We Made It


“It means buckle your seatbelt, Dorothy, cause Kansas is going bye-bye.” – Cypher, in the Wachowskis’ The Matrix

The charge past 1600 (and 15,000 on the Dow – two round numbers in one day!) was led by yet another central bank rate cut (the European Central Bank) and a jobs report that might just as easily have gone the other way. The latter wasn’t robust, with an initial estimate of 165,000, and not much ahead of the consensus estimate of about 155,000 or so. But therein lies a tale.

After the ADP payroll report checked in Wednesday with a figure of 119K, well short of expectations, fears of another sub-100K report (March was originally 88K) were well in place. Indeed, I was half-expecting it myself. The apparently small beat was much larger in that context, and the roar of “risk on” echoed across trading desks.

I’ve more to say about the jobs report below, but the fact that about 130K of the total – 43K in leisure & hospitality, 31K in temping, 26K in health care and about 29K in retail trade, all low-paying jobs at the bottom of the scale – suggests that the labor market is not as strong as some of the beaming faces on newsreaders would suggest. There was also an increase of 163K in part-timers, and while that number comes from a separate survey than the headline payroll data, it’s something to keep in mind.

The economy isn’t shrinking, it’s slowing. But not rapidly. This allows for both bull and bear viewpoints to be loud, if not exactly thrive. Lately the sentiment has been fearful even as the market has robotically advanced, which in turn allows the market to keep rising when the worst fears aren’t realized.

It’s not a new scenario, yet is a peculiar dynamic that’s never been easy to predict. I’ve been seeing “unjustified” rallies for decades, and the main characteristics they seem to share are the capacity for going on longer than seems possible (or justified), sudden endings that seem inevitable in retrospect, and perhaps most importantly, two other phenomena tied to the calendar. One is that the first hiccup usually comes in May-June, occasionally July. This is typically followed by a we-didn’t-die-after-all rally that lasts into the fall, when the final coup de grace is administered and the rally is crushed. Rinse and repeat.

If you’re wondering why I’m calling this rally unjustified, it’s because both earnings and revenue growth are miniscule, even non-existent. There are always calls for things to get better in the back half of the year – every year I’ve been in this business, and probably every year since the Depression – but I didn’t hear much of it from corporate management last month. I haven’t forgotten about the Fed, either. If Fed rallies and policies were all-powerful, the Dow would be at 50,000 and unemployment 4%. Don’t hold your breath.

Still, what matters in the short term isn’t how true perceptions are, but how widely believed they are. “True enough for now” could be the slogan of many a rally. Even so, a correction should begin within a week or two anyway, if not this week. I wrote last week that equities would try to punch through 1600, led by the ECB and possibly the jobs report. But they are past now. There isn’t much else to lean on, though a few days more momentum is certainly possible.

The defiant tone of Friday’s rally is typical of the last blip that comes before every downturn. Stocks are now well overbought on a short-term basis, dangerously overbought on an intermediate one, and massively overbought on a long-term one, more so than at any time since the tech bubble. Equities usually chop for a while after a breakout to new symbolic levels. The robot trading that drives the market (they’re the marginal buyers and the most active) switches into defensive mode at this time of year, and other traders know that. The same news that gets winked at in March will get taken more seriously in May.

Looking at the patterns in the economic data and stock prices, it looks to me like we are setting up for a repeat of 2007. A fading economy is accompanied by an insistence that it really isn’t – and even if it is, the Fed is on the job. A spring high is followed by a minor correction in the summer, followed by fresh highs in the fall. Then reality starts to sink in again. If Europe holds everything together with chicken wire and spit for another year, then the day of reckoning will get postponed. If not, it’ll happen this year.

There is always the chance that the EU comes to an elegant, orderly solution, but they have given absolutely no signs of doing so yet. Those who claim that Europe is at the turning point now, do so on the reasonable basis that one, things can’t get much worse and so some sort of rhythmic blip is nearly inevitable; and two, one can always simply blame the policymakers afterwards if the prediction doesn’t come to pass. But both the EU and China have to confront their bad debt in one way or another.

Japan lost decades by pretending its bad debt didn’t exist. The EU doesn’t pretend such, only that it might go away on its own if nobody talks about it too much (and if they do, they should speak of it only in German). I don’t know what China will do. It’s clear that its government is aware of the problem. Skeptics claim that bad debt always comes home to roost, bulls claim that monolithic government policy and huge foreign reserves can fix anything – but I remember that being said about Japan, too.

The US, to its everlasting credit, dealt with the lion’s share of its bad debt some time ago, to the point that big profits are now being realized by those brave enough to go in and buy during the crisis. But it can’t go it alone, day-trader sentiment notwithstanding. Ask a banker what happens when all of its customers are broke.

If you take a pass on the Economic Beat every week, then here is one spoiler: job growth has slowed, the April report notwithstanding. 2013 is running slower than 2012. Keep that in mind before you decide that a spring correction is now passé.

