investors should be buying value and selling growth. The “reversion to the mean” trade would help investors who have a diversified portfolio of large/small/international holdings perform better than the averages, which are still dominated by large growth names.

The circular argument of “why are stocks going up? Because people are buying. Why are they buying? Cause stocks are going up”, will come to an end at some point. There are not yet any hints that stocks are going to do much more than correct their torrid run this year. A large “wow” drop is not yet in the cards. Still scanning the horizon for signs though…

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

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