Daily Comment (February 2, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] Happy employment day!  We cover the data in detail below but the initial read is that it’s a blowout.  Payrolls rose sharply, better than forecast, and wage growth accelerated (although not for all workers).  Financial markets are not taking it well; it’s another “red day” where interest rates are rising, equities are weaker and the dollar is up.  Here is what we are watching:

Is Goldilocks stuck with a porridge that is too hot?  Economic growth in the U.S. and around the world is solid.  Of the 38 countries that report manufacturing PMI, 35 are above 50.  As we note below, the employment data was quite good.  Although it is early in the forecasting process, the Atlanta FRB’s GDPNow report is rather shocking.

We expect this number to come down but, even at this early stage, it reflects an expanding economy.

So, why isn’t this good news?  A key factor to the strength in both bond and stock markets over the past nine years has been slow and steady growth, which has produced rising earnings with low inflation.  Growth acceleration raises fears of inflation and will likely prompt the Fed to raise rates steadily.  The three hikes expected for this year could turn into four and, eventually, rising rates will adversely affect the economy.

Equity prices are a function of earnings and investors are willing to pay for those earnings.  Rising inflation will tend to undermine the willingness of investors to pay up for earnings.  So, even though rising economic growth could bring even stronger earnings, equities could be constrained by a moderating P/E.  At the same time, it’s important not to become overly pessimistic here.  Bear markets are usually tied to recessions and there isn’t any evidence that a recession is approaching.  A more likely outcome is a stronger equity market with increased volatility.  The steady rising market we have seen in the past couple of years probably won’t be the path in 2018 even though the trend is higher.

Bitcoin tumbles: Bitcoin continues to spiral lower as governments boost regulatory scrutiny.[1]  India is now joining China, South Korea and the U.S. in either taking full regulatory steps or at least examining such measures.  Axios reports that foreign governments are using cryptocurrencies to evade sanctions.[2]  All this suggests that the movement is facing headwinds.

(Source: Bloomberg)

As the chart shows, bitcoin is down over 53% from its closing peak in mid-December.

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[1] https://www.wsj.com/articles/rise-of-bitcoin-futures-prompts-regulator-to-revisit-hands-off-approach-1517394600

[2] https://www.axios.com/how-cryptocurrencies-used-to-evade-sanctions-b752de25-0c2e-42f1-a04c-33aad930c6ed.html?utm_source=newsletter&utm_medium=email&utm_campaign=&stream=top-stories