A Reality Check: The Market’s Not-So-Happy Slap in the Face

Just when we were all getting comfortable, basking in the glow of a market that seemed unstoppable, reality decided to drop in with a bucket of cold water—and it wasn’t just a splash, it was a full-on slap across the face. Yes, I’m talking about the recent bombshell: the revision of job numbers that tells us the labor market isn’t as strong as we all thought.

Riding the Highs Before the Slap
Let’s rewind a bit. The stock market has been on a tear, with the S&P 500 (through the SPY ETF) almost reclaiming its all-time highs after a sharp V-shaped recovery from the lows of August 5th. The rally has been impressive, leaving many investors feeling invincible. But as we approach those historical peaks, it's a good time to pause and consider the risks.

The Initial Jobless Claims Rollercoaster
Two weeks ago, we all breathed a sigh of relief when the initial jobless claims came in lower than expected at 227,000, sparking hopes that maybe the labor market wasn’t as fragile as feared. But last week, the number jumped back up to 232,000—exactly what the market was expecting, but still above the critical 230,000 threshold that tends to unsettle investors. And while this figure met expectations, the fact that it crossed 230,000 again is concerning. It highlights the volatility and inconsistency in the jobless claims data, which makes it difficult to gauge the true health of the labor market. We need to keep a close watch on this trend, especially since the drop two weeks ago seemed to give the market a false sense of security.

Then Came the Revised Job Numbers: Ouch!
But then, bam! The Bureau of Labor Statistics comes out and tells us that job growth wasn’t just slowing down; it was crawling—818,000 jobs fewer than we thought. This revision has certainly changed the narrative, making the labor market appear much weaker than previously believed. The Sahm Rule, which was already signaling caution with a 0.53% increase, now looks slightly more concerning, rising to 0.57% if the August unemployment rate hits the predicted 4.4%.

This brings us to a critical question: is this still a “false alarm”? Last time the Sahm Rule crossed 0.5%, both its creator and Fed Chair Powell reassured the market that it might not be a reliable indicator this time, citing the pandemic's disruptions to the financial system. They suggested that the 0.53% spike could have been an anomaly. But here’s the thing: if this was truly a false alarm, we should have seen the Sahm Rule normalize in the following months. Yet, here we are, with projections suggesting the Sahm Rule could continue to rise in the coming months. If that’s the case, can we still dismiss it as a mere anomaly? I’m skeptical.

And what about the Fed’s explanation? If the Sahm Rule continues to climb, how will they justify this persistent upward trend? The market is already on edge, and if the Fed’s narrative starts to fall apart, we could be in for a rough ride.

Fed Policy Shift: Powell’s Jackson Hole Speech
Powell’s speech at Jackson Hole also marked a significant shift in Fed policy. He made it clear that the Fed has completed its "pivot"—the focus is now on maintaining a strong labor market rather than solely targeting inflation. Powell emphasized the slowdown in the labor market and warned of the need to tread carefully. This was the first time he used strong language like “unmistakable” and “we will do everything we can,” signaling the Fed’s commitment to doing whatever it takes to support the labor market. This shift in tone and focus suggests that the Fed is deeply concerned about the current state of the economy and is willing to take aggressive actions to prevent further deterioration.

A Watchful Eye on September: Preparing for What’s Ahead
While we’re still holding onto some hope for a soft landing, I believe the real test will come in early September. That’s when we’ll get the updated unemployment data and see if the market’s optimism has been justified or if we need to start bracing for a more serious slowdown. If the unemployment rate ticks up to 4.4% or 4.5% and the Sahm Rule nudges higher, the market could start recalculating the odds of a recession. Given the historical context where September often yields poor returns—sometimes as much as 4% in losses—it’s important to remain cautious as we head into this traditionally challenging month.

Moreover, if the Fed decides to cut rates by 0.5% (two basis points) instead of the expected 0.25%, it could signal that we’re not heading for a soft landing but rather a hard landing—a scenario where the economy takes a sharper downturn, leading to a recession. In such a case, the stock market could take a hit while U.S. Treasuries would likely surge as investors seek safer assets.

A Few Thoughts on Strategy
So, what should you do? If you’re already sitting on some nice profits, think about selling a portion of your stocks and beefing up your cash reserves. It’s not a bad idea to have some dry powder ready in case the market dips again—you don’t want to be caught with your pants down if things go south. Alternatively, you could consider reallocating some of that cash into U.S. Treasuries, specifically through ETFs like TLT. With unemployment on the rise and the Sahm Rule showing signs of stress, bonds might offer a safer haven than stocks.

Remember, this isn’t just my opinion. Bloomberg and other analysts are also waving the caution flag, suggesting that things might not be as rosy as some of the more optimistic investors believe. So, before you get too comfortable, take a step back and make sure you’re ready for whatever the market throws your way.

In times like these, being too optimistic can be a dangerous game. Stay vigilant, stay prepared, and don’t let the market’s short-term gains blind you to the potential risks ahead.

Wrapping Up with a Note of Thanks
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