Robert Genetski: Today’s jobs report shows the labor market growing rapidly in May, while rising prices remain a problem.
The Week That Was
Today’s report showed May jobs continued to grow rapidly. The total monthly gain was reported at 272,000, with 229,000 private jobs.
The job report is consistent with business surveys showing the economy continues to grow at about a 2 percent to 3 percent pace in the current quarter.
Earlier in the week, business surveys for May also reported growth. Although the ISM (Institute for Supply Management) survey had some weakness in manufacturing, it was more than offset with a surge in the service sector. Both ISM and S&P surveys agree the economy continues to expand at a moderate pace while inflation remains a problem.
Things to Come
Wednesday’s CPI report likely will show inflation elevated with year-over-year increases in the 3½ percent vicinity.
A sharp decline in oil prices will reduce overall monthly inflation. The Cleveland Fed’s forecast for the total CPI in May will show only a 0.08 percent increase. However, it projects a core rate of 0.3 percent for the month. If these numbers are correct the year-over-year inflation would be 3.3 percent for the total and 3.6 percent for the core.
The Fed will have this information for its Wednesday afternoon policy announcement. With yearly CPI inflation likely to remain well above its target, the Fed will signal its intent to keep short- term rates elevated until there is more evidence inflation is contained.
On Thursday, producer prices are expected to follow the lead from consumer prices with only moderate gains due to lower oil prices and higher increases in core prices.
Market Forces
The bulls are running as major indexes registered new all-time highs. Our current analysis shows the S&P500 is 34 percent overvalued. The greater the overvaluation, the greater is the risk of holding stocks.
Although significantly overvalued, the potential for further significant gains still exists. Market psychology remains positive. Investors welcome good news on the economy assuming it means higher profits. Investors also like bad economic news on the assumption it will lead to lower interest rates. Market psychology isn’t always logical.
If today’s positive psychology were to reach the extremes from the second quarter of 2000, the S&P500 would be above 8,000. Given the power of psychology to drive markets to extremes, it can be helpful to closely monitor technical (psychological) indicators. Our extensive analysis of these indicators suggests they can provide useful signals to where stock prices are heading.
Our technical model uses over a quarter century of daily S&P500 data to identify patterns of short and long-term cyclical patterns. These patterns indicate the probability associated with further increases in stock prices. The current probability is 65 percent. This means the near-term outlook for stocks is mildly positive. More details on our technical model will be discussed in the upcoming monthly report.
The recent sharp decline in longer-term interest rates has their 10-day averages below their 50-day averages for Treasuries (and are about to cross for corporate yields). This shift tends to signal a shift from the upward trend of the past five months, increasing the odds of lower interest rates.
Outlook
Economic Fundamentals: positive
Stock Valuation: S&P 500 overvalued by 34 percent
Monetary Policy: restrictive
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