Good News is Bad News (U.S.) and Bad News is Bad News (China)
Welcome back from what we hope was a wonderful Labor Day weekend. As we think back beyond the long break, we think of more of the same in the markets. Last week brought more of the same uncertainty that has kept investors on edge throughout the latter half of the summer. Global market volatility persisted, as investors remained nervous about China's slowing economy and a possible interest rate increase at the U.S. Federal Reserve's mid-September meeting. Market volatility was elevated on a daily basis, with major market indices down overall. A positive U.S. jobs report added to nervousness about rate hikes on Friday. The VIX index, which measures U.S. stock market volatility, stood near 27 Friday, historically higher than normal but down from a midweek peak above 33.
News on the jobs front continued to improve, even if incrementally. The U.S. economy added 173,000 jobs in August, fewer than expected, but initial estimates for August tend to be revised up substantially in later months. We will keep readers posted on that score as revisions come in later in the fall. The unemployment rate fell to 5.1%, the lowest in more than seven years. Average hourly earnings increased 8 cents and average weekly hours worked rose to 34.6 The broader U6 measure of joblessness, a data point we pay particular attention to as it includes discouraged workers and those working part-time for economic reasons, fell to 10.3%, the lowest rate since June 2008.
Another area we pay particular attention to is worker productivity, a necessary component to a healthy, growing economy. U.S. nonfarm productivity rose 3.3% in the second quarter, its strongest pace since the fourth quarter of 2013. This result is good news, especially compared to the 1.1% contraction in the first quarter. However, the longer term trend in productivity remains weak, which has been a concern of ours for some time, even taking into account disagreement among analysts regarding the accuracy of productivity measurements.
Unit labor costs, a key component of inflation, remain well contained, falling at a 1.4% annual rate in the second quarter. The year over year rate of increase was 1.7%, which is below the Fed's target and in and of itself not a catalyst for Fed rate hikes.
Unfortunately, we have to include the latest from China, where the official Purchasing Managers Index ("PMI") fell from 50.0 in July to 49.7 in August, a three-year low. New export orders shrank for the 11th straight month. Additionally, a privately measured PMI (Caixin/Markit) fell to 47.3, the weakest reading since March 2009. The country's labor market worsened in August for the 22nd straight month, a losing streak even Seattle's hapless Mariners cannot match! We will spare readers further negative data points, as we assume you get the point.
As for MPCA portfolio positioning, an increase in yellow caution flags in our decision-making matrix over the past month has led to a slight tactical increase in cash to reduce portfolio volatility and raise dry powder should the current pullback intensify into a full blown correction. We continue to resist the temptation to tell the market what to do and will follow our indicators where they lead. For now, that means relative overweight exposure to U.S. equities, especially mid-caps, with minimal exposure internationally and no direct exposure to emerging markets.