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The February employment report crushed expectations for the number of jobs created (313,000 vs the consensus expectation of 205,000), and wage growth moderated from the surprisingly high January levels. For the moment, this is a best of both worlds scenario. The markets are sensitive to concerns about inflation, yet the February wage growth numbers softened after the spike up in January. This can mean that the Federal Reserve (Fed) will feel less pressure to raise interest rates aggressively and equity markets generally feel this is a “good thing”. LPL Research is calling for three rate hikes this year, citing a tight labor market and that wage growth is worth keeping an eye on.
Why all of this talk about inflation and interest rates? Historically, Equity Bull markets end, and Bear markets begin when the Fed has pushed interest rates above long term rates, which is often referred to as “inverting the yield curve”. For example, the S&P 500 Index peaked in 2000 and 2007 when the 3-month to 10-year Treasury yield cure was inverted by about 0.5% (3-month Treasury yields were roughly 0.5% above the yield on the 10-year Treasury note). The yield curve is considered one of the most reliable leading indicators because every recession over the past 50 years has been preceded by the Fed hiking rates enough to invert the yield curve – 7 out of 7 times. The yield curve inversion usually takes place about 12 months before the start of a recession, but lead times vary, ranging from about 5-16 months. The peak in the equity market has historically come around the time of the yield curve inversion, and ahead of the accompanying downturn in corporate profits.
This is a strong reason that LPL Financial Research believes the equity Bull market will continue this year. With the 3-month and 10-year Treasuries currently yielding 1.67% and 2.89%, respectively, the Fed must push up short term rates by more than 1.7%, assuming a constant 10-year yield, to invert the yield curve by 0.5%. According to LPL, the roughly seven hikes of 0.25% each that would be necessary to push the fed funds rate over 3.4% may still be two years away, if not more. Hopefully, this encouraging information finds you well and as always, contact us with any investment questions you may have – Mark
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. Economic forecasts may not develop as predicted. Some of this research material has been prepared by LPL Financial. All indices are unmanaged and may not be invested into directly. Referenced material: LPL Research Weekly Market Commentary & LPL Research Weekly Economic Commentary, both dated March 12, 2018. Approved Tracking #: 1-709819.