Market Musings 061024: A Payroll Present

Market Musings 061024: A Payroll Present

Summary:

• US recession fears calmed by surprisingly strong US non-farm payroll report on Friday

• Sharp reaction in US bond yields, the 10-year Treasury yield rising to 4.0%

• Israel-Iran missile strikes raise tensions, oil prices as geopolitical risk premium rises

• US infrastructure spending continues to be a strong investment theme

• Tin, Copper and Industrial Metals generally get China stimulus-related boost

Question marks over the speed and depth of the decline in the US economy have led several commentators to forecast recession (a prolonged period of economic contraction) in the year ahead. Key to this was the rise in the US unemployment rate, which has climbed from a mid-2023 low of 3.4% to 4.3% as of July. Employment is a classic late-cycle economic indicator - and if employment were to fall, then consumption would also suffer and recession would follow.

Friday’s non-farm payroll data for September was therefore a closely-watched report, with economists forecasting on average a gain of 140,000 jobs in the month. In the end, the September non-farm payrolls rose by 254,000, far better than the forecast of even the most optimistic economists. The payroll numbers for the previous months were also revised higher to show a better overall trend in employment gains, together with a decline in the unemployment rate to 4.1%.

September US employment gains were much stronger than expected

I am very focused on the employment level in the residential construction sector (housebuilding), as this is a good early warning signal for the trend in US employment as a whole. The good news here is that residential construction employment continues to rise, suggesting that construction companies are hiring rather than laying off employees.

Focus on residential construction “canary in the coal mine”

With the decline in interest rates, we have seen the start of a recovery in the construction sector as mortgage demand has begun to return. We have to hope that this rising mortgage demand will translate into greater demand for houses, which will then support construction sector activity - a very important segment of the overall economy.

After hitting a recent low at 3.6%, US Treasury bond yields rebounded to 4.0% on Friday as expectations for the path of future Federal Reserve interest rate cuts were tempered. The market now expects the Fed to cut the benchmark Fed Funds rate by a further 0.25% in November, with the probability of a 0.5% cut back to almost zero following the non-farm payroll surprise.

US 10-year bond yield prices better growth in jump back to 4.0%

In turn, the US dollar strengthened substantially against major currencies such as the Yen, Euro and Pound Sterling. But this has to be set against a context of the downwards trend in the US dollar since peaking in late June.

US dollar also strengthened on expectations of fewer Fed rate cuts

The other major market event of this last week was the rousing military exchanges between Israel and Lebanon, Yemen and Iran. The Iranian launch of around 200 ballistic missiles against targets in Israel came in response to the Israeli killing of the Hamas leader in Tehran in July. After a sharp sell-off in crude oil prices since early July on concerns over rising supply from the OPEC+ group of oil-producing countries, Brent crude oil saw a repricing of geopolitical tensions, jumping 12% in a week.

Rising Israel-Iran tensions bring modest reaction in crude oil prices

Unsurprisingly, the oil & gas sector benefited from the recovery in crude oil prices, particularly in US oil & gas producers. This is logical, as US producers would not be affected by any potential closing of the Straits of Hormuz (through which most Middle Eastern oil is transported), but would benefit from any resulting spike in oil prices to $100/barrel and beyond..

Positive reaction from US Oil & Gas majors

These geopolitical tensions and the rise in long-term bond yields did not prevent the equal-weight S&P 500 index and the S&P 400 mid-cap indices from recovering close to the recent all-time highs. Note, however, that the technology mega-cap stocks continue to struggle to match this momentum. Ultimately, this broadening of the US stock market advance to include more stocks and segments is a positive development for the health of the current uptrend.

US Stocks: Equal-weight S&P 500, S&P 400 Mid-Cap lead, Nasdaq lags

I continue to be a big believer in the US infrastructure investment theme, given the tax credits available and the growing need to upgrade the electricity generation and transmission infrastructure to cope with rising electricity demand driven in large part by AI-related data centres. US energy infrastructure should also benefit from the ongoing LNG demand from Europe, which requires Texas natural gas to be transported to the East Coast for liquefaction before transportation further east.

US Infrastructure: A strong growth sector with good yields

Keep a close eye on silver, as it follows gold in finally breaking out to a new multi-year high above $32/ounce. Industrial demand for silver remains strong from electronics and solar panels, accounting for over 55% of total silver demand. I remain optimistic that the silver price can advance further, bearing in mind that the all-time high set in 2011 remains $50/ounce.

Silver: Finally following Gold with a new multi-year high

Silver miners should evidently be boosted by improving profitability on the back of rising silver, gold and copper prices. Recall that most silver miners do not mine only silver, but that in most cases, silver production is a secondary product after primary production of copper, zinc or gold. Copper, zinc and gold prices have all enjoyed strong upwards momentum of late, which should also support higher profitability for this sector.

Silver Miners: Should follow to make a new high

Industrial metals including copper and zinc have received an indirect boost from the recently-announced China central bank and government economic stimulus measures. Note that industrial metals prices are strongly correlated with Chinese stock markets - and that Chinese bourses have risen 25-40% in the past few weeks.

Tin, Zinc and Industrial Metals get China stimulus-related boost

Copper and Copper Miners are also rebounding post China stimulus

Fingers crossed for the week ahead,

Edmund