Back To A ‘Bad News’ Is ‘Good’ Market
US equity markets registered modest gains last week as they digested a slew of economic data, bookended by a sluggish ISM manufacturing report (48.7 – sixth straight month in contraction territory) to kick off the week and a squishy soft jobs report on Friday. Before getting into the jobs report, let's run through how the major markets performed last week. The S&P 500 made a new all-time high of 6,532 on Friday morning before profit-taking took hold going into the weekend, while finishing the week with a +0.33% gain. The Nasdaq Composite managed a gain of +0.94% on the week despite Nvidia trading lower (down four weeks in a row) on the back of the news that Chinese tech giant, Alibaba, is coming out with its own semiconductor chip. The small-cap Russell 2000 index continues to rally (+0.98% on the week) on the anticipation of Fed rate cuts, and the Dow was the big underperformer with a -0.32% slide.
Anti-dollar trades performed well with gold closing the week at a new all-time high of $3,640/oz (gaining +4% on the week), silver rallying +2.8%, and Bitcoin rising +3.15%. As for the dollar, it was roughly flat on the week, but continues to show little in the way of an upside impulse. No doubt one of the major drivers of a weak dollar is the decline in interest rates we are seeing at the front-end of the Treasury curve, where the 2-year T-bill yield is down to 3.49% from 4.25% at the start of 2025 as the bond market front runs upcoming Fed cuts. The yield on the 10-year T-note continues to melt lower, trading at 4.06% as I type – down from 4.57% at the start of the year.
As for last week's data, August payrolls came in below expectations with just +22k jobs added vs. expectations for a print of +70k. Revisions to prior months saw July revised up to +79k from +73k, while June was revised down to -13k from +14k. Should that negative June print stand, it will mark the first monthly decline in payrolls in 53 months – ending the second-longest streak of jobs gains in US history. The unemployment rate rose from 4.2% to 4.3%, while that's partly because the labor force participation rate picked up, the broader U6 measure of unemployment jumped to 8.1% from 7.9% – confirming that labor market weakness is broadening out. Bottom line, this is a soft report: hours worked were revised down a tenth for July and held at that level for August, average weekly hours held near the low of the cycle (34.2), the construction and manufacturing sectors showed job losses for the fourth consecutive month, and ex-education and healthcare the U.S economy would have seen headline payrolls contract by -24k. These are signs that labor demand is weakening alongside what was already a troubled supply story due to immigration reform.
But as of now, investors are interpreting the stalling in economic momentum over the past four months as nothing more than a growth scare (self-inflicted with tariff chaos) while anticipating activity will pick up over the balance of the year and gain steam through the first half of 2026. Admittedly, I find myself in agreement with this view. Still, I’d be lying if I didn’t admit that a negative payroll print (like we had in June) doesn’t put me on notice to be prepared to abandon that view in short order if we don’t start to see indications of a pickup in the data beginning as soon as next month.
Last month’s Fed Beige Book was another data point detailing how economic weakness has broadened out across the country: more than half the country was either contracting or flatlining over the past six weeks, with four districts in contraction mode (Atlanta, Minneapolis, New York, and San Francisco). The comments on the labor market were consistent with what we’ve witnessed in payroll reports over the past several months:
“Eleven Districts described little or no net change in overall employment levels, while one District described a modest decline. Seven Districts noted that firms were hesitant to hire workers because of weaker demand or uncertainty. Moreover, contacts in two Districts reported an increase in layoffs, while contacts in multiple Districts reported reducing headcounts through attrition.” — Fed Beige Book, September 3rd
Another variable the bull camp has going for it is the repricing taking shape in the bond market as interest rates fall in anticipation of the oncoming Fed cuts. The bond market is now priced for 100% odds of a 25 basis point cut on September 17th, and the odds of a 50 beeper have moved up to 12% from 0% a week ago. Market-based odds of a subsequent rate cut at the October 29th Fed meeting have moved up to 84% from 54% before Friday’s jobs report was released. All told, markets are pricing in 75% odds that the Fed cuts 75 basis points over the year's final three policy meetings (up from around 45% on Thursday). This is why the 2-year T-bill yield is down around the 3.5% level, and as of now, why the equity markets are firm, as the lower cost of capital supports valuations and potentially breathes some life into interest rate-sensitive parts of the economy that have been choking on high borrowing rates. The chart below from Deutsche Bank shows that non-recessionary cuts can fuel huge equity rallies (median +50% in two years), though the S&P is only +15% since last year’s first cut.
So far, investors are betting on a soft landing, and rather than tell the collective intelligence of the market it's wrong (the S&P 500 is at an all-time high, after all), just go with it. However, keep in mind that the reason the Fed is cutting matters. Should this soft patch evolve into a recession rather than a reacceleration, then there will be a lot of investors drastically out of position.
I must admit that I’m a bit skeptical that rate cuts will act as the catalyst many investors are hoping for. A recent economic piece I was reading suggested the part of the US economy that is interest-rate sensitive is more than -10% below its historical norm. If that is true, then we’ll be looking at a Fed attempting to push on the monetary policy accelerator but simply spinning its wheels. Complicating the interest rate markets are factors outside of central bank controls, where fiscal concerns are starting to surface in those countries pushing the envelope on large-scale deficit finances.
