Just Right


“And what is so rare as a day in June? Then, if ever, come perfect days.” – James Russell Lowell

Goldilocks is back in the house – or so the markets thought on Friday, when another mild beat (10,000) of the consensus set traders off on another delirious rise that included a little tape-painting at the close to force the Dow into a plus-200 day. As with the April report a month ago, a below-consensus ADP report two days earlier had the market worried the Labor Department (BLS) number would fall short as well, and once again the unexpected beat set the house on fire.

I don’t expect the reaction to reach quite the violence of last month, when the market was still riding the long momentum wave and coming off an ECB rate cut the day before. The Federal Reserve has also introduced the fear of policy withdrawal into the conversation since that time, which raises the possibility of whether traders might take a run at daring the Fed to say anything again at the June meeting. It was, after all, another average number that was a little weak underneath. I wouldn’t count out the gambit entirely, as traders might be feeling emboldened by the bounce off of the 50-day moving average.

There was certainly a leap back into beta, with buyers piling back into the usual suspects, and a rather remarkable run from around lunchtime on Thursday that approached a 3% move on Friday. The bounce off the 1600 level is understandable, but running up into the close that strongly on the eve of a jobs report is unusual, to say the least. However, we all know that no one ever trades on inside information on Wall Street.

The issue now is how the market bridges to the FOMC announcement on the 19th. Looking at the US calendar only, I would guess a continuation of the run until Thursday, when the next significant report (May retail sales) is released. A near-empty calendar usually favors a continuation of the Friday move. However, China has a data dump over the weekend, and it’s not out of the question that Japan gums up the machinery. It’s had some serious volatility in its market, officially entering a bear market by touching a 25% correction during the latter part of the week.

Further Japanese trouble could involve some collateral-unwinding in other asset classes that adds to selling in equities. On the brighter side is a fair chance that the markets there will instead try to rally off the US Friday move. It will need to get some legs. A lot depends on how the dollar trades, which in turn relies on the tea-leaf reading – and perhaps a bit of simple dumb panic – about the Fed’s next move.

One strategist who weighed in on Fed withdrawal was former chairman Alan Greenspan, who insisted Friday that the bank needs to get started on shrinking its balance sheet right away before facing a potential tornado in the bond market. Greenspan added that he thought that equities could withstand the hit overall and come out better for it, and he may be right. It certainly wouldn’t have stocks rallying at the outset, but once the bill had been paid they could very well be placed for more sustainable gains over time, rather than the lurching-drunk performance of recent weeks. That kind of stuff ends badly.

As ever, it can be hard to read Greenspan’s meaning, but it did look to me like he was telling his former Fed brethren, “don’t be afraid of the stock market.” Upon reflection, I think he has a valid point. After all, it isn’t as if the Fed’s job is to guarantee that the stock market never drops more than a few percent. Stocks are at all-time highs, propped up by what long and short alike acknowledge to be almost entirely bets about continued Fed liquidity.

A fifteen or twenty percent hit that dropped the S&P to the bottom of its long-term upward channel wouldn’t be the end of the world, nor would it seriously harm the economy. It would actually leave the market in a much healthier spot for real investment, rather than the current nonsense of leveraged betting over what might be behind the curtains. Greenspan even implied that the uncertainty over when the Fed finally acts was a drag on spending plans, and he may be right. Get it over with, the sooner the better, before the price tag gets too high and before your hand is forced. There is nobody who better knows the perils of waiting too long than former central banker Greenspan.

Equities did not rise on Friday because the jobs report pointed to growth. Many economists were quick to point out afterwards that the data are perfectly consistent with a drop in second-quarter GDP to below 1.5%. They rose because of the belief it puts off the evil day of no more infinite liquidity. Markets and CEOs alike are too focused on when the Fed might pull back from a program that has never gotten GDP to 3% and probably never will, because it cannot fix Europe’s banking problems nor China’s bubble. It can build an inverted pyramid of money that is finally too big to juggle any longer, and as Greenspan implied, lead to runaway problems in the bond market that the Fed might be unable to contain.

Some feel that the Fed will wait until September to act, when it has a press conference and perhaps a few more months of data for cover. There are some reasonable arguments there, but it does risk markets getting too high and setting off another fall crash. What’s more, the Fed will almost be certainly forced to lower its 2013 GDP forecast (2.3% – 2.8%) at that meeting, making the timing awkward.

I agree with Greenspan here – get it over with before it’s too late, and while you can still keep the funds rate at zero. Mortgage rates at 4% cannot possibly be bad for a sound housing market, though they may clip a speculative one.

It’s really not clear yet which way the markets will move over the next two weeks, though a bias to the upside seems likely. For what it’s worth, something that stood out to me as a red flag in Friday’s aftermath were the many voices talking about how the jobs report had been “just perfect.” In my experience, traders rhapsodizing about perfection has usually led to a top within a few weeks – and a long slide downward afterwards.

The Economic Beat

It’s tempting to call the jobs report “much ado about nothing,” and I probably won’t be the only one to suggest something like that. I had a minor presentiment that the jobs report might print up from May, if only because that’s the way the Labor Department (BLS) presented it a year ago. The recent survey data didn’t look strong to me, nor did claims, but nothing looked disastrous either.

