-- Milton Friedman
Headline payroll numbers today were strong, and talking heads all over the place are excited. Indeed, it was a solid beat, and we should all cheer more hiring in the US economy. However, quantity isn't enough. For true reflation to occur, there also needs to be quality beyond straight-up payroll growth. Average hourly earnings went nowhere fast, and that's undeniably still a cause for concern, combined with no lengthening in the average hourly workweek and falling participation rate.
Long-duration bonds aren't buying it so far, although admittedly the headline number may still be enough to push more money into equities. This is one of the more unusual junctures, given various areas of the investable landscape that have behaved as if a correction has been under way at the same time broad large-cap indices have held on strong. Treasuries further out on the curve have strongly outperformed. As noted in "An Intermarket Approach to Tactical Risk Rotation," the third-place-winning Wagner Award paper that I coauthored, when Treasuries do well, you tend to have higher volatility in stocks after strength has occurred. Of course, this isn't a guarantee, but the odds do increase.
In a honey-badger stock market, though, nothing matters. Perhaps the "overbought" nature of defensive sectors and Treasuries is about to be undone, and in the very near term provide an opportunity for stocks to try for another leg higher. The most bullish sign out there is a minor pickup in inflation expectations, which Treasury inflation-protected securities (TIPS) can help get a sense of. Take a look below at the price ratio of the iShares Barclays TIPS Bond Fund ETF (NYSEARCA:TIP) relative to the PIMCO 7-15 Year US Treasury Index Fund (NYSEARCA:TENZ). As a reminder, a rising price ratio means the numerator/TIP is outperforming (up more/down less the denominator/TENZ).
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If this trend continues, investor sentiment would likely continue to be supportive of risk-taking; however, the above has had many fits and starts in the past. Inflation expectations matter because they tend to be the conditions under which investors favor stocks versus bonds. Last year was a notable exception given very real deflationary behavior, but historical intermarket relationships appear to be normalizing.
Strong payrolls? Check. Wage growth? Nope. Reflation? Remains to be seen.
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