Chairman Powell no longer appears to be the stock market whisperer he once was. It seems he thinks that he can maintain the ultra-easy monetary policy of the past decade to support financial markets, while also achieving the Fed's objective of full employment without realizing the higher long-term interest rates and inflation that come with it. Despite his assertion that he will not withdraw any of the continuing monetary policy accommodations, the bond market is tightening financial conditions for him. Inflation expectations have risen to a 12-year high, long-term bond yields are soaring as a result, and the stock market darlings of yesterday are no more.
Construction spending rose 1.7% in January, led by the residential side again, where spending was up 2.5% for the month and 21.1% year over year. Non-residential spending rose 0.5% for the month but has declined 5% over the past year. The good news is that there was strength in January across the board.
ISM Manufacturing Index
The Institute for Supply Management's Manufacturing Index rose for the ninth consecutive month to a three-year high of 60.8% in February. New orders and production are showing particular strength, as well as the employment sub-index, which climbed for a third month in a row to 54.4%. Sixteen of the 18 industries surveyed by the ISM were expanding last month. The only concern comes with the shortage of raw materials, which is leading to a surge in prices. That could be a headwind to demand and growth if the price surge continues.
IHS Markit Manufacturing Index
IHS Markit's Manufacturing Index for February came in at 58.6 and tells the same story as ISM. It was the second fastest rate of growth since April 2010, led by output and new orders, but input costs are soaring due to supply chain disruptions and supplier shortages. Costs rose at the steepest rate since April 2011. Still, employment growth is strong, and confidence has improved markedly.
ISM Non-Manufacturing Index
The Institute for Supply Management's Non-Manufacturing Index fell from a two-year high of 58.7% in January to a nine-month low of 55.3% in February. This shows the service sector is still growing, but at a more moderate pace. The culprits in this slowdown were shortages of supplies and difficulties in obtaining them. This led to a surge in prices with the price sub-index rising to a 10-year high of 71.8%, as can be seen in the chart below. As a result, service providers are starting to pass on higher costs to their customers. Inflation is coming. The only weak spot in this report was in the employment sub-index, which fell from 55.2% to 52.7%.
IHS Markit Services Index
The Markit Services PMI did not see the softening in service sector activity that was seen by ISM. Markit's index rose to 59.8 in February, which was a six-and-a-half year high, led by new orders and output. Similarly, input cost inflation accelerated at a pace that was the fastest since October 2009. In response, businesses raised selling prices at the second-fastest monthly rate in the survey began 11 years ago. Again, inflation is on the rise. Employment is improving very modestly, but that should be expected, as the labor market is the caboose in the recovery cycle.
Initial claims filed through state programs rose 9,000 to 745,000 for the week ending February 27. The number filing under federal pandemic-relief programs rose by 437,000, resulting in a total of 1.18 million. The day we can fall below one million total claims will be a psychological turning point. Continuing claims under all state and federal programs fell to 18 million through February 13, which is down by one million from the week before. These numbers should improve dramatically over the coming 2-3 month period as the majority of Americans are vaccinated this spring.
The Jobs Report
This was a blow out number! The Bureau of Labor Statistics estimates that the economy created 379,000 jobs last month, led by service sector positions in restaurants, hotels, bars, and retailers. Leisure and hospitality jobs accounted for 355,000 of the total figure. The prior month's number was revised up from 49,000 to 166,000. The unemployment rate fell from 6.3% to 6.2%, while the labor participation rate remained unchanged at 61.4%. We need that percentage to increase to pre-pandemic levels that were closer to 63%.
As the vaccination rollout accelerates, and the economy more fully reopens, expect jobs to be recovered at a much more rapid pace. I can a million-plus jobs or more recovered per month this summer.
As I mentioned in this report weeks ago, exceeding 1.5% on the 10-year Treasury yield would be a major headwind for the stock market, because that is the approximate yield for the S&P 500 index. Finally, there is an alternative.
More importantly, the reflex reaction to the bond yield spike is to sell the most expensive stocks in the marketplace with the fastest growth rates. This should come as no surprise, as I have been warning about it for months. Stock valuations that are more dependent on profits down the road (think Ark Invest) tend to have a much stronger inverse correlation with long-term interest rates. This is because those future profits are discounted to determine their present value based on rates. The higher the rate, the greater the discount to present value. As a result, the Nasdaq Composite has now corrected 10% from its high, which may be just the beginning of a revaluation of the entire technology sector. I do not envision a repeat of the bear-market decline from the 2000 through 2003, but I do see a revaluation of growth in a similar manner and a reemergence of value and more cyclically oriented sectors.
My target has been 2% for the 10-year Treasury yield this year, and that is gradually becoming the consensus call on Wall Street, which implies a lot of volatility ahead. It means an even stronger headwind for high-flying growth stocks, as well as the popular investment trends towards a number of high-yielding securities, especially the ones that use leverage. The deleveraging process after a decade of near-zero interest rate policy will be extremely painful.
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