It was a quiet week in the markets with modest changes in both stocks and bonds. For the week, the S&P 500 was up fractionally (+0.2%) while the NASDAQ dipped -0.4%. Small-caps underperformed with a -1.2% loss while international stocks outperformed. The EAFE was up +1.0% while EM equities were up +0.5%. Hong Kong and Brazilian equities stand out with over +2% returns on the week.
Bond yields were little changed week-over-week, although bond yields did increase (prices fell) on Friday after the solid jobs report. It was the same story for the dollar. It was under pressure all week until it staged a rally on Friday. For the week, the dollar was little changed. But it’s August after all. Congress and the President are on vacation. Traders and PM’s head to the beach. While the month tends to be negative for stocks, volumes are almost always on the low side.
Will We See 4% This Year?
Friday’s payrolls report was solid. The economy added 209K jobs in July while June’s number was revised higher to 231K from 222K. The unemployment rate slid to 4.3% from 4.4%. This matches the 16-year low hit in May.
The increase in average hourly earnings met expectations. Earnings were up +0.3% in July, resulting in a year-over-year rate of +2.5%.
This doesn’t mean much for third quarter economic growth. Expectations are all over the board. After Friday’s payrolls report Goldman increased their estimate by one tenth to +2.6%. The Atlanta Fed’s widely watched estimate is running at +3.7%, as you can see below. In the office pool you could do worse than simply taking second growth and extrapolating it into the third quarter.
Finally, the payrolls number didn’t move expectations for Fed policy much. The odds of another quarter point hike by December ticked higher to roughly 47%, as you can see below, but traders still think there is a decent chance of no hike for the rest of 2017.
This seems overly optimistic. Steve Blitz, chief economists at TS Lombard summed the situation up well:
“The Fed looks at employment in the aggregate and what it will see in the July data is reason enough to keep with their forecasts and, by extension, their plans to begin balance sheet reduction in October and raise the funds rate another 25bp in December. The great deceleration in hiring that began at the beginning of 2015 and ran through 2016 is now done with, monthly private sector job gains are settling in at an average of around 180,000.”
This means the market is probably underpricing the odds of a December hike. There is no reason to expect employment growth to soften materially over the next three months and the unemployment rate should continue to push lower. Will we see a 4% unemployment rate this year? It is certainly possible, although the first quarter 2018 looks more likely. But either way, the prospect of 4% should keep the Fed on the tightening war path.
Oil and the Venezuelan Wildcard
The Economist cover last week spoke for itself.
What’s happening in Venezuela has been in the making for many years. Hugo Chavez started the ball rolling, but the economic, political, and humanitarian crisis really began to spiral downwards under Nicolas Maduro. Plummeting oil prices and (almost undoubtedly) massive corruption have bankrupted the country. The chart from The Economist below shows how bad things have gotten. The economy may have contracted -15% last year. Between 2013 and the end of 2017 GDP will probably have declined by more than -35%.
An often-quoted statistic from a survey carried out by a group of universities earlier this year found 90% of people are living in conditions of poverty and can’t buy enough food, and 75% of people have lost significant weight in the last year. These numbers are believable when you consider that the monthly minimum wage (in dollars) has fallen from roughly $300 to just $20 while inflation is running at 1,000% per years (chart below). While the official exchange rate is $1=10 bolivares, the black-market rate is $1=9,000.
The Economist closed their piece on an ominous note:
“Barring a negotiation, the other route looks bleak. There is a growing sense of anomie and anarchy. On the opposition side, there is desperation in the self-barricading of its own neighbourhoods, an action which does little to hurt the government. Social media have been vital in undermining the regime’s control of information. But they also spread rumours and undermine moderation. Middle-class caraqueños are reading books on non-violent resistance. But on the streets many protesters express mistrust for the MUD. The “Resistance” is well-organised and trained. It would not be hard for it to take up arms.”
A Half Million Barrels Makes a Difference
The human situation is undoubtedly tragic. But the political turmoil could also meaningfully impact the oil markets in the months to come. Despite all the problems, oil production in Venezuela has been pretty stable. As you can see below, they produce about 2 million barrels per day, down from roughly 2.4 million back in 2015. But over this period OPEC production (and U.S. shale production) has more than offset the contraction.
At the moment, the U.S. imports 800,000 barrels per day of Venezuelan heavy crude. The rest of the country’s production goes largely to China (to pay off past loans) or to Cuba and other Caribbean countries at below market prices.
However, if violence were to break out, the oil infrastructure in Venezuela would be a natural target. OPEC and U.S. production couldn’t quickly make up for the loss of another 400K to 500K barrels. Take a look at OPEC’s June production numbers. They were up 400K barrels. Over the same period oil prices fell from roughly $48 to a low of $42.53.
If, in the months to come, Venezuelan production takes a hit, prices could easily push back towards $60 before OPEC and the U.S. could respond.
And finally, if you want to see a counterintuitive chart, look at the Caracas stock market (chart below). Over the last 12-months it is up 1,317%.
Strangely, with inflation running at 1,000% cash has no value. Local investors are forced to buy real assets or equities. Of course, such an increase doesn’t come close to compensating for the collapse in the currency.
Have a good weekend.
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