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What a Hawkish Powell Means for Markets

 

January’s private sector job growth reported on Friday came in hot at 317k, significantly above expectations of 170k.

  • The hot print reduced the probability of rate cuts priced for 2024
  • Treasury bonds and precious metals took a big hit, as interest rates and the dollar spiked
  • However, stocks have yet to respond as investors continue to bid up tech

A resilient labor market reduces the urgency for the Fed to cut rates. However, there are a few other things worth considering:

  • Monthly job growth is very volatile, with spikes often reverting to the moving average
  • Job growth has been trending down since the Fed began its aggressive rate hike campaign

We expect the trend will continue to deteriorate, keeping inflation low and lead the Fed to cut rates in 2024. However, they’ve also clearly stated that they want to avoid cutting too early, which could cause some short-term upside on bond yields.

Strong disinflationary momentum is countering the resilient labor market:

  • The 3-month annualized core PCE inflation rate is currently 1.6%, below the Fed’s 2% target and matching the pre-Covid average
  • Consumers have run out of excess savings to fund big spending, which we believe will prevent inflation from picking back up

We’ll review the recent macro developments and assess where we stand in our asset positioning through a Macro Newsletter that we’ll post later this week. Stay tuned!

There’s been a couple of important developments since our last Weekly Asset Ratings update:

  • We’re downgrading TLT to a Long rating of 7 from a Strong Long of 9 given the last week’s messaging from the Fed against cutting rates too early
  • We’re swapping out Uranium Miners (URA) with Uranium Spot (SRUUF) given the latter is a much less correlated asset with U.S. equities (i.e., increasing diversification)

Ratings:

Gold Miners (GDX ETF)

Rating = Strong Long (8)

  • In a recent Flash Update, we upgraded GDX to a Strong Long of 8 from a 7. We capitalized on recent GDX weakness, upgrading when the GDX/SPX ratio bounced off critical support.
  • We’re bullish GDX as a levered bet on gold and expanding equity market breadth. We believe that the macro environment favors gold, and we expect market breadth to expand in the first-half in follow-through to the S&P 500’s technical breakout.
  • That said, GDX’s momentum has weakened lately and it’s now trading below the moving averages. If the GDX/SPX ratio fails to hold support as we’ve shown in prior ratings updates and in our recent Flash Update, we’ll downgrade to Neutral and re-evaluate the trade.

  • Spot gold and S&P 500 market breadth (i.e., share of index members trading above 200-DMA), have significant power in explaining the moves in GDX. We built a model to how GDX was being valued relative to these two factors.
  • We found that in the last six-months, GDX should have been up by 2% based on the rise in spot gold and breadth over that time, versus the 11% drop that GDX has seen. As a result, we expect less downside on GDX in coming months.

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Uranium Spot (SRUUF)

Rating = Neutral (5)

  • Over the last few months, we’d been covering Uranium Miners (URA) in our asset ratings posts, and had a Neutral stance as of our latest report posted last week.
  • However, we’re swapping URA with the Sprott Physical Uranium Trust (SRUUF) in our asset ratings to track the uranium spot market instead. We start with an initial rating of Neutral.
  • The uranium spot market is much less correlated with U.S. equities than uranium miners are. We prefer SRUUF given that we’re looking to diversify our overall exposure.
  • While we believe that uranium’s fundamentals look bullish in the long-term, we’re currently on the lookout for an opportunity to short SRUUF given how overextended it is today.
  • Please take a look at last week’s Investment Radar piece where we focused on the uranium market for more details. As we mentioned there, we’re using the Canadian vehicle (U.UN) for the technical chart given that its data extends further back in time.

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Technology Stocks (XLK ETF)

Rating = Neutral (5)

  • We’re monitoring the behavior of Tech stocks around channel resistance for signs of a rejection. The stocks look overextended, making them vulnerable in the short-term. A breakdown in the technicals here would see us downgrade our rating.
  • Given their big weight, downside in Tech stocks would corroborate our tactical view of the S&P 500, where we expect weakness in coming weeks before an otherwise resilient first-half.

