June 4, 2016, Weekly Summary: Confusion, Uncertainty, and Assumptions

Confusion, Uncertainty, and Assumptions

The employment numbers came in looking worse than anyone had imagined. Nonfarm payrolls increased by only 38K, while the April number was reduced from 208K down to 186K. This is not a healthy trend, as illustrated in the chart below.

This undeniable slowdown in job growth is in stark contrast to the initial claims readings that have stayed below 300K for more than a year, and the unemployment rate that dropped from 4.9% to 4.7%. Unemployment hasn’t presented this low since November 2007, but we have to keep in mind that the labor force participation rate (employment/population) dropped from 62.8% down to 62.6%, indicating that it was workers leaving the arena, not more people working, that reduced the unemployment rate.

Factory orders were up, consumer spending came in very strong for May, but the ISM services were down. There is still more data reporting for the month of May coming this week which has the potential to add further confusion and uncertainty. With uncertainty comes volatility, equity discounting, and assumptions about how the FED is going digest this contradictory data.

The CME Fed Watch tool is now implying only a 3.8% chance of a rate hike in June (we never gave much credence to a June hike), and only a 30% chance of one in July. Under these conditions, the dollar’s slap-down is no surprise, nor is the pop in the gold price. The question remains, however, what is the FED going to do now that its trial balloon has been popped?

The FED has made it clear that it is desperate to raise rates soon, but has hedged itself by touting its dependence on data. So, how will it handle this confusing data? Will it take the slowing job growth as a sign that the economy is not strong enough to take a rate hike? Or will it point to the eight-and-a-half-year low in unemployment, the factory orders, and the consumer confidence as evidence that a rate hike is needed? Keeping unemployment at 5% is half of its dual mandate, while the other half is getting inflation up to the 2% target. It has not succeeded in accomplishing the latter.

U. S. Inflation

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Our Price Modelling System continues to give a negative reading, even though it is less negative than it was a week ago. Our other studies are also painting a picture of weakness in the S&P 500. In the chart below, notice how the pattern of negative divergences in the Rydex Bull funds and the S&P has preceded corrections in the S&P. Normally, the bullish allocation of funds increases as the S&P rises (positive correlation), but when the bull allocation drops as the S&P rises (negative correlation), a market correction follows. That pattern could be in play at the moment.

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Finally, the counter-trend sentiment pattern (chart below) is still a possibility and shouldn’t be discounted.

The assumption made by the market that the FED is not going to raise rates any time soon has sent the dollar tumbling down, and bonds and gold rallying strongly.

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The chart below shows the gold and 30-year bond moving synchronously, which is normal behavior.

The chart below shows the gold versus dollar move. We note that the move, so far, in gold and the dollar, is not outside the pattern that we were expecting (blue arrows). As long as the dollar stays above the 92 level (on a close basis), then gold will likely not break the $1300 resistance. Like always, however, these are only probabilities, not prescience.

The commitments of gold traders were reduced again this week with both the large speculators and the commercials reducing their positions. This is the most bullish of the indicators and raises the probability of further price increases in gold, but we won’t have an idea of what happened on Friday until the end of next week. The speculators are still heavily long (78%) and the commercials are still heavily short (72%), however. Notice, in the charts below, that the positions of both groups tend to reduce along with the price of gold, so how the positions changed on Friday will indicate the expectations of the speculators and commercial traders.