Cracks in Employment Boost the Case for TLT

Investors got a very important data release on Friday. The ISM Services PMI for December showed a significant decline in employment in the service sector:

• Services employment dropped to 43.3, the biggest contraction since July 2020
• The service sector had been “pulling the economy’s weight” as manufacturing has been weak
• A recession is more likely if both services and manufacturing sectors are contracting

Weakness in the labor market is consistent with our view that we’re approaching the end of the cycle, with a recession in 2024.

That said, the exact timing could prove difficult as it could take some time for the “resilient” labor market to really unwind.

Non-farm payrolls were also reported on Friday. At first glance, the report was more constructive than the ISM one, with 216k jobs created compared to estimates of 175k.

However, we should take that with a grain of salt. Almost all the monthly payroll numbers reported in 2023 have been revised much lower than initially reported.

The weakening in the labor market is consistent with the steepening in the yield curve, we expect the economy to turn more vulnerable as the year goes on.

We’ll have more on that in an upcoming S&P 500 Memo later this week.

We’re not making big changes to our ratings on the back of the new jobs data:

• We’ve already been very constructive on recession hedges like TLT, GLD, SLV, GDX and XLU, and will remain so
• The pullback in TLT could prove an opportunity to buy on weakness for investors that may not have participated in the Fed pivot
• We remain very confident in TLT, particularly following the weakness in ISM Services employment

There were a couple of key development since our last ratings update:

• We’re reverting URA to Neutral from a 6 given that it closed the week below our stop-loss of $27.15 that we had set in a recent Flash Update
• We reverted XLE to a Neutral rating from a 3 in a Flash Update last Thursday given the potential for an imminent move higher in oil due to geopolitical flare-ups in the Middle-East

Ratings:

Assets:

Utilities Stocks (XLU ETF)

Rating = Buy (7)

• XLU re-established itself above the 200-DMA last week, something it struggled with throughout 2023. Price has been testing our $63 stop-loss but didn’t see a decisive break below it.
• The break above the 200-DMA could indicate a potential change in sentiment in Utilities. We’ve held a Buy rating of 7 since November, benefiting from the market pricing in a Fed pivot.

• The XLU/S&P 500 ratio is very close to multi-year channel support, and the recent move higher in XLU has coincided with a slight rebound of that ratio off it.
• XLU has been underperforming the S&P 500 for the last year. While it has recovered a bit, we could see another re-test of that support in the next couple of months. We’d be more willing to upgrade to an 8 or a 9 in the latter case.
• We see XLU as a very attractively-priced hedge with a favorable asymmetric setup where they stand to outperform in a Fed pivot, whether a recession materializes or not.

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Uranium Miners (URA)

Rating = Neutral (5)

• We’re downgrading URA to a Neutral stance from a 6 as it closed the week below our tight stop-loss of $27.15. We had upgraded URA a couple of weeks ago in a Flash Update on the basis of a potential technical bounce that could fill the gap-down of December 28th.
• The gap-down was mechanical in nature, driven by the URA ETF manager selling some of the fund’s holdings to fund dividend payments to shareholders on record. It wasn’t driven by weakening fundamentals, as that would not have led us to upgrade URA.
• Given no change in the fundamentals of URA, we were cautiously optimistic that the gap would be filled (hence the modest Buy rating of 6). That’d be an opportunity to get long with a better risk-reward. However, recent weakness in stocks could be spilling over to URA, acting as a drag.
• We’re monitoring the recent worsening in the technical picture for URA, as it decreases our positive bias on the asset.

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Equally-Weighted Tech Stocks (RSPT ETF)

Rating = Neutral (5)

• We added RSPT to the ratings a couple of weeks ago as a calculated bet on a Fed pivot rally. The equally-weighted Tech ETF offers very similar attributes to Tech names without the baggage of expensive valuations. Fed pivots systematically favor lower valuations.
• We started RSPT at a Neutral rating because price seemed overextended and close to resistance. The recent rejection off resistance confirms our concerns that the stocks looked vulnerable in the near-term.

• The recent weakness in RSPT looks outdone based on historical precedents capturing similar types of moves. That puts the ETF in our radar screen for a potential upgrade as a bet on a Fed pivot having legs, without taking a huge amount of risk like would be the case with XLK.
• If weakness in RSPT continues and price were to find support in the moving averages, as was the case in 2023, we’d be willing to upgrade to a 6 on the back of a more favorable risk-reward.

