Payrolls shock doesn't mean inflation reprieve; Here's a way to position: Alpha Tactics

  • April’s weak employment numbers threw the markets a curve, resulting in a counterintuitive reaction to payrolls missing expectations by more than 700K.
  • Stocks rallied, with the Nasdaq (COMP.IND) (NASDAQ:QQQ), S&P (SP500) (NYSEARCA:SPY), Dow (DJI) (NYSEARCA:DIA) and Russell 2000 (RTY) (NYSEARCA:IWN) all higher.
  • And bonds sold off, with the 10-year Treasury yield (NYSEARCA:TBT) (NASDAQ:TLT) up 2 basis points to 1.58%, making a round trip from the initial tumble to 1.47% after the report hit the wires.
  • Strategists pointed to how the sharp miss in payrolls, and a small rise in the jobless rate, will allay concerns about the Fed tapering bond buying anytime soon. Fed chief Jay Powell says he want to see more than just one good employment report and the tally still stands at one.
  • That cuts the likelihood of a taper tantrum. But the Treasury action supports the notion of a market worried about the Fed letting things run too hot.
  • “We’re walking into the biggest CPI prints of the recovery to date, there’s plenty of anecdotal evidence that prices are rising, and crude oil is rallying,” DataTrek Research wrote this past week.
  • The 10-year breakeven inflation rate, the difference between the nominal and real yields, rose to 2.49, the highest level in eight years.

  • “Powell clearly sees this as the market doubting that the Fed can actually get to its 2 percent inflation goal,” DataTrek said. “He is therefore entirely comfortable that inflation breakevens are at 2.4-2.5 percent right now. In fact, we suspect he would like them a little higher still so that when the Fed does start raising rates they can settle down to slightly above the Fed’s 2 percent policy goal level.”
  • J.P. Morgan says inflation already began in November and temporary frictions relating to supply chains, reopening and political and business decisions could compound it.
  • “Given the still high unemployment, and a decade of inflation undershoot, central banks will likely tolerate higher inflation and see it as temporary,” J.P. Morgan global markets strategists Marko Kolanovic and Bram Kaplan wrote in a note.
  • “Portfolio managers likely will not take chances and will reposition portfolios,” they added. “The interplay of low market liquidity, systematic and macro/fundamental flows, the sheer size of financial assets that need to be rotated or hedges for inflation put on, may cause outsized impact on inflationary and reflationary themes over the next year.”
  • To position for this, they recommend shortening duration and reallocating from bonds to equities and commodities.
  • Commodity indexes are “perhaps the most direct inflation hedge” and even with the latest surge, commodities are historically cheap as the only major asset class that has declined in absolute terms in the last decade, J.P. Morgan says.
  • In stocks, investors should buy value and short low volatility, as growth and quality “also have a negative correlation to inflation.”
  • The top five holdings in SPLV, the Invesco S&P 500 Low Volatility ETF, are Verizon (NYSE:VZ), Expeditors International of Washington (NASDAQ:EXPD), Bristol-Myers (NYSE:BMY), Costco (NASDAQ:COST) and Waste Management (NYSE:WM).
  • “Investors should also be cognizant that by embracing ESG they introduced additional short inflation exposure into portfolios (e.g., via long tech and short energy exposure),” the strategists wrote.
  • J.P. Morgan still remains overall bullish on U.S. stocks, though, with price target of 4,400 on the S&P.
  • Seeking Alpha contributor MTS Insights outlined on Friday why wage growth will be overcome by inflation.

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