Risk from rising unemployment, plus bitcoin's value-add to a 60/40 and year 3 of cyclical bulls
The Sandbox Daily (10.7.2024)
Welcome, Sandbox friends.
Today’s Daily discusses:
the unemployment rate risk, explained
bitcoin’s value-add to a 60/40 portfolio
downside catalysts, not old age
Let’s dig in.
Markets in review
EQUITIES: Russell 2000 -0.89% | Dow -0.94% | S&P 500 -0.96% | Nasdaq 100 -1.17%
FIXED INCOME: Barclays Agg Bond -0.34% | High Yield -0.43% | 2yr UST 3.993% | 10yr UST 4.026%
COMMODITIES: Brent Crude +3.79% to $81.01/barrel. Gold -0.21% to $2,662.1/oz.
BITCOIN: +0.72% to $63,064
US DOLLAR INDEX: -0.02% to 102.504
CBOE EQUITY PUT/CALL RATIO: 0.48
VIX: +17.86% to 22.64
Quote of the day
“They who dream by day are cognizant of many things which escape those who dream only by night.”
- Edgar Allan Poe
The unemployment rate risk, explained
Within the broader mosaic of the labor market, investors have found themselves paying particular attention to one measure: the unemployment rate.
While the unemployment rate ticked lower to 4.1% in September, it remains well above the cycle low of 3.4% set back in April 2023.
In the longer context of history, the current rate is well below the average – but notice how the unemployment rate never hovers around the long-term average; it’s either increasing above it or decreasing below it.
The gradual trend higher in unemployment has sparked concerns the labor market could be cooling too quickly. However, looking under the hood, things are not as alarming as headlines might suggest – as famed former Fed official Claudia Sahm has publicly indicated.
Unemployment can rise for two reasons: 1) fewer people working or 2) more people entering the labor force to look for a job.
The recent data shows the rise in unemployment has been driven not by a decline in employment but rather by a growing labor supply and recent immigrants. Reference the steadily increasing orange bars below in the left chart.
Initial jobless claims and reported layoffs remain historically low, indicating that the labor market is still relatively stable. In fact, last week the Bureau of Labor Statistics reported that the U.S. economy created 254K new jobs in September, well above consensus estimates.
However, job growth hasn’t kept pace with labor supply growth over the last year. A post pandemic immigration surge (below, left chart) and labor force participation (below, right chart) rising to levels last seen in 2008 have left some new entrants into the workforce without a job.
Despite a higher unemployment rate than a year ago, wage growth in September remained elevated at 4.0% YoY, marking the 17th consecutive month in which wage growth has outpaced inflation. This, coupled with a high number of job openings – approximately 8 million – suggests sustained demand for labor.
Against this backdrop, investors should remain cautious about recent labor market trends but not overly pessimistic. As long as layoffs remain low and wage growth continues to outpace inflation, the U.S. economy should remain resilient. Looking ahead, even if employment conditions soften on the margins, real wage gains should continue to support the consumer and their spending, allowing the U.S. economy to expand at trend growth into 2025.
Source: YCharts, Goldman Sachs Global Investment Research, Torsten Slok, DataTrek Research
Bitcoin’s value-add to a 60/40 portfolio
Adding cryptocurrencies to a diversified portfolio can be additive from a systematic risk perspective because its underlying drivers to traditional risk metrics are fundamentally different from stocks, bonds, and commodities.
While some investors are drawn to bitcoin and other surrogate crypto derivatives for their speculative high growth potential, other investors seek inclusion to the nascent asset class because of their low correlation to other securities. From a theoretical standpoint, this allows investors to achieve higher returns over time while potentially dampening volatility. Of course, crypto investing involves a whole host of its own unique (and significant) risks that should not be dismissed, either.
One of the more difficult questions to answer within the cryptocurrency space is what is the appropriate allocation positioning for investors to the asset class, if any.
While there are many analytics to opine over (Sharpe ratios, return distributions, upside/downside captures, etc.), here are some numbers from Wisdomtree that present different mixes of portfolio assets and the marginal impact of adding incrementally larger allocations to bitcoin. The data uses a 10-year reporting period from December 2013 to December 2023.
Empirically, the historical record suggests adding crypto to a standard 60/40 portfolio has been beneficial from both a return and a risk-adjusted return standpoint (Sharpe Ratio) while only adding a limited amount of additional risk.
Source: WisdomTree, Grayscale, Bitwise
Downside catalysts, not old age
The current bull market is up an awesome ~60% cumulatively from the lows in the fall of 2022 – good for 4th of 13 cyclical bulls that lasted at least two years since ~1950.
Looking at year 3 gains, the returns are more muted at an average gain of just 4.4%. If the cyclical bull endures, the average gain in year 3 is 13.1%. However, if the cycle dies in year 3, the average gain is -5.9%.
Taking it one step further, the equities team at Ned Davis Research made the following point:
“Bull markets do not die of old age. Three were killed by recessions. A fourth fell victim to the Fed, with the August 1968 cut reversed in December. The fifth was spurred by the European sovereign debt crisis and U.S. credit downgrade in mid-2011.”
In other words, history has shown that some major economic, geopolitical, or trade event is generally required to derail the cycle. Markets don’t just die because of a certain age limit.
As such, the bias should remain to the upside until a Fed policy error, geopolitical shock, rise in unemployment, or some other factor puts a lid on year 3.
Source: Ned Davis Research
That’s all for today.
Blake
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Welcome to The Sandbox Daily, a daily curation of relevant research at the intersection of markets, economics, and lifestyle. We are committed to delivering high-quality and timely content to help investors make sense of capital markets.
Blake Millard is the Director of Investments at Sandbox Financial Partners, a Registered Investment Advisor. All opinions expressed here are solely his opinion and do not express or reflect the opinion of Sandbox Financial Partners. This Substack channel is for informational purposes only and should not be construed as investment advice. The information and opinions provided within should not be taken as specific advice on the merits of any investment decision by the reader. Investors should conduct their own due diligence regarding the prospects of any security discussed herein based on such investors’ own review of publicly available information. Clients of Sandbox Financial Partners may maintain positions in the markets, indexes, corporations, and/or securities discussed within The Sandbox Daily. Any projections, market outlooks, or estimates stated here are forward looking statements and are inherently unreliable; they are based upon certain assumptions and should not be construed to be indicative of the actual events that will occur.
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