The Economic Beat

In all the table-thumping over the jobs report – “Job Gains Calm Slump Worries,” read the Wall Street Journal headline – what’s being overlooked is that job growth has nevertheless slowed. Whether you look at adjusted or unadjusted data for payrolls, employment growth through the first four months of 2013 is in fact lower than it was in the same period of 2012 and 2011. The household survey is showing employment growth at half the rate of the first four months in 2012.

One has to be careful comparing monthly data between the household survey and the establishment payroll sampling – they converge over time, but can be quite different in a given month. Still, it’s interesting that household growth for the last two months is only about 80K (adjusted), while the payroll growth is 300K. The household survey had a sharp drop in March, followed by a sharp recovery in April, a month that also saw a large (163K) increase in people working part-time on an involuntary basis (“for non-economic reasons”).

As most of the job growth in April was at the bottom of the ladder in occupations that have high percentages of part-time workers – leisure and hospitality, home health care, temping – one possible explanation for the divergence between household and payroll data is that people working more than one part-time job are being counted once in the household survey, and more than once in the payroll sample. That doesn’t make it the right explanation, but it does fit.

It appears to me that the retail hiring data may still suffer from the lack of December hiring, throwing the BLS model off. The category will take a hit from the pending closure of the Sears (SHLD) and Wal-Mart (WM) portrait studios. I certainly didn’t hear in corporate earnings discussions that anyone not connected with the mobile software business is anxious to hire.

There isn’t much hiring elsewhere, including manufacturing (goods-producing occupations fell). Weekly jobless claims took another big fall, but so long as California keeps sending in estimates followed by huge revisions, I’m going to presume that the first quarter trend is intact. The Challenger layoffs report stated that its measure of the first quarter of 2013 was identical to the first quarter of 2012.

The ISM purchasing manager surveys also fit a picture of a slowing economy, though there was some similar market relief in the fact that the manufacturing survey wasn’t negative. It was slightly below consensus and about neutral (50.7), but there was plenty of fear it would be below 50 (contracting). The non-manufacturing survey was also below consensus at 53.1, the lowest April since 2009. The industry scores were alright (though they can change quickly) with 13-5 in services and 14-4 in manufacturing.

The Chicago purchasing survey and Dallas Fed business survey were similar to the other regional surveys – getting weaker all the time. The Chicago PMI was actually better than it looked, taking a bit of downgrade from seasonal adjustment factors, as new order rates stayed level. But it was also the weakest April since 2009 and the pricing and employment components flatted out to the neutral zone. April auto sales stayed strong, led by pick-up trucks.

Factory orders fell (-4.0%) in March, well short of expectations but actually better than they looked. New orders for durable goods were revised down, which will weigh on this quarter’s GDP, but the business investment category got a big revision upward from plus 0.2% to 0.9%. Unfortunately shipments and backlogs were down, which won’t help the GDP measurement.

The Case-Shiller report was the magic talisman that market bulls kept chanting all week. Although the monthly gain only met expectations with a 0.3% increase, it was the year-on-year gain of 9.3% (up from 9% last month) that was paraded about. Housing is going to fix everything, it seems. It reminds me of a couple of years ago when commodities were roaring – the answer to every raised eyebrow was “China.” It works until it doesn’t.

A rise in homeowner equity is welcome, but shouldn’t be taken for granted quite yet. We’re coming off historically low levels, and the “boom-time gains” (Econoday) are being led by investment pools, whether it’s Blackstone Group (private equity) leading the charge as a distress play, or venture capital funds throwing money around Silicon Valley to fund more software concerns.

It’s fairly typical for the comeback in an asset class to be led by private investment pools, but in the case of housing there are still some important constraints that have not only not gone away, but could stay in place longer than the headlines and droolers suggest – tight credit, affordability, and sluggish employment. A great illustration is that construction spending fell in March, while residential construction spending rose.

Personal income and spending rose at the modest rate of 0.2% in March. The year-on-year rise in real disposable income stands at 1.1%, while spending is at 2.2%. 1.1% is just too low for the economy to get any real speed, perhaps tied to productivity being up just 0.9% year-on-year in the first quarter. Safeway (SWY) CEO Steve Burd observed that he has never seen such a disparity between first-of-month receipts and the end of the month, when many consumers are tapped out.

The shrinking, but not too much, data also allows for two views within the Fed to co-exist. The latest FOMC statement had it both ways, saying the committee could go either way, which provided more reassurance to the heroin addicts.

Next week brings the data to a screeching halt, which is good for bullish momentum, although questions and doubts about the jobs report may get louder. That leaves the field clear for earnings and overseas data. The bulk of high-profile earnings reports have either come and gone (March quarter) or won’t be ready for a couple of weeks (April quarter), but one potential bright spot is Walt Disney (DIS), which usually executes well and has good things to say. Something to watch out for is the European data on the slate, with Germany and France scheduled to report purchasing manager and industrial production data.

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