Macro
Friday’s payrolls show gains of 206k (vs. 188k estimate), a touch stronger than 190k expected. Cyclical employment has only risen by 55k, as 70k of the increase comes from government jobs and 82k from healthcare and private assistance. However, May and April’s data were revised significantly by a combined 111k jobs. The job growth was initially exaggerated as the business failures and closures were not fully captured in the initial estimates. The equilibrium rate to replace jobs we have right now is 100k, meaning that this is a breakeven rate.
Labour force participation in June was as expected at 62.6% (increased by 0.1% from 62.5% in May), and wage inflation fell to 3.9%. The unemployment rate rose for a third straight month to 4.1% (vs. the 4% estimate), pushing closer to triggering the Sahm rule.
After the presidential debate, people were concerned about the outcome of November. Observers are concerned that now, with the increased chances of Trump winning the election, it becomes more likely that we will have even more expansionary fiscal policies. This might boost growth in the short term but is unsustainable in the long run as it will bring higher debt burdens and higher rates in the long term. Furthermore, potential further tax cuts will reduce fiscal revenue and further increase debt, while planned tariffs could lead to increased inflation. The US economy is already growing at full capacity, while the current government has been running a deficit of 6-7% for the last few years, and with Trump, this might go up further.
Rates
Strong tan expected payroll data caused a surge in the treasury curve, from 13 bps at the front to 10 bps all the way at the back. The 10-year, which moved 12.5 bps, surged the most since the March CPI report. This short-term move is likely overdone and offers an excellent opportunity for rate investors to lock in yields at this level. This is likely because the market expects the cuts at the end of the year, and the FED admits that rates are currently restrictive and cuts are on the horizon.
At the end of 2021, we have entered a new era of monetary tightening. Once inflation started rapidly declining, fixed-income rate products offered investors significant growth of their purchasing power for the first time in 15 years. Fixed Income investors can now get 6 to 7 percent return without much of a volatility or long-duration risk. US Treasuries investors have now over 2% real yields across the curve, starting from 2.75% at the front end to 2.15% for long-term maturities. More attractive real yields at the front of the curve and the curve inversion attract investors to buy shorter duration.
Furthermore, it is reasonable to assume that the natural rate is somewhere near or above 3% rather than the 2% present in the previous monetary regime. In this instance, there is less downside risk of not extending the duration when the FED starts cutting rates, and therefore, there are fewer incentives to position on the back of the curve. Similarly, the stickiness of inflation in the era of fracturing and deglobalization and the fiscal deficit issues in the medium-to-long term demand more premium for the long-term rates.
Credit
The credit market story is a total yield story, with spreads reaching the bottom of the historic range. With those tight spreads, investors are positioning themselves for the late-stage cycle and trying to avoid economically sensitive securities.
Credit analysts face an environment of tight spreads and an undersupply of attractive securities. Value can be added through careful security selection and diversification away from traditional corporate issuance toward securitized credit and structured products.
Issuers have taken advantage of the very tight spreads over the last year, pushing away the wall of maturities. This has effectively reduced the potential trigger for the high level of defaults. Furthermore, with loose levels of covenants over the last decade, issuers have more flexibility to restructure their debt.
Equities
Equities were higher last week, with S&P and NASDAQ hitting their new all-time high and a three-week and five-week streak of gains, respectively. Gains were driven mainly by Tesla, which materially surprised with the Q2 delivery of 444k units (422k off Compact Model 3 and Model Y SUV), above the 437k consensus. Also, Tesla made it onto the Chinese government purchase list, an important move after the shipment of Tesla from the Shanghai factory fell by 24% YoY. This move means that government workers can purchase Tesla’s Model Y for official use, a great marketing strategy that can help boost demand in China. Despite strongly negative sentiment toward EVs, Tesla has fully recovered all the losses since April’s bottom, and it’s flat for the year but still 38% below its ATH from November 2021. Most bullish investors argue that the biggest upside will come from Vehicle Autonomy and Humanoids, and we might see share price acceleration coming up to the robotaxi-focused event in August. One of those Tesla bulls is Cathy Wood of Ark Investment, which currently holds a 5-year price target of $2,600.
Magnificent 7 stocks have added $8.8t to their market cap; in comparison, the second largest market in the world, China, has a market cap of $12.1t. They are in a unique position to deliver earnings and cash flows in the technology-driven economy.
Gen AI adds value across all economic sectors; cost savings and productivity improvements need to be priced in. This should then increase both the top and bottom lines and lead to broadening the market to other areas. In the first half of the year, Nvidia alone accounted for one-third of S&P 500 returns, and together with Microsoft, Meta, Amazon, and Eli Lilly, those five stocks account for 55% of index returns. The CBOE Implied Correlation Index has dropped significantly this year. The top 10 stocks account for 35% of the S&P 500, meaning that risk has moved from market risk to idiosyncratic risk from an allocation perspective.
Looking at the index performance, we see 22, 17, and 4 percent year-to-date returns for NASDAQ, S&P500, and DJIA, respectively, or 34, 27, and 15 per cent year-on-year returns. The picture is clear—tech drives the market. The S&P 500 is now also 14% above its 200 DMA. The ratio of the S&P 500 Equally-weighted to Market Cap Weighted is the lowest since the GFC, and the ratio of the S&P 500 Momentum index to Market Cap Weighted is the highest since the GFC.
Today’s tech sector has a 29.7x forward PE ratio, nearly twice the 20-year average of 17.2x. The Implied Equity Risk Premium is 4.1%, the lowest since 2008. Also, the current earnings yield is 3.84%, compared to the current 10-year yield of 4.27%. Investors are still focused on rate cuts, but the closer we get to November, the more this focus will shift to the impact of policies, taxes and fiscal support.
So far, the equity market is an AI market, and investors have been calling for broadening, but small and midcaps have yet to join the rally.
Early AI products are already showing massive value to productivity, but their revenue is low compared to the big Capex spending that has been made in that space.
Often an underestimation of the potential of new technologies. At the beginning of the first industrial revolution, when the rale started in the UK from 1800 to 1850, GDP grew at a 1% higher rate than in the past 50 years, and manufacturing in the UK doubled, cementing its status as a global superpower.
In the current environment, investors are bullish on equities, and even if things are getting a little frothy, money is rotating within rather than getting out of equities. There is still much disbelief in current growth.