“It’s three AM, there’s too much noise, don’t you people ever wanna go to bed?” – Jagger-Richards, Get Off of My Cloud
Two weeks ago, we said that the market was about to come down. A week later, we said that the market was desperate to stage a big, manly comeback rally, and we got one Thursday. It’s nice to be on a hot streak, but let’s not live in the past – what about next week?
If we could tell you where oil will be, we’d have a much better idea. On the one hand, this is a market that has started to chop, but still wants very badly to resume the good old days of the nearly unbroken uptrend that ran from the end of August to two weeks ago. Clearly the market has belatedly started to get the idea that oil may matter, but the will to believe in the rainbow hasn’t gone away.
The week actually began with WTI (West Texas Intermediate, the U.S. market reference grade for oil trading) oil prices falling Monday morning even as the Brent price (the reference grade for the rest of the world) was climbing. You gotta believe, you know? The first day of the month has seen a terrific record for most of the last two years, so traders floated the market higher on Monday (the last day of February) in anticipation of a similar result on Tuesday. You gotta believe.
That ended badly, as did the big manly rally on Thursday that was half-based upon the manly imperative that the jobs number would be a blowout on Friday. Alas, events weren’t kind to either sure thing: when oil prices rose sharply on Tuesday, doubts crept into traders’ fervid minds. As for the blowout jobs number, it fell short of exaggerated expectations (although some of the business press tried to pretend otherwise), and on Friday traders wanted their money back. A last half-hour rally had to be staged to fend off the second triple-digit loss of the week for the Dow.
For all the triple-digit moves, though, the markets finished the week almost dead even with the previous week. Consolidation phase, or will we continue to correct?
It’s likely to depend on what is going to happen in Libya next week, but no one can tell what that will be. There are some predictions we can make, however. One is that there will be almost nothing in the way of domestic news next week: the economic calendar is empty and the earnings calendar very light. Perhaps that will give our politicians a chance to scare the markets instead.
Another prediction is that commodity markets will be volatile. Many are trading at multi-decade highs and some are raising margin limits. Regardless of what happens with the Middle East, we don’t expect oil prices to ease much in the short term. They tend to come down slowly anyway, and Libya seems less amenable every day to any kind of smooth transition back to the status quo. Even if Gadhafi were to leave suddenly – alive or not – the risk of continued civil disorder in Libya for the week – if not for months – to come appears high.
The pressure for military intervention by the West is growing every day, and that wouldn’t be likely to curb oil’s ascent, nor would it do much to slow silver or gold. At least the last one has little impact on the global economy. And in the face of all of this, European Central Bank (ECB) head Jean-Claude Trichet feels the need to get up and talk gravely about raising interest rates.
We understand that Trichet needs to mollify the Germans, but all concerned are dreaming if they believe that raising rates could do anything to slow inflation that has nothing to do with European economic policy or conditions. It could only aggravate the situation in an already sluggish Eurozone economy, which reported an anemic quarterly growth rate of 0.3% for the fourth quarter.
The recent rally in the euro (which we are gladly shorting) may make the central bankers feel as if they deserve a gold star, because they still score economic virtue by currency strength. But as far as the Eurozone economy goes, it’s a big negative that will only deepen the misery in the periphery.
The new Irish government isn’t likely to get on with German Chancellor Merkel for very long, either. Europe’s problems may have been pushed off center stage by the events in the Middle East, but they are festering away and we reckon will come to our attention again before the summer arrives.
China’s payback period is creeping closer too. Inflation, a lending and property bubble – not nationwide, admittedly, but certainly concentrated where most of China’s wealth and growth is – and rising commodity prices have been nipping more and more at the country’s heels. The latest Purchasing Manager Index reported its lowest level in seven months, and monetary policy has tightened almost weekly.
The U.S. equities market still isn’t pricing these risks in. It wants to go back to its narrative of America enjoying a robust 2011 (in particular, a robust stock market) and the rest of the world being too far away to matter. The eventual disappointment will weigh on prices. If by some chance the rally is able to resume, we will almost surely be selling into it.
The Economic Beat
As noted above, the market’s big Thursday rally was based partly upon a willingness to trade the rumor of a whisper number of plus-225,000 for the jobs number. Partly this was inspired by rally fever looking for an excuse, with a convenient one being provided by the weekly claims number, the “lowest in three years!” The survey week for the jobs report had ended a couple of weeks prior, but like we said, rally fever.
