By Albert Lu
Last week’s strong jobs report sent U.S. stocks soaring. The Dow Jones Industrial Average rose over 300 points Friday on news the U.S. economy added 266,000 jobs in November, substantially more than the 187,000 expected by economists.
The S&P 500 reversed its losses for the week as it edged closer to yet another all-time high.
However, the news was not good for all. The strong economic data sent U.S. Treasury prices and gold futures down as markets priced in the possibility of a more hawkish Fed outlook. The benchmark 10-year Treasury yield climbed to 1.84%, while Comex gold futures for February delivery fell by 1.2%.
The report was more good news for a market that has returned over 25% on the year.
WHAT’S THE CATCH — IS THERE ONE?
Don Luskin, the chief investment officer of Trend Macrolytics, says no. Nevertheless, the author and economist concedes that trouble could still be around the corner.
“As you move forward through time, eventually something bad is going to happen. You never know what it’s going to be. … You could conceivably have an oil shock. You could have something that stops global oil supplies and oil goes to $300 a barrel.”
“The thing that’s caused more recessions than any other is the Fed tightens interest rates too much,” he explained.
But what constitutes “too much”?
If last year’s stock market performance is any indication, one might conclude that anything above 2% is problematic — recall, investors sent stocks tumbling close to 20% following an October policy decision that pushed the Federal Funds upper target to 2.25%. Markets eventually recovered, but only after considerable dovish jaw-boning by Fed officials.
ECONOMIES DON’T DERAIL THEMSELVES
Despite the appearance of a strong economy, Luskin identifies three key risk areas investors should watch — the first being the organization led by Federal Reserve Chairman Jerome Powell.
“Failure has many fathers; the Fed is certainly one of them. The good news is the yield curve inverted in May this year. That sent the Fed a loud and clear smoke alarm message: The house isn’t burning down, man, but you’ve got a fire in the kitchen — so put it out. And they did.”
“Did they save the world? Yeah, they saved the world from themselves.”
But will it last? His concern is it won’t.
Luskin believes the economy requires a steeper yield curve but questions if Powell is up to the task.
“We’re going to have to see if Powell can do better than his current posture, which is to say, ‘the economy is in a good place and policy is in a good place.’”
“If he doesn’t, then what this Fed chairman is telling you is that 2% is just fine. And that’s normal — you’re doomed to that.”
CHINA TRADE DEAL LOOMS
“The deal is close,” according to Larry Kudlow, economic adviser to President Trump.
We’ve heard that before.
However, as the U.S.-China trade war approaches year two, both countries are paying a steep price. In the U.S., manufacturing and agriculture sectors have suffered considerably. To soften the blow, the government last year paid farmers $8.6 billion in market facilitation payments — also known as Trump bucks — and has funded another $14.5 billion in 2019. Overall, U.S. GDP came in at 2.1% for the third quarter for 2019, higher than original estimates but still sluggish.
In China, growth slowed to 6% last quarter, its lowest rate in nearly three decades. Economists predict economic growth to slow further, dropping below 6%, in the fourth quarter.
The international dispute has affected asset prices across the spectrum. Mohamed El-Erian, chief economic adviser at Allianz, told CNBC: “This is once again a single-issue market — trade, trade, trade. It’s all about trade.”
Luskin agrees the continuing trade war is a potentially serious problem.
“The risk is that the trade war lingers long enough so that it truly impairs China’s economy and throws it into recession, which would in turn spill over into a global recession.”
THE GLOBAL OIL GLUT
The third big risk, according to Luskin, is oil.
The Organization of the Petroleum Exporting Countries (OPEC) and Russia, under pressure from U.S. shale producers, announced additional production cuts last week in an effort to bolster soft crude oil prices. The new proposal will bring the group’s total effective cuts to 2.1 million barrels per day.
“We are in a global oil glut and it’s getting worse and worse. We’ve been in a secular bear market for oil since 2008. Now, there was a secondary peak in 2014 and oil got as low as $25 in 2016.”
But inexpensive energy is not a bad thing, as Luskin freely admits.
“The reason for it is all good. It’s because we have a miracle in the United States called fracking that is making oil limitless … if we want it.”
Sounds good. But here’s the catch. As Luskin explains, the lost revenue carries consequences.
“Seventeen percent of the U.S. high-yield bond market is issued by frackers. And when the oil price collapsed in 2015 and 2016 … that shut down the whole junk bond market for the first quarter of 2016.”
Indeed, a repeat of that scenario would not be pretty.
REASON FOR OPTIMISM
Although his words spark concern, Luskin assures his warnings are not predictions.
“If these risks don’t eventuate and, in fact, if they get solved … then we’ll have another great year.”
“It’s the natural tendency of human beings to get up every morning and work, and try to make their lot better, and try to be inventive and creative and more productive, if you possibly can, for your own sake and for your family’s.
“So, the bias is for growth. The bias is for progress everywhere in the world.”
Let’s hope that’s enough.
Listen to Albert’s interview with Don Luskin here: