The Cycle Is Just Cycling Forward

1.) CYCLES – Economic cycles dictate movements within capital markets. For example, when growth and inflation are accelerating from their base effect (a MoM or YoY comparison), you have an environment that might “feel” bad for consumers as inflation accelerates, but capital markets thrive in that environment. Conversely, when you have both growth and inflation decelerating from their base effects, you have an environment where markets tend to really struggle and sometimes crash. An environment like that is hard for consumers to sometimes understand because inflation is subsiding. But that often limits demand as people watch prices fall and decide to “wait for lower prices.” So that brings deflation…very bad for capital markets. So where are we now? Demand ↑, Prices ↑ = growth and inflation accelerating, by definition. The largest part of the largest economy in the world notched a 4-month high in May as ISM Services printed the 2nd best reading since 2024, New Orders rose, and Breadth (# of industries reported growth) spiked to a new cycle high. Most people have no idea of this positivity. The media doesn’t report it. On the Prices/Input cost side, May marked a second month of “none” – as in the number of commodities down in price were “none”…inflation accelerating. Yesterday I commented on the labor market firming. Well, ADP just reported, and private payrolls printed +122K in May…a 16-month high. That’s the largest of 11 straight month-over-month gains. That just points to sustained labor-market momentum. 8 of 10 sectors gained with small employers (+49K) outpacing the gain in large employers (+40K). That’s important since small business is the real engine. ADP said… “Hiring was more broad-based than we’ve seen in years… the labor market continues to show sustained momentum.”

2.) DERAIL – So what’s the catalyst for a potential derailment? That’s always hard to predict, but at the forefront would be an episode of too-far-too-fast in long-end bond yields. Right now that isn’t an issue as long yields are down over the last two weeks. But they are also still in a bullish trend (upward bias) for now. Bond volatility is still contained, but a derailment would likely start there… a volatility spike that short-circuits stocks. Like anything, it can go too far. If the growth and inflation accelerations continue to intensify and/or inflationary pressures continue to accelerate, the Fed could be forced into a hawkish “tone.” That could cause the market to begin pricing multiple rate hikes and a path towards legitimately restrictive policy. Markets would not like that. We’re not there at this point, but there is a potential July/August fragility convergence. Based on the base effects (that’s just the previous number that gets compared), July is signaling a slowdown in growth and a continued acceleration in inflation. By definition of cycles, that’s stagflation. Q3 earnings comps also start to come out then, and they are meaningfully harder. Moreover, any residual tax stimulus benefit will have fully burned off by then too. Then there is the SPR (Strategic Petroleum Reserve). Will the energy shock intensify as they exhaust reserve releases? Right now, none of these are scored as acute market risks. Just items that could cause some bumpiness.

3.) OIL – West Texas Intermediate crude continues to trade in a bearish (downward bias) condition. That’s good heading into a typically busy summer driving season, but also interesting considering the likelihood of increased demand. Of course, it is very volatile with Oil Volatility (OVX) at 60.52. But that volatility is way down from the 126 high set back on March 12. If volatility can continue to settle down, we should see prices continue to as well.