Financial markets find themselves presently entangled in a strange disagreement of sorts. On one hand, there flows this relentless desiring for risk assets fueled by the accommodative efforts of both the European Central Bank, and the Bank of Japan. Yet, on the other, there breathes this severe lack of market liquidity and resultant skittish price action more often seen in periods of stress.
Friday's release of payrolls adds to the present oddness, falling as it does on Good Friday with U.S. equity markets closed as well as many European markets, by extension creating the ever-present oversized moves which we’ve grown accustomed.
Preparing for the Second Quarter
In an effort to gain both confidence and perspective, investors will spend the long weekend reflecting back on recent history. The fourth quarter of 2014 was severely dominated by petroleum’s collapse. Meanwhile, the first quarter of 2015 was led by a pageant of issues including both well-advertised and surprise central bank rate cuts, Greece and its creditors, along with persistent U.S. dollar strength.
This long tapestry of events will, no doubt, cause investors to stop and ponder while preparing for the second quarter. They’ll replay the current narrative that includes - European economic data continuing to outpace expectations while U.S. economic data – in aggregate – falls flat. Some will question why the market seems just intellectually or theoretically prepared for an imminent Fed tightening path, while others will wonder if the looming first-quarter earnings season will repeat like last by dismissing company outlooks as only temporary?
For the very short-term, U.S. stocks face a near winless proposition. Weak data no longer is considered a virtue, and very strong numbers would be bad as well. That would cause the Fed tightening expectations to shift forward. The March U.S. nonfarm payrolls report is a glaring example as the economy added just 126,000 jobs, or half of expectations, and the slowest rate of growth since 2013. This number halts an impressive string of gains of at least 200,000 jobs that rivaled the gains since 1996. Markets have responded in kind with S&P 500 futures shedding 20 points to 2039.50, a general dumping of the U.S. dollar, while U.S. 10-year Treasury yields plummet to 1.81%.
How to Think Within the Current Dispensation?
It has been markedly difficult to reconcile the bigger picture when global central bank policies are heaving foundational principles of human nature and economics straight out into the trash heap. We’ve together been dulled by endless ink spilt over particular European rates being so negative that companies are actually paying interest on bank deposits. Where investors may be paying for the honor of lending money and, they are delighted to do so.
The best chance for U.S. equities will be a succession of economic numbers consistent with expectations and a Federal Reserve that commences tightening by the Sept meeting. Currently, the opposite is true where U.S. economic numbers are generally flat and the CME Eurodollar futures market is now only pricing in 34 basis points (bps) of cumulative rate hikes through 2015, down 20 bps. in the last six weeks!
U.S. equities still haven’t fully come to terms with the reality of higher rates but that process doesn’t have to be long or be very unsettling. Once it actually happens, U.S. equities will be able to finally break-free from their laborious range. In the meantime, pay special attention to anything regarding the effect of the U.S. dollar on domestic growth (currently being over-emphasized in my view) along with the path of the Feds lift-off cycle (remember the “how much” means more than “when”).
With the apparent economic divergence at hand, I still remain overweight European equities versus the U.S. However, within the U.S. subsectors, I continue to see value in top quality oil services names along with the recently beaten down banking sector. I foresee a range bound U.S. dollar, a continued strong demand for credit, and idling gold prices.