“I’m out of work. I need a job, I’m out of work.” – Gary U.S. Bonds, Out of Work
That was some payback. And it may not be over.
Back in March, the indices sunk to lows that erased all of the gains on the year. Then the March Miracle happened, and prices rose ten of the last trading days (nearly six percent) to magically close the quarter near the February highs. Admittedly, the market was oversold at the beginning of the miracle, but the abrupt turnaround and relentless climb left most observers at a loss to come up with a reason (legitimate, that is) for the turnaround.
The Street loves to repeat anything that’s worked before – has anyone heard of the short-dollar trade, or CDOs? – so in April we did it again. This time the bell rang two days later, and the markets rose eight of the last nine days of the month, nearly five percent higher (it was five percent at the high, but couldn’t quite hold the last day. Blame the calendar for putting the last day of the month on a Friday). At least we had the excuse of earnings beating estimates, although that is nothing new. The estimate bar is pretty carefully set, and the long-term average is that about two-thirds of companies beat them every quarter.
May is a more difficult month on the trading calendar; this time we had to wait until nearly the end for our mark-em-up magic. It needed the help of the light Memorial Day holiday weekend volume to get traction, but a sharp four-day rally appeared from nowhere, with the last day of the month – last Tuesday – being the most laughable of all. Despite bad news on the economic front – confirmation of a double-dip in housing, and a whopping decline in consumer confidence – prices rose from the open and closed on their highs. Another month saved!
Alas, salvation couldn’t make it through the next day. Tuesday’s gains were erased on Wednesday – along with most of the previous two days – and by the end of the week both the end-of-May rally and the end-of-April version had been wiped out. Along with them went the boosterism talk of the “solid gains” of the last days of May, and the even sillier notion that investors had been cheered by Europe on Tuesday.
The biggest problem isn’t that we’re headed for double-dip recession, an alarum that is sounded so predictably at every sign of slowing that it’s beginning to turn into nothing more than a springboard for the next relief rally. No, it’s that that the majority of portfolios are not positioned for weak growth. To increase the level of discomfort, it really looks as if the Fed is determined to sit this one out. How dastardly! Doesn’t Washington know the IPO calendar is full?
So what’s it all mean for the near term, you ask? Unfortunately, it’s rare that the market is at a decisive turning point, and we aren’t at one now. But we can tell you a few things. One is that the calendar for next week is light on economic news. Ordinarily, this favors a continuation of the preceding week’s trend, which in this case is clearly down.
Technically, though, the market is oversold. Not slam-dunk, put-your-money down oversold, like March of 2009, but it is oversold. We’re ready for a relief rally, even if prices weaken first. The most likely source of a bounce is another European extend-and-pretend package for Greece, and we could see one of those band-aids any day now, maybe even before Monday’s U.S. open. Anything that takes the dollar down pushes the risk button again, sending equities and commodities back up.
There are other possibilities. Perhaps China will get nervous and announce it is loosening bank lending again. That would be a disaster longer term, because it would increase the size of the bubble, but governments – even the totalitarian Communist type that financiers here seem to worship so much, at least from a distance – do make mistakes.
The Fed might get worried and flirt with the markets in one way or another to try to shore up animal spirits. We really think another round of quantitative easing (QE-3) would blow up in its face politically and the Fed knows it. Besides, it can’t be seen this time around as running to prop up the market at every sign of easing. But a lot of the governors are speaking next week, including Bernanke late Monday afternoon, and they might drop a coy hint or two.
Beyond that, there isn’t much that appears promising. The European and English central banks meet next week, and while it doesn’t appear as if they will be talking a tightening game, one never knows. ECB chief Jean-Claude Trichet is leaving soon, and may wish to exit wielding pitchfork and flames. There is quite a bit of economic data the week after next, including retail sales and some manufacturing surveys, but unless we can pull off the trick of lowering expectations to the ground, it doesn’t appear that there will be positive surprises in store.
