HH Potential For A Stronger Second Half In Stocks

Seems as though much has taken place in the first five months of this year that is newsworthy and impactful to the markets, i.e. Iran, North Korea, tariffs, an increasing 10-year yield, and I could go on. With the volume of news flow though, the equity market has essentially traded sideways this year with the S&P 500 Index price return equaling just 1.78%.

It seems with an equity market that has been pretty boring, some have focused on other issues, with one being a flattening yield curve. In the below chart, and I could go back further in time but suffice it to say that an inverted yield curve is not a positive signal, i.e., it is a recession predictor. As the below chart shows though, as the curve goes through the flattening process, stocks have been exceptionally strong performers. Recently though stocks have not been rewarded in spite of the continued flattening of the yield curve so far this year. Is the equity market spring being coiled?

Having noted the positive influence a flattening curve has on stocks, investors do not want to see the curve invert. In that regard there are two important economic events occurring that place upward pressure on the 10-year Treasury yield. First, inflation pressure is on the rise. The maroon line in the below chart shows the consumer price index (CPI or inflation) above the Fed's 2% target, i.e., rising at a 2.5% annual rate. The consumer segment accounts for approximately 70% of economic activity and if the consumer earns more in wages, they are likely to spend it; thus, having a positive influence on economic growth.In the same chart below, the blue line is the unemployment rate and it is at an extremely low 3.9%. This is an indication of a tight labor market and historically, this low level of unemployment has lead to higher inflation.

Secondly, the maroon line in the chart below shows a steady trend higher in the growth of average hourly earnings since 2013. The growth rate in wages is now running near the same level as inflation, i.e., 2.5%. Also notable on the chart below is the blue line that represents the percentage of small business firms (NFIB Survey) planning to raise compensation. In 2010 the percentage of firms indicating they were increasing compensation was essentially zero percent and today it is over 20%. Increasing growth in labor cost is fairly certain as one looks ahead, all else being equal.

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Disclosure: None.

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