Last week, we saw 30-year yields across the globe press higher. 30-year U.K. debt reached 5.69%, the highest since at least 2006. German and Dutch 30-year yields climbed to 3.4% and 3.57%, respectively, representing 14-year highs. At 4.49%, yields on French 30-year bonds closed at their highest level since 2008, and yields on long-dated Japanese debt have reached their highest levels in the past 25 years (see chart below).
This is all about bloated fiscal largess around most parts of the world coming home to roost, and it is a bit confounding that this is coinciding at a time when most central banks are in easing mode. The U.S. is at the forefront of this fiscal largesse, where it is now running annual deficits in excess of 6% of GDP and 100%-plus debt/GDP ratios for the first time ever in a non-war economy, and investors are seeing daily that the government is spending more on interest costs than on national defense (which attests to the structural erosion in fiscal finances which the Big Beautiful Bill failed to redress). Ergo, the trend towards steeper yield curves across the planet continues unabated.
This is definitely a market that investors need to watch closely going forward, because we are in an extremely fragile environment. Uncertainties surround not just bloated deficits bumping against all of the AI-related funding needs, but also the legal threat over the tariffs. I believe the bond market is comforted by the fact that the U.S. is creating revenue via tariffs (otherwise known as a tax) to offset fiscal excess in other areas. I don’t think markets will take kindly to the loss of this revenue source because I think it will cause a spike in interest rates, which will ripple through the entire financial system.
This is another of the many reasons why investors should have some gold exposure in their portfolio. It is a hedge against fiscal largesse, trade-related uncertainties, and diminishing Fed independence. Some investors perhaps aren’t as versed in history, but the last time we witnessed the Fed come under as much pressure and scrutiny as it is today was back in the late-60’s through the mid-70’s. In the years that followed Lyndon B. Johnson’s nattering at then Fed Chairman Martin and Richard Nixon’s constant badgering of Burns to cut rates, the gold price went on to soar 20-fold in the span of less than a decade. Gold is just about the best hedge there is against policy missteps.
But perhaps most importantly, gold is a hedge against currency debasement. The more I study the long-term trajectory of global fiscal finances and the unwillingness of global leaders to make the hard decisions today to rein in deficits, the more confident I become that the policy solution government officials will choose to address our over-indebtedness dilemma will be to inflate their way out. When I look at the performance of various asset classes and industries in the global capital markets today, I see the thumbprints of the debasement trade paying out. Granted, we’re eight or so months into what I expect to be a multi-year (maybe even lasting a decade) trend, but so far it is undeniable that investors allocating to real-asset investments have been rewarded. Look at the below chart, where I rebased various asset classes to 100 to gauge their relative performance since the start of this year:
What stands out is that while everyone continues to focus on the S&P 500 or Big Cap Tech, both of which have done well, their ytd performance pales in comparison to gold miners nearly doubling on the year. Sure, Nvidia is up +26% ytd (full disclosure – we own it in client portfolios) but the best performing of the Mag7 group is underperforming gold, copper miners, and modestly above global equities (ACWI) and emerging market equities (IEMG). I’m not disparaging US equities by any means. What I take away from this chart is that paper assets like the US dollar (-7% ytd) and 10-year US Treasuries (+5% ytd), which lack a claim on cash flows that are linked to prices going up, are underperforming real assets, which do have cash flows linked to prices going up.
This thesis has some staying power and is set up to perform well for the foreseeable future, but it won't play out in a straight line and will experience some ebbs and flows that cause investors to question whether or not it's still valid. However, as long as global policy makers continue to favor populism, fiscal largesse, mercantilism, and policies that perpetuate inequality, I think this thesis works. Should we see a shift towards austerity, leveling the inequality playing field, and/or some version of price controls, then I would be forced to change my view.
Now humor me as I throw out a dose of caution over the near-term setup. I know, I know…I’ve been espousing near-term caution for several weeks now, and yet the S&P 500 continues to log all-time highs. If we’re being fair, yes, the S&P 500 is at all-time highs, but it's really only up 2.45% since the end of July with a couple of modest 2% pullbacks along the way. Let me be clear, I’m not suggesting investors should unwind a well-diversified, process-driven investment portfolio.
My caution is more along the lines of aggressively chasing risk assets across the board. If you want to get into a position today, I suggest legging into it by buying a little and adding to it over time if the thesis continues to warrant such action. Prices have moved up a lot in many areas, and while they very well may continue to trend higher, it doesn’t mean today is a great entry point for most of them. Keep in mind the S&P 500 is trading at one of its richest valuation levels in history, and while valuations are a terrible timing tool, it doesn’t mean they are useless. Not to mention the Vix is down nearly 70% over the past 20 weeks – the largest decline since 1990. This is what complacency looks like. Not to mention virtually all of the big money, systematically driven investment strategies are currently fully allocated to equities.
Oh, and by the way, we just learned that the US economy saw job losses in June for the first time in this post-COVID recovery cycle. The historical archives are littered with caution flags when the US economy registers outright job losses late in a cyclical recovery. I fully admit that I am keeping an open mind to the uniqueness of this current soft patch being self-inflicted, and likely a pause that refreshes after a skyrocketing level of business uncertainty. But the threshold for my open-mindedness to be breached is razor-thin. My advice in a nutshell, move forward, but with caution.
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