Note the series of financial crises in the graph below that have occurred when the bond volatility index (MOVE) is elevated by more than one standard deviation. We wrote two articles in recent weeks linking Fed rate hike cycles to crises. The first, A Crisis Is Coming: Who Is Swimming Naked?, helps appreciate why a financial crisis occurs every time the Fed hikes rates. We followed with From LTCM To 1966. The Perils Of Rising Interest Rates. The summary of two such crises stresses the importance of the Fed’s reaction function to quell a situation before it gets out of control. The high bond volatility raises our concerns.
The graph shows that bond option pricing currently implies significant interest rate volatility in the near future. For leveraged investors, stock or bond volatility increases the collateral required to maintain leverage. When collateral calls can not be met, liquidation events can occur. Some are market-moving. As if bond market volatility wasn’t causing enough stress, the market is also dealing with a surge in interest rates. The ingredients for a crisis are in place. The question isn’t whether we will have trouble. It’s when it will occur, which firm, sector, or country it will involve, and how quickly the Fed will react. Such may sound scary, but a reactive Fed, as we saw last March, can quickly offset the consequences of a crisis.
What To Watch Today
Market Trading Update
The market rebounded a bit yesterday as weaker employment data offset stronger service sector data. Interest rates also reversed after the recent thrashing boosting stock prices. The stock/bond correlation remains elevated for now.
Notably, the last two weeks of September and the first two weeks of October are generally weak in nature. However, as the end of next week approaches, earnings season will begin, which should support equity prices near term. With a large short position against equities, negative sentiment, and oversold technicals align, such provides the fuel for a counter-trend rally into November. We suggest using that rally to reduce and rebalance risk as needed for now. As discussed yesterday, if the recent bout of selling was indeed a liquidation event, we may not be out of the woods just yet. Therefore, keep a watch on the 200-DMA as a warning level near term.
The ADP Employment Report
“We are seeing a steepening decline in jobs this month. Additionally, we are seeing a steady decline in wages in the past 12 months.” – Nate Richardson- Chief Economist, ADP
The September ADP report shows job growth for September of 89k, almost half of what was expected. That is the slowest growth rate in over two and a half years. As shown below, large companies, in the aggregate, let go of 83k employees. The second graphic, courtesy of Bloomberg, shows that the Leisure and Hospitality industry accounted for 100% of the job growth. Many jobs in that industry tend to be temporary and low-paying. Consequently, slight changes in economic activity can quickly reverse the strong job growth we have been witnessing in the industry and in the entire labor market.
Yesterday, we shared the bullish jobs report from JOLTS. In particular, we highlighted the importance of focusing on the trend, not single-month data points. Furthermore, ZeroHedge backs us up on the importance of not reading too much into any one report. Per ZeroHedge:
According to ADP, Professional and Business services jobs plunged 32K. Why is this hilarious? Because JOLTS reported a 509K increase in Professional and Business Service job openings
All Sector ETFs Are Below Their 50dmas
The graph below, courtesy of Bespoke, shows that every S&P 500 sector ETF is below its respective 50dma. The last time we had a similar occurrence was in early October 2022. That instance was a prelude to a nearly year-long rally in the S&P 500. Similarly, the second graph shows that 93% of stocks are below their 50dma. Further, it highlights with arrows what occurred in the S&P 500 after the last four instances. The markets appear washed out and are overdue for a bounce.
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