By Dr. Chuck Lieberman, Co-founder and CIO
Economic growth is very strong, profits significantly outperformed optimistic expectations and hiring is robust, even as bottlenecks and labor scarcity hamper the pace of recovery. The rally in the bond market turned on a dime. Most Fed officials still seem to prefer maintaining the current highly accommodative policy stance, but the data are making an eloquent case, at a minimum, that the Fed’s bond buying program should be brought to a swift end. These conditions keep us positively disposed towards stocks and highly cautious about prospects for the bond market.
Evidence for a robust recovery is everywhere and crystal clear in the labor market. With 935,000 new hires in July, an upward revision of 119,000 to prior months, and a 0.5% decline in the unemployment rate to 5.4%, the strong pace of growth is indisputable. The difficulties firms are encountering in hiring are spilling over into wage rates, which have risen 4.7% over the past year and 5.5% at an annual rate over the latest two months for nonsupervisory workers. These cost increases are unlikely to stop.
Delta variant cases raised concerns that growth might weaken and the bond market rallied sharply since mid-March. With the Fed buying Treasury debt as fast as Treasury was issuing new bonds, the enormous deficit was not dumping large new supplies of bonds into the market. Even so, with strong growth and rising labor costs, the Fed’s hopes that inflation pressures will prove to be entirely transitory look increasingly like wishful thinking, so the bond market fell very sharply for two days. Conversations on when the Fed should start to taper its bond buying programs have surely been underway for months, but disagreements are now being expressed in public. Some are suggesting that the bond buying program should be tapered this year instead of waiting until next year. It appears Fed Chair Powell and a number of others would prefer to keep rates low by continuing to add more liquidity, despite the strength of the housing and labor markets, but the strength of the economy and wage inflation make that view harder to sustain. Chair Powell will speak later this month at the Jackson Hole Conference, a venue that has previously been used to announce changes in policy. Even if they choose to defer that decision a bit longer, they are running out of runway. Tapering will begin by the beginning of next year, at the latest, and could start sooner, unless Delta becomes much more problematical. But we suspect the rise in Covid cases will reverse within a few weeks, following the tracks of the U.K. and India.
The implications for investors are really straightforward. The economy is roaring ahead and profit projections are being revised higher, so the stock market should continue its ascent. On the other hand, we have likely hit the low yields for the bond market for the year and rates could rise substantially in the coming months. So, we remain positioned for more economic reopening in stocks and remain fairly defensive in our bond exposure, a game plan that has worked well this year and that should continue to work for the near term.
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