  • Almost all the Magnificent 7 stocks have reported Q4 earnings (Nvidia on 2/21). The group, which is mostly Tech megacaps, shows weak sales growth (compared to pre-Covid trends), alongside a big increase in operating margins (i.e., operating profit as a share of revenue).
  • However, the improvements in margins appear to have peaked, meaning that the companies will become increasingly dependent on cost-cutting (i.e., layoffs) and AI-driven demand to justify their expensive valuations.

  • We believe a better bet on Tech stocks is through an equally-weighted exposure (RSPT) that avoids putting too much weight on the expensive Tech megacaps that dominate XLK.
  • That’d be a more calculated bet on equities, following the pullback that we expect in coming weeks. We’d expect RPST to outperform XLK amid a backdrop of a Fed pivot, as those events generally see breadth expansion and expensive stocks underperform.
  • We don’t see an objective entry into RSPT today (we have a Neutral rating) as the RSPT/S&P 500 ratio is near resistance. We’d look to upgrade our rating to a Long if the ratio were to re-test support.

Treasury Bonds (TLT ETF)

Rating = Long (7)

  • Following our upgrade to TLT to a Strong Long of 9 on 1/22, TLT gained over 5% due to the Treasury announcing no increases in coupon or floating-rate debt in coming quarters, and because of renewed concerns around regional bank exposure to commercial real estate.
  • However, Friday’s hot labor market report saw TLT fall over 2%. That’s a risk we’d mentioned last week in our last asset ratings post. Moreover, Fed chair Powell warned against cutting rates too soon, reiterating one of the key messages from Wednesday’s FOMC meeting.
  • As a result, we’re downgrading TLT to a Long rating of 7 on the back of these recent risks.

  • As we highlighted in last week’s ratings update, there’s a potential head and shoulders in TLT. If activated, it could lead TLT to fall to $86 in confirmation that investors got too ahead of themselves in pricing in rate cuts against the Fed’s stance.
  • We continue to believe that TLT offers a favorable risk-reward if a recession were to materialize later this year. We remain constructive above $92.

Copper

Rating = Long (7)

  • Copper has been trying to build an uptrend since November, and has recently rebounded off trendline support and is back above the 50-DMA.
  • Copper has been moving higher on the back of a Fed pivot weakening the dollar. Copper has proven very sensitive to dollar moves. A falling dollar would ease global financing conditions and help restart the manufacturing cycle, which would drive demand for copper higher.
  • We remain bullish with a stop-loss at $3.67. A breakdown from that level would see us revert to a Neutral stance.

  • We’ve liked copper as a bet on China rolling out fiscal stimulus, which would boost copper demand (biggest consumer of copper) with positive spillover effects for global manufacturing. We believe we’re getting very close to that point.
  • However, one key risk is that the dollar looks weak relative to U.S./China government bond yield differentials, which the dollar tracks. That’s because excitement around a Fed pivot has overwhelmed fears of Chinese weakness spilling over the rest of the world.
  • That makes copper vulnerable to the Fed pushing out rate cuts, which would delay any potential relief for global manufacturing and therefore negatively impact a key growth factor for China’s economy.

Gold (GLD ETF)

Rating = Long (7)

  • GLD benefited last week amid renewed concerns around risky regional bank exposure to commercial real estate. New York Community Bank (NYCB) posted big losses and had to set aside significant capital as a safety buffer against CRE exposure.
  • Regional bank stocks were down 7% last week. It’s uncertain whether the crisis at New York Community Bank (NYCB) will extend to the rest of the regional banks. However, this is exactly the type of environment that favors holding gold in portfolios.
  • Later last week, however, the above-consensus non-farm payroll print reported on Friday knocked out some of that momentum that GLD had built. With the trend in job growth down, we don’t see a significant threat to our bullish view on gold.

  • Gold has also benefited by rising geopolitical risk, which has been the case in recent weeks due to increasing tensions between the U.S. and Iranian-backed militias.
  • The yellow metal is a more valuable hedge than bonds in times of geopolitical uncertainty and when there’s uncertainty around the trajectory of inflation. Both are true today.