It’s always dangerous to try to guess an individual month, and recent data had left the market prepared for the worst (though not the buyers who suddenly appeared at lunchtime on Thursday. That was odd indeed). An informal CNBC pre-release poll had the majority guessing downside, as were its two economic reporters.

Perhaps the best thing to do in such circumstances is just follow what the BLS has done in the past, and I suspect that such thinking may have informed the consensus estimate, which was quite close to the actual total (165K guess vs. 175K actual). It had been resting at 170K at the beginning of the week, before the ADP report came along and prompted some trimming. Last month’s consensus of 155K also turned out to be closer in fact, as April was revised downward to 149,000.

Something that stood out to me quickly on crunching the June numbers is the so-far remarkable consistency in the payrolls number in 2013. Using unadjusted numbers, the year-on-year rate of increase has been in a very tight range of 1.57%-1.63% through the first five months, with a mean of 1.58% and the June number coming in at 1.6%. That mean is also significantly below the 2012 average of 1.78% over the same period. It’s a valid question to wonder whether the difference might not be at least partly due to undercounting, as the original 2012 numbers were lower than the present data. However, the last benchmarking (February) was supposed to overcome that, and it may very well be that this year’s numbers are coming out higher than a year ago for exactly that reason.

This is a significant possibility and one largely undiscussed in the investment community, so far as I can tell. The original, pre-benchmark revision data for 2012 showed an average year-on-year growth of only 1.47% through the first five months, well below the current figure of 1.78%. In other words, the BLS might be sampling the same tallies as it did a year ago, when it was printing job totals under 100,000 for May and June, with the real difference being a change in its estimation process.

That could have important ramifications. The ISM surveys, retail sales growth, personal income and spending data and business investment spending, are all signaling softer conditions. If the changes in the current employment data are due to the changes in estimation, then GDP growth may be slower than optimists believe. This is even more true if the estimation methods producing this year’s average rate of 1.58% are consistent with last year’s 1.78%, as they certainly should be. Last year’s nominal GDP ran at 4.0%, and the four-quarter rate slowed to 3.6% in the first quarter. I would say that apart from housing and energy services, corporate management-speak leans towards the slower conditions notion.

Other aspects of the report are not so encouraging. The last two months were revised with a net loss of 12,000, and many feel that the direction of the revision is as important as the original estimate. Some of the troubling aspects of the April report were echoed in the May report – the average workweek didn’t move up for the second month in a row (it actually declined in April), hourly earnings were unchanged again (up a penny, to be precise), the jobs were concentrated at the bottom of the scale. The leading gainer was the restaurant worker category, with an additional 38,000, followed closely by clerical with 35,000 and retail trade with 28,000, the latter bumped up by seasonal adjustments.

The economically-sensitive goods production category lost 1K on balance, with manufacturing contributing a loss of 8K and construction a gain of 7K. The last figure doesn’t live up to the billing that the housing recovery has been getting, but there could be a lag. The year-on-year rate in construction hiring did pick up a bit, though you still have to go back to 1997 to find a smaller pre-crash workforce. The participation rate ticked up a tenth, a result I immediately heard lauded on the radio by a Wall Street economist as a sign of economic strength. The Labor Department referred to it as “little changed” and noted that it remains 0.4% lower than a year ago.

Temp hiring increased, which was hopeful, but the ADP report was soft again at 135K, or about 35K short of consensus. It certainly helped pave the way for another BLS surprise rally. In sum, it was another average report, below the magic 200K necessary to drive down unemployment, and another month I would not be surprised to see revised slightly downward next month. It remains consistent as well with the low growth in personal income and GDP.

The ISM surveys did not hint at better hiring intentions. The manufacturing survey signaled a slight contraction with a reading of 49.0 (50 is neutral), though a perusal of the underlying details seemed to suggest a plateau effect. The weakness in new orders was a tad more worrisome, as the number of industries reporting shrinkage (8) outnumbered increase (7). The non-manufacturing survey result of 53.7 was the lowest May result since 2009, continuing a pattern that has prevailed throughout 2013.

Factory orders for April came out, with new orders for business investment unchanged from the durable goods report earlier (+1.2%). The year-on-year change fell again and was negative for the second consecutive month (unadjusted). If the usual third-quarter lull happens, it’s going to take one heck of a reordering cycle in the fourth quarter to keep nominal GDP from finishing below 4%.

The Beige Book came out and didn’t seem to offer anything new, with conditions “modest to moderate” everywhere but housing (“moderate to strong”) and consumer spending (“slight to moderate”). As usual, the weekly chain reports offered conflicting views and the monthly same-store sales reports were better than expected, thanks in part to a vanishingly small sample size that sees all the strugglers drop out. The May report from the Commerce Department is due Thursday, and is the next major pivot point on the calendar until the FOMC announcement the following week.

International trade continues to soften, as this chart from Econoday shows:

There isn’t much QE can do about that.

Next week begins with a load of weekend data from China, then a quiet calendar until Thursday, with the retail sales report. Friday will have the Producer Price Index for May, followed by the Industrial Production report. I will be watching the wholesale sales and inventories report on Tuesday, though it has little market impact.

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