DROP IN PRODUCTIVITY AND JUMP IN LABOR COSTS RAISES INFLATION CONCERNS -- RISING YIELDS HURT HOMEBUILDERS -- YIELD CURVE INVERTS AGAIN
MARKET TURNS DEFENSIVE ... Two of the factors that have helped keep inflation under control are rising worker productivity and low labor costs. But that may now be changing. Fourth quarter worker productivity fell for the first time in five years. At the same time, labor costs rose for the first time in a year. Labor costs are one of the major factors in price inflation. Low labor costs over the past few years have helped offset rising raw material prices and have allowed corporations to hold back on attempted price increases. Rising labor costs increase the odds that raw material price inflation may start translating to consumer price inflation sooner rather than later. That would keep pressure on the Fed to keep raising short-term rates. And that helps explain why the stock market is reacting negatively to those two employment reports. Chart 1 shows the S&P 500 once again threatening its 50-day moving average. The MACD histogram bars remain in negative territory and have failed to confirm the recent price bounce. The Nasdaq 100 is already back below its 50-day line.
Chart 1
NATURAL GAS LEADS ENERGY PULLBACK ... Natural gas prices are leading a retreat in the energy sector. While most other oil indexes are in new record highs, Chart 2 shows the AMEX Natural Gas Index (XNG) pulling back from its late September peak. That's a logical spot to expect some short-term profit-taking. Crude oil is also pulling back from its fourth quarter highs near $70. That's also weighing on the market since energy stocks have been a recent pillar of strength (even though that's not a good thing longer-term). Another potential problem for the market is continued selling of homebuilding shares.
Chart 2
DR HORTON THREATENS 200-DAY LINE ... Housing stocks have been another pillar of the market over the last six years. Not anymore. The homebuilding group peaked in July and has been weakening since then. As a result, the group has gone from a market leader to a market laggard. The chart of DR Horton is a good example of that weakening trend. After peaking last summer near 42, the stock fell below 30 in November. The fourth quarter rally brought the big homebuilder within a fraction of its summer high. It's been falling since then. Today's trading has put it in jeopardy of breaking its 200-day moving average. The failed January rally may also be the second part of a major "double top". The relative strength ratio also appears to have peaked last summer. That's not good because housing has been a big source of consumer spending over the past few years.
Chart 3
YIELD CURVE IS INVERTING AGAIN ... Part of the reason for the selling of housing stocks is the recent jump in the 10-year Treasury yield which is the basis for determining mortgage rates. Unfortunately, shorter term maturities are rising even faster. Take the 2-year for example. The 10-year yield (Chart 4) has risen to a new three-month high (it's at 4.55% today). Chart 5, however, shows the 2-year yield having already exceeded its fourth quarter highs (and trading at 4.58% today). That puts the 2-year yield at a higher level than the 10-year which means that the yield curve has turned negative again. That can be seen better in Chart 6 which is a ratio of the 10-year to the 2-year. The stock market weakened in late December when the yield curve turned negative. This week's negative curve may be hurting the market again. What's different this time, however, is that long-term rates are starting to move higher along with short-term rates. In my view, that's bad for housing and is a bigger threat to the economy and the stock market. The fact that long-term rates are starting to rise also suggests that inflationary concerns are starting to play a bigger role in the mix of things. That may explain why gold is trading up to a new 25-year high today and inflation-sensitive stock groups have been doing so well of late -- while housing stocks haven't.
Chart 4
Chart 5
Chart 6
