Wage Growth Disappoints, Sending the 10 Year Yield Lower

Stocks Decline, But They’re Still Overbought

Stocks fell on Friday amidst the modestly disappointing jobs report, but they are still overbought. We need a flush lower to cleanse the market of euphoria, not a 0.29% decline. CNN fear and greed index only fell 2 points to 91 which is extreme greed. Usually the CNN index doesn’t stay this high especially when stocks fall. It needs to see at least 2 down days in a row in the S&P 500 to get out of extreme greed. 

Only category not in extreme greed is still volatility. It's only in neutral because volatility has been low for a while. This category measures the VIX versus its 50 day moving average which is low. Mostly because there hasn’t been any volatility since early October.

According to Sentiment Trader, the S&P 500 has had 26 one year highs in the past 3 months. Every time in the past 15 years, this number of highs has been reached there has been a decline in the next week. I’ve been calling for a decline in January, so I obviously agree. 

50 day equity put to call ratio is the lowest since the January peak. Of the past 5 times this threshold has been reached since 2009, 4 of them led to big corrections. I’d be shocked if stocks didn’t fall at least 5% from peak to trough this month. Many are expecting about a 10% correction. 

Decline will be blamed on some new fear. Personally, I’m actually less likely to get caught up in the negative hype because I’m expecting a decline. That’s not to say a negative catalyst can’t cause me to turn bearish on the intermediate term even after stocks fall 5% to 10%.

The graphic below is interesting because it’s the rare example of an indicator not saying stocks are way out of line. As you can see, the Bank of America Bull & Bear indicator is at 6.5 out of 10 which is neutral. Anything 8 or above is a sell signal. Credit market technicals, bond flows, and long only positioning are all neutral. It’s useful to show a near term indicator that isn’t flashing a warning sign.

Friday’s Market Action

VIX was up 2 basis points to 12.56. That’s a pretty small increase for a down day with the VIX starting at such a low level. Nasdaq fell 0.27% and the Russell 2000 fell 0.44%. Russell is down 0.65% year to date which is below the S&P 500’s 1.07% gain. 

Best sectors were real estate and utilities which rose 0.95% and 0.24%. They liked the 3 basis point decline in the 10 year yield to 1.82%. That decline is also why the Russell 2000 fell. Worst performing sectors were the financials and energy which fell 0.78% and 0.64%. 2 year yield fell 1 basis point to 1.57%. This points towards more rate cuts as the odds of a cut in 2020 are 66.4%.

Wage Growth Falls

The catalyst for the action in the financials, the 10 year yield, the utilities, and real estate on Friday was the disappointing wage growth. When hourly wage growth was spiking in 2H 2018, the 10 year yield was rising. 10 year yield’s subsequent decline predicted the decline in yearly GDP growth and the peak in wage growth. 

High wage growth in 2019 catalyzed the decline in profit margins. Lower inflation and costs are good for businesses, but lower pay growth is bad for consumers. If this trend continues, 2020 could see a rebound in profit growth and weakness in GDP growth.

Specifically, average hourly wage growth fell from 3.14% to 2.87%. That’s the lowest growth since July 2018. When the data is rounded to the hundredths place it looks much worse than if it’s rounded to the nearest tenth. Estimates were for no change in wage growth and it fell 27 basis points. The comp got harder by only 3 basis points, so the 2 year stack fell sharply. 

However, that was still a tough comp because it was the 2nd highest growth of the cycle. The toughest comp will be in February when growth peaked at 3.4%. As you can see, growth is down 53 basis points from the peak. This is a downtrend not a blip.

It's good to look under the hood beyond the headling reading of the report to understand where wage growth changed. Details there were poor too. Average work week was 34.3 hours which missed estimates for 34.4 hours. November reading was revised 0.1 lower to 34.3 as well. 

Declines in hours worked growth and hourly pay growth is a terrible combination for weekly wage growth. It fell from 2.84% to 2.27% which is the lowest growth since March 2017. It’s down from its peak of 3.63% in October 2018. As you can see, it peaked before hourly wage growth. Its comp was 33 basis points tougher, but it’s 2 year growth stack still fell 24 basis points.

Headline story of this report should be the massive decline in production and non-supervisory wage growth. You can see it in the red line in the chart above. Production and non-supervisory wage growth had been outperforming wage growth from managers, but that gap shrunk a bit with this report. 

Their wage growth fell from 3.39% to 3.03% which was the weakest reading since September 2018. 2 year growth stack fell 23 basis points. If inflation doesn’t fall, real wage growth will decline sharply. This report makes the 19 year high in the Bloomberg consumer comfort index in the first week of January surprising.

Conclusion

Stocks are still overbought despite the modest decline on Friday. Wage growth’s sharp decline pushed the 10 year yield lower. This decline in yields is bad for financials and good for real estate and utilities. A decline in wage growth is bad for consumer spending and good for profit margins.  

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