Our guess is that left to its own devices, the market will probably test the 200-day moving average on the S&P 500 before long. Right now that’s about 1260, which is also very close to the March low of around 1250 (about 4% lower than Friday’s close). That zone would provide a convenient area for a rebound into second quarter earnings season.
There wasn’t a lot of short interest coming into the current period, so relief bounces may be short-lived until we get down to the crucial chart line in the Year of the Charts. The trendline from the QE-2 rally that began last August has just been broken, but that should invite a reversal attempt. On the other hand, the failure of such an attempt would be even worse for sentiment. Could the Groupon IPO save the market’s bacon, or perhaps a couple of big mergers? It’s all a guess. Caveat emptor!
The Economic Beat
Oh, that jobs report. Was it all that bad? One would have thought we were sliding off the cliff after listening to the business channel newspeople look wide-eyed aghast at every interviewee and ask if it wasn’t time to find every panic button and push it. Hard.
It was weak, make no mistake. Two months of elevated jobless claims didn’t exactly obscure what was coming, though. You know, the ones that for several weeks were dismissed as seasonal. Then technical. Then transitory. Then an elevated 422k again last week. The ADP payroll report that helped trigger Wednesday’s sell-off printed an estimate of 38,000, causing another hasty round of downward revisions that in the end still weren’t enough.
The truth is that it wasn’t a disaster. It almost certainly was a little light from the Japanese shutdowns – manufacturing posted its first drop in months – and a dismal spring in much of the country had left retailers sitting on piles of inventory and seasonal workers wondering where the season was.
We would guess that the underlying trend number is probably around 100,000. Manufacturing hiring has been centered on the auto industry, and it lost about 5,000 instead of gaining its customary 20-30,000. The late start on warm weather should mean that the demand for seasonal workers rebounds quickly, but manufacturing will probably take a few more months to recover. The parts supply situation for the auto industry will take more time to resolve, and demand will naturally ease as we get into the summer.
For the other categories, the issue might best be framed by the argument over whether we are in a pause from a more elevated run rate, or whether the recent string of 200k months was a spike above a lower true rate. The Liscio report noted the IMF’s observation that the typical growth rate after a monetary crisis is around 55,000 a month. That doesn’t speak for a big lift from last month’s total of 58,000.
Some job growth is better than no job growth, but it could invite a policy problem. If employment is growing slowly, it could tempt more would-be workers into looking for a job. That may not seem like such a bad thing, but it would raise the unemployment rate (which went up two ticks to 9.1%). Such an event normally happens during a recovery, but in a different manner – at some point strong job recovery tempts people off the sideline in droves, so that the rate rises despite widescale hiring. We could get the weaker cousin of this phenomenon.
A bad sign from the report is the decline in temp hiring. It’s a leading indicator, usually, and the drop didn’t go unnoticed. Good signs were the 0.4% increase in weekly payrolls and the 0.3% increase in hourly earnings. But there is no mistaking that the demand for labor has weakened. The continued declines in government employees seem likely to deepen after this month, when the fiscal year ends for most government bodies. There will be derivative effects on consumer demand.
Perhaps the best verdict is from looking at the yearly comparisons. The unemployment rate has declined from 9.3% to 9.1%, the U-6 measure (including underemployed and “marginally attached”) fell from 16.1% to 15.8%. Total employment has increased by about 420,000 (household survey) and private payrolls are up about 1.5 million (establishment survey). The jobs recovery is slow, not robust, but it’s real, just like the economic recovery. Such a coincidence.
The other news that shook the markets Wednesday, the ISM manufacturing report, showed deceleration across the board. It too had been tipped off by a string of subdued regional reports, including a Chicago PMI on Monday that came in with a report far below consensus and showed similarly broad slowing: new orders dropped to the lowest reading since September 2009, backlog dried up, inventories rose and prices stayed elevated. The only thing missing was an actual decline. Yet the Chicago reading still came in at an expansionary 56.6. It was a big drop from the previous month’s 67.6 and that rattled markets, but it’s not a bad reading, though the other parts are worrisome.
