In this era of cheap money, it is not surprising to see stock indices at record highs. Nevertheless, Friday’s job report catapulted the high flying S&P 500 to this point. Investors suddenly turned bullish and started acquiring stock when they saw that the US economy had added a whopping 287,000 new jobs in June. That figure comes in stark contrast of dismal job growth figures for the month of May, – only 11,000 new jobs were created in May 2016 – blowing past the most bullish job creation expectations which were around 180,000. But these figures by themselves hide more than they reveal, and great highs are sometimes indicative of impending downturns.
Investors should now be looking at the reasons why May brought only 11,000 new jobs whereas June brought job growth that was 26 times higher than that. Probably the first indicator is precisely cheap money. Back in May, most analysts were certain that the Fed will be hiking rates more than once during the year. With Brexit and a stubbornly low inflation effectively postponing Fed rate hikes, companies felt more comfortable hiring.
Cheap money – or low interest rates – basically fueled job growth because it sparked investment. That investment also comes in the form of portfolio investment or stock acquisition, making low interest rates a dangerous multiplier. In theory, high job creation and low unemployment should trigger higher inflation, which should prompt the Fed to increase interest rates. This however has not happened yet, and with oil prices plummeting again, inflation is bound to remain stubbornly low.
This means that the economy could easily overheat without showing any signs of doing so. As long as the abundance of available oil stays high, inflation will not budge, triggering more demand. But when demand catches up and tips the scale, any Fed measure to hike rates would have come too late to spare the economy any pain. Prices could start spiraling out of control as a result. Harsher measures from central banks would have to be implemented, driving stock prices – which are close to being over-valued – down.
There are many investors who are seeing these risks and are buying insurance. Gold prices stayed almost flat on Monday, which indicates than not everyone is buying into the S&P frenzy. That is the best indicator that investors have to complete their analysis. Ultimately if the US economy is adding so many jobs, while the Fed is keeping interest rates low and inflation is stubbornly low, there should be less reasons to acquire gold than equity. If the price of gold stays high or even keeps on growing moderately, it will serve as a warning signal of a possible downturn.
The S&P rally and the stellar job growth figures in June following disappointing figures in May, are indicative of high volatility in the market. Investors must take that into account before they make their next move, and they should be keeping an eye on the price of gold.