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Energy Stocks (XLE ETF)

Rating = Neutral (5)

• Last week we reverted XLE to a Neutral rating from a 3 in a Flash Update due to rising risks that Energy stocks could see an imminent short squeeze on the back of flaring geopolitical risks.
• The downgrade followed an intraweek breach of our $85.50 stop-loss and the formation of a head-and-shoulders with a target of $90. Please refer to that note for more details.
• We’re still looking to have XLE as a Sell because we are still very much confident on the macro setup. But we’re waiting for the technicals to look more opportunistic and with less risk of extending losses.

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Technology Stocks (XLK ETF)

Rating = Sell (4)

• XLK saw a sharp rejection off key channel resistance, something we had been warning in our recent work and consistent with our Sell rating of 4. XLK was significantly overextended, trading far removed from the moving averages.
• Price may retrace to near-term support and could make a run at filling the gap of November 13. That may ultimately coincide with finding support at the 150-DMA.

• We’re not downgrading XLK further because we’re not yet fully convinced that its upward run has come to an end. The XLK/S&P 500 ratio still has a bit more room to go to match the peak of the Tech bubble of 2000.
• We’ll wait a bit more for a re-test of that key resistance level before considering a downgrade. A rejection off that level would likely develop into a more sustained pullback that sees XLK re-test multi-year uptrend support, and possibly break it.
• For investors that are worried about XLK’s risks here, we recommend to look into RSPT given that it looks a lot less vulnerable due to lower valuations.

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Treasury Bonds (TLT ETF)

Rating = Strong Buy (8)

• TLT is taking a breather after a strong run on the back of the Fed ending its hiking cycle, validating our Strong Buy rating we’ve had since early-November.
• Despite the recent consolidation in TLT, we don’t see anything in the technicals that threatens our bullish stance. So we don’t see a need to downgrade at this moment. We remain constructive on TLT as long as it’s trading above $92.

• Despite the big gains in TLT in the last couple of months driven by the Fed pivot, we believe TLT still has significant runway ahead. The yield curve has a great track record in helping to predict the business cycle and it’s telling us today that we should expect a recession in 2024.
• The timing of a recession may prove tricky to get 100% right, and we could still be early in our conviction. However, the weakness in the PMIs that we saw on Friday tell us that the direction is down from here. We expect weakness in the economic data to accelerate as the year goes on. __________________________________________________________________________________________________________________________________

Copper

Rating = Buy (7)

• We’ve been turning more optimistic on copper in recent weeks, moving from a Neutral stance to a Buy rating of 7 as the technical setup has turned increasingly favorable. We see copper as an uncorrelated bet to U.S. stocks with Chinese fiscal stimulus as the driving factor.
• We’re constructive on copper as long as it trades above $3.67. A breakdown from that level would see us turn Neutral.

• Some members have asked why we’re bearish oil but bullish on copper, given that both are industrial commodities tied to the global cycle. We see copper as a different bet than oil, centered on potential for China (the largest consumer of copper) to deploy big fiscal stimulus.
• Also, copper prices look low relative to the huge demand in the energy transition over the coming decade. Positioning ourselves in a constructive stance ahead of potentially-decisive fiscal stimulus in China, would see us sync-up short- and long-term tailwinds for copper.
• While a U.S. recession poses a risk for copper, we’d expect it to force China to deploy large fiscal stimulus to counter that threat. That’d be a huge boost to copper prices, which have extensive runway to outperform oil based on a long-term channel.

Oil

Rating = Sell (4)

• Oil prices can’t seem to break out from key moving averages despite the recent rise in geopolitical risks lately related to flare-ups in the Middle-East. We’ve had a Sell rating of 4 since early-December and expect significant downside in a recession materializing this year.
• Price is hovering over key horizontal support. If that were to break, it’d indicate a very bearish signal for oil that could have legs, activating a head-and-shoulders pattern. We’d consider downgrading our Sell rating to a 3 or lower on a breakdown.
• We’d remove our bearish rating on oil on a break above the downward trendline.

• Outside of unpredictable geopolitics, one potential risk to our short oil view is that falling interest rates from a Fed pivot stimulates economic activity, boosting demand for oil and increasing prices. However, weakening demand trends are happening while supply is also rising.
• U.S. oil production has ramped up in recent months and helped offset production curbs being implemented by OPEC+. The combination of weakening demand and rising U.S. supply is a big negative for oil prices in coming months.