Stock valuations provide a gauge of the actual price of a stock. Unlike most goods and services, the dollar price of a stock doesn’t tell us how rich or cheap it is. What matters are stock valuations or the multiple investors are willing to pay for earnings, sales, cashflows, or a host of other income-related metrics. Real rates are interest rates less the inflation rate or expected inflation rate. Like stock valuations, they help us assess whether bond yields are too rich or cheap versus the current or expected inflation climate.
Low or negative real rates are economically stimulative. Consequently, periods of low real rates tend to accompany higher stock valuations. Conversely, as we have today, high real rates are restrictive of economic activity. As such, they tend to weigh on corporate profits and stock prices. The graph below affirms the strong relationship between stock valuations and real rates. But, since October 2022, the correlation has severed. As shown in the Bloomberg/SoFi graph, real rates have risen sharply to fifteen-year highs over the last ten months. At the same time, stock valuations have become loftier. The recent gap between them is not sustainable. How will they converge? Lower yields? More inflation? Falling stock prices? Higher earnings? Or will some combination of those events or other possibilities close the irregular gap?
What To Watch Today
Market Trading Update
The market mustered a good rally yesterday ahead of Nvidia’s (NVDA) earnings last night. Not only did stocks rally yesterday, but bonds also rallied as interest rates reversed after their recent spike higher. We have seen several of these events over the last few years as sentiment becomes extremely negative on bonds, just about when owning bonds becomes optimal. Using the iShares 20-Year Treasury Bond ETF (TLT) as a proxy, the chart below shows that bonds recently pushed into deeply oversold territory, suggesting that a near-term rally was likely.
With the MACD signal close to a “buy signal,” such suggests that we could see a further near-term rally in bonds and lower yields in the days ahead. While TLT could rally to 102, which has been important resistance for bonds in recent months, a break above that level will suggest much higher bond prices, and lower yields, likely coinciding with weaker economic data. However, that is a discussion for later on this year or in early 2024.
Employment Data Revised Lower By 306k Jobs
For decades, one of the most important pieces of economic data has been the monthly BLS employment report. Investors and traders buy and sell based on the number of job gains or losses for a given month. While the data is very hyped, it is preliminary and often revised significantly. Notably, it is usually revised lower before recessions.
With that, the BLS just revised payrolls lower per its press release below:
Each year, the Current Employment Statistics (CES) survey employment estimates are benchmarked to comprehensive counts of employment for the month of March. These counts are derived from state unemployment insurance (UI) tax records that nearly all employers are required to file. For National CES employment series, the annual benchmark revisions over the last 10 years have averaged plus or minus one-tenth of one percent of total nonfarm employment. The preliminary estimate of the benchmark revision indicates a downward adjustment to March 2023 total nonfarm employment of −306,000 (−0.2 percent).
The graph below shows the monthly revisions year to date. As shown, prior to the -306k revision yesterday, they have already been revised down by about 200k. Be cautious in making long-term trading decisions based on government data, as revisions are often significant.
New Home Sales and Mortgage Applications
The graph below, courtesy of Renaissance Macro Research, shares another curious divergence. This time, the once reliable correlation between new home sales and mortgage purchase applications has broken down. Mortgage applications are at levels last seen in 1995, yet new home sales are trending higher.
What gives? Two factors explain the divergence. One, many new home builders are offering their potential customers lower than current mortgage rates. Instead of discounting their house prices to sell them, they discount the mortgage rate. Second, few existing homeowners want to sell their houses with low mortgage rates and buy a new house with a much higher mortgage rate. Consequently, new home sales garner a much larger percentage of home sales than is typical.
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