The Chicago number may be why the ISM manufacturing estimate didn’t get revised down further. The national survey result of 53.5 should probably have been less of a surprise, considering the weakness in the other regionals. The most difficult aspect of the report was the just-barely-positive reading of 51.0 in new orders (50 is neutral), and backlog disappeared, just like Chicago. Prices are still elevated, while decreases in activity were broad. The silver lining: the score of industries reporting growth versus contraction was still 14-4, and comments remained upbeat.
The ISM services number, by contrast, came in better than expected at 54.6 (consensus 54, previous 52.8) and helped steady the jobs-frightened market. However, the underlying was not so good. New orders did increase, which seemed to cheer traders, but new orders aren’t as significant in the services report. What’s more, the increase was entirely due to seasonal adjustments. The growth-contraction score was a healthy 14-2, but complaints about pricing were widespread. The business activity index was actually unchanged (down a meaningless one-tenth), while respondents were cautious about the future.
The slowdown in the ISM manufacturing was echoed in the April drop in factory orders, which fell 1.2%, worse than the consensus of (-0.9)%. Inventories are up, shipments and new orders down. One consolation was an upward revision in business investment spending from (-2.6)% to (-2.3)%.
Another number that should have shaken the markets, if wise guys weren’t so busy marking up the tape for the last day of the month, was the Conference Board’s latest report on consumer confidence. Its jobs component also indicated that the employment report could be soft, and optimism about future conditions fell markedly. At 60.8, it was the lowest reading in six months and after a month (April) that saw an earthquake and $4 gasoline. The weakness in the jobs market was clearly part of the reason, and we would put the rest at the door of the lousy weather and a weakening stock market.
Construction is still struggling. April spending rose by 0.4%, but only because March suffered a steep revision, from +1.4% to a barely changed 0.1% (and one has to wonder if the April result will stand either). It’s down 9.3% over the last twelve months.
Motor vehicle sales were disappointing in May, in particular for the Japanese manufacturers who were suffering from car shortages. However, only Chrysler had a good month amongst the domestic manufacturers. Same-store sales were generally below expectations for May as well, excluding the high end, and the retail sales report due the week after next could be a challenge. Newell Rubbermaid (NWL), in a sign of the times, lowered its annual guidance on Friday and complained of softening demand.
Americans were willing to step up and spend for Christmas, but then retreated. They were willing to step up again for Easter, but then seem to have pulled back once more. Surveys show that the increased energy prices are biting everywhere but for the high-end consumer.
One problem is the increased correlation between equity prices and the price of oil. Lots of money is desperate for returns, and any sniffs of growth has sent them pouring into equities and oil, where the bets are leveraged (much lower margin requirements in the futures market). Impresario James Cramer had a point last week when he observed that raising margin requirements in the oil pits to the level of equities (fifty percent) would chase a great deal of hot money out of oil and deflate the price in a hurry.
Although the Case-Shiller report on home prices generated considerable buzz in the media, it didn’t have much impact on a stock market that has written off the sector in favor of wherever it can find growth. Prices are now down 3.6% year-on-year, and 18 out of 20 markets showed monthly declines. Perhaps the most widely reported nugget was that the national price level – the one that had never gone down after World War II – is now down to 2002 levels. Anecdotal evidence suggests that more and more people are beginning to view housing as a risky investment, instead of the sure-fire guarantee it had once been. Combined with tight credit, the rate of home ownership is set to keep declining.
Next week is a light week on the domestic calendar, which tends to favor the trend of the previous week. The only monthly data of note are the trade report Thursday and import-export prices on Friday, neither of which are big market movers. The Beige Book (regional Fed survey of business conditions) comes out on Wednesday, and while it’s usually an excuse for a rally during times of expanding activity, this one will probably have a more cautious tone. The European Central Bank and Bank of England both come out with the latest policy statements on Thursday, so the end of the week could turn on the dollar. Again.