Why The June Employment Report Is Worth Closer Attention Than Usual

• Labor market crystal ball
• What are the credit markets saying
• Commodities ripe for a correction?

Labor market crystal ball

The weakness of last month’s Employment Report was a surprise to just about everyone, including yours truly. One month doesn’t make a trend, but two months of bad data could be the start of one. I am not forecasting weakness, nor strength as I honestly do not know. However, I can point out that one very reliable indicator is at a very critical level. Unlike the nonfarm payroll number, which is a coincident indicator, this one is a leading indicator of the labor market and a very reliable one at that.

It’s the Conference Board’s Employment Trends Indicator(ETI), which is constructed from eight leading labor market series. It’s published on the Monday following the Friday Employment Report. The red vertical lines show the approximate beginning of the 7 recessions since the 1960’s. As you can see, the actual data in the top panel has already crossed below its 12-month MA. However, we need to focus on the PPO (3/18) in the bottom window as the zero line acts as a sort of a recession signaling mechanism for the ETI. You can see from the vertical lines that by the time the indicator crosses below zero a recession is typically underway.  No indicator is perfect, as a false negative was triggered in 1966. However, the current reading is very close to the equilibrium line. This underpins the potential importance of the June report. That’s because a weak one could well send the indicator below zero, whereas a strong one would pull it back from the brink. It’s not the only leading indicator of course, but given the importance of labor market conditions politically, in the Fed’s mashinations, and as a driver of markets, Friday may give us some clearer direction on what we might expect moving forward.

Chart 1

What are the credit markets saying

The basic message I get from the technical position of the credit markets is that lower yields are here to stay for a while and that reflects a weakening economy. Charts 2 and 3 feature the two and five-year yields. The two-year series has clearly violated  an important up trendline in a fairly decisive way. The Special K has penetrated an even longer line and completed a top. This indicator is constructed by combining short, intermediate and long-term momentum into one series. Usually, but certainly not always, it peaks and troughs more or less simultaneously with the price series it is monitoring. Such turning points are subsequently confirmed, after the fact, by the kind of trendline violations we have just seen. In effect, recent action by the Special K for the two-year yield has just signaled an important trend reversal.

Chart 2

Chart 3 features the 5-year yield. The associated Special K has been falling for some time. The yield itself has completed a major top, whose formation began in 2013. The overall impression given by the chart is that rates are in a confirmed downtrend still.

Chart 3

Chart 4 features the two-year compared to the ten-year yield. This treasury yield curve spread also looks as though it is headed south as it has just violated two up trendlines as well as its 200-day MA. The Special K has completed a small top and ruptured a 2-year up trendline. The long-term technical picture suggests that this series is headed south as well.  A declining yield curve is known as a “steepening” and typically indicates a weakening economy. All recessions since the 1940’s have been preceded by this yield curve rising to .10 or greater and then falling. A reading in excess of .10 means that the two-year would be higher than the ten-year and this reflects a tight money policy. This condition is known as an “inversion”. When the curve starts to fall (steepen) the decline implies that the tight money policy, implied by the inversion, has begun to adversely affect the economy.  While the vast majority of recessions are preceded by the curve inverting, there are a couple of examples prior to 1940 when a recession developed without such a process taking place. Bearing in mind the softening economy indicated by the Employment Trends Index, it will be of more than passing interest to see whether the current steepening is  telegraphing something greater than a slowdown in the growth rate of the economy.

Chart 4

Commodities ripe for a correction?

Commodities, in my book, are in a confirmed primary bull market. As you can see from Charts 5 and 6 both the DB Commodity ETF and the CRB Composite are above their 200-day MA’s. Their respective Special K’s are also above their averages as well. Having said that, it is also apparent that both momentum series have reached, or are close to, resistance in the form of a multi-year down trendline. That, combined with a few negative short-term technicals suggests that some form of corrective activity lies ahead. In the case of the DBC that could well be the right shoulder of the indicated potential inverse head and shoulders in Chart 5.

Chart 5

Chart 6

Chart 7 for instance, displays a bearish short-term KST. The price has already violated its intermediate red up trendline and it looks as though it is going to complete a small top. This confirms the bearish action by the KST. If our bull market assumption remains a reality any corrective activity is likely to be limited say, to the 200-day MA at around $14.

Chart 7

Chart 8 features a key commodity in the form of the US oil ETF, the USO. Its price on an intraday basis has violated the neckline of a 3-month head and shoulders pattern. It remains to be seen whether it closes there, but it certainly looks as though a break of some kind has developed.  Note that the KST is already in a bearish mode and therefore likely to support such a move.

Chart 8

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.