The latest jobs data are so ambiguous that we’re not sure what to think. There seems to be a developing sense of urgency that all and sundry should stand together and talk up data in the best possible light, thus reviving the virtuous circle of confidence. One good reason is that it would have a beneficial effect on hiring and possibly the economy, and we’re certainly not against that. Yet another, somewhat less pristine motive is that the fund community is by and large fully invested, and so those who dare to publicly question data are furiously pounced upon as being saboteurs and fifth columnists.
One good reason for ambiguity is that unemployment data is always a bit of a muddle when emerging from a recession. Hiring lags. Unemployment rates often move up during the early stages of recovery, because as the hiring environment starts to improve, people begin to re-enter the labor force faster than companies can handle.
So while we want to applaud the month’s increase of 192,000 as a good step in the right direction, there are lots of troubling signs underneath that suggest longer-term problems. Trying to sort these issues out from the usual murkiness of recovery-stage data, though, is something of a guessing game.
We’ll start with the good part: it was the largest growth number since last May, and the increase of 222,000 in private payrolls was the best in some time. The unemployment rate fell to 8.9%, the first “eight-handle” since April 2009 (the last word in Street fashion for some time has been to refer to the whole number part of popular figures as the “handle,” so the 10-year bond yield of 3.49% has a “three-handle,” etc). Manufacturing added 33,000 jobs, and both January and December had modest upward revisions of about 30,000 each.
Yet even the Wall Street Journal (no doubt inundated by now with angry email from the fully-invested portion of its subscribers) had to observe in its weekend edition that the data “mask a troubling rise in people dropping out of the labor force.” It’s true. The labor-force participation rate remains stuck at its lowest level since the mid-1980s.
1.7 million people have been removed from the labor force in the last 26 months, along with 6.2 million jobs. If one were to calculate the unemployment rate by using the number of currently employed people against the number of people counted as being in the labor force in October 2008, just after the Lehman failure, the unemployment rate would be 9.8% (seasonally adjusted). Adding salt to the wound, there are nine million fewer jobs than at the peak in October 2007, barely 3½ years ago.
Looking at the weekly claims data, it’s true that claims were at their lowest in a few years – and came during a holiday week. It’s also true that we’re into our seventh quarter since the recession allegedly ended, so what victory it was certainly hasn’t come quickly. It does seem to be the case that the layoff rate has slowed, but it doesn’t seem like the hiring rate is really picking up all that much. The “flow rate” of unemployed applicants getting jobs was unchanged.
It was good to see construction jobs make a recovery from the January weather. But weekly hours are unchanged, temp employment is weak, hourly and weekly earnings barely moved. In short, there is no sign of budding pressure in employment demand. The manufacturing rebound may already be slowing.
That may seem like a crazy statement, given that the ISM survey reached its highest level at 61.4 in nearly seven years, tipped the day before by a spectacular Chicago regional reading of 71.2. But we think that this diffusion index – it only measures direction of change, not depth – has probably peaked this month or the next. The diffusion index in manufacturing employment declined, the growth of new jobs in the sector fell despite the weather rebound, and the growth in motor vehicle production rates is due for a pause or slowdown.
Motor vehicles sales did do well in February, rising comfortably past estimates. We would point out (again) that the principal reason for the sales rebound has been the availability of credit, in sharp contrast to the housing markets. Chain-store sales were a mixed bag, but with three more prominent chains dropping monthly sales reports last month it’s getting hard to say how representative the remaining sample is. Personal income rose by 1.0% in January, thanks to the payroll tax cut, but spending was subdued, rising by only 0.2%.
On the non-manufacturing side, although the retail sector lost jobs last month, the latest ISM non-manufacturing survey produced a good result, with the strongest business activity index in seven years. Both manufacturing and non-manufacturing industries are complaining about price inflation, however. Soaring oil prices aren’t going to help.
The net result of the ISM activity in January was a good increase in factory orders of 3.1%, but much of the gain came from prices increases, particularly in energy. In housing, conditions remain weak. January pending home sales fell by (–2.8)%, and mortgage-purchase applications slid sharply again last week.
The Beige Book reported the same “modest and moderate” state of improvement as last month, but showed some alarm over rising prices. We’ll get a better sense of the rise the week after next, when the producer and consumer price indices are released. In fact, we’re resigned to waiting until the week after next for almost any data at all, as the typically empty second week of the month falls upon us.
The calendar is devoid of major reports next week. There’ll be a wholesale inventories report on Thursday, and Friday will bring international trade and the preliminary consumer sentiment reading. On the earnings side, the cognoscenti will want to know what Fedex (FDX) has to say on Thursday.