Spring Surprise


“When everyone thinks alike, everyone is likely to be wrong.” – Humphrey B. Neill

by M. Kevin Flynn, CFA

No, we aren’t going to say, “I told you so.” It’s tempting – we’ve been saying for weeks that while the economy is growing, it isn’t growing as fast as the press clippings would have you believe. The March jobs report, which we examine in more detail below, would seem to a pretty solid brick in our wall.

But we refrain from gloating for a number of reasons. The first is that it doesn’t exactly cheer us that we are stuck in a trend of soft growth, especially where employment is concerned. In the second place, the ISM non-manufacturing report had a decent uptick in the number of respondents saying that they were hiring “more.” It wasn’t so large a number to indicate a barn-burner, but it did suggest a reasonable chance that the February trend could hold on and we posited thusly on the Seeking Alpha website.

The problem with diffusion surveys such as the ISM, though, is that they don’t say anything about the level of activity. If two firms plan to hire ten more people and a third plans to sack a thousand, the diffusion survey will tell you that hiring is directionally robust. Or a firm might hire a hundred workers in January, fifty in February and then five more in March, but the answer to each month’s survey would only be, “more.”

And last but not least, it is April, the best month of the year for the stock market. It’s commonplace for part of the April rally to be borrowed in March, such that subsequent stumbles in the early part of the month are practically routine. But the market – especially a trader’s market like the one we have – will always try to find a way to have the rally that it believes it’s entitled to.

Economic data coming out of Europe was disappointing last week. The recession there is deepening, and the troubles of the periphery countries are moving back onto the front pages. The domestic economic releases here were very much a mixed bag as well. But the FOMC minutes that set off a bout of selling shouldn’t have been a surprise to anyone paying any attention to what the chairman and governors have been saying; the real surprise was the manifestation of how hooked the markets have gotten on monetary easing.

Despite these problems, though, we doubt that a market reset will happen quite yet. Sometime in the next couple of weeks, traders will find another rallying cry. The obvious candidate is of course QE-3, or round three of quantitative easing by the Federal Reserve. Let us regale you with an example from history: near the end of the tech bubble, a spring jobs report that was an off-the-charts disaster of a surprise resulted in a huge counter-rally on the very same day. Within an hour of the open, traders concluded that Fed help would be on the way and the rest was, well, mind-boggling. It was one of the great reversals we’ve ever seen. It was also a great selling opportunity, so long as you waited until the close – we wouldn’t mention it to the few shorts that were still alive at the end of that époque of mass delusion.

So while Friday’s abbreviated futures session priced in a percent drop, we’re not making any predictions for Monday – except to remind our American readers that most European markets will be closed, as it is Easter Monday, and that could help stem some of the selling pressure. The calendar is light until Thursday night, and that usually a favors a continuation of the previous week’s action: downward. But Fed Chairman is giving a speech Monday night, and doubtless his remarks will be finely parsed for any clues at more liquid lightning (quantitative easing).

In any case, the Fed cannot head off the European recession. As the Spanish announced more wage cuts, the Germans passed out wage raises all around, public and private both. We’ll let other heads argue the rights and wrongs of that decision, but you don’t need Socrates to tell you that it isn’t going to enhance European harmony. If Socrates were here, though, he’d probably tell you in turn that no European recession can head off the April rally – though you may have to wait another week.

The Economic Beat

As usual, we lead off a new month’s Economic Beat with the jobs report. It was not only a lemon, it was more of a lemon than you may realize.

The non-farm payroll number of 120,000 was roughly half of consensus and below the bottom of the entire range of estimates. That’s bad enough, and had Dow futures down triple digits in Friday’s mini-session. The underlying details were no treat either.

Not all of the report was bad – the unemployment rate fell a tenth, and the “underemployment,” or U-6 rate, fell a bigger four-tenths to 14.5%. Unfortunately, the household survey reported that the number of people working actually fell, seasonally adjusted: the unemployment rate fell because people dropped out of the labor force. Those are only first estimates, and in particular the household ones are subject to large revisions. But they aren’t great news.

Temp hiring, which is a leading indicator, fell. Department store jobs fell for a second straight month, lending additional weight to the warm-weather argument that claimed jobs and sales were being pulled forward from latter months. We suspect that the number of additions were overstated, the number of departures similarly overstated, and we are now seeing the netting out.

Average weekly hours ticked down, and the weekly aggregate payroll index – which tends to track personal income – had its smallest gain in months. There is no hiring pressure nationally, though there is some tightness in select specialties and regions. We read a self-styled “bright spot” noting that hourly wages were up, albeit barely, without mentioning that average weekly wages – i.e., the paycheck – ticked down (also barely) with the drop in hours.

It isn’t disaster, but it isn’t “escape velocity,” nor “gaining momentum” nor the other folderol being splashed around by the media in recent weeks. It’s a slow economy that got a little lift from some inventory accumulation, a little rouge from the warm weather, and is now returning to its dowdier self.

You may have also read that the weekly jobless claims were the lowest since April of 2008. It was really May of 2008, but that’s not much of a quibble. The observation helped the markets rebound a bit in the face of disappointing data from Europe. So if claims were so good, what’s up with the jobs report?

A quick answer might be that the last couple of weeks fell after the end of the jobs report measurement period – maybe the report was a fluke? But we don’t think so, for a couple of good reasons. The first would be the year-over-year change in monthly claims. It’s a relatively decent leading indicator, and the data show that the decreases in claims have been slowing. The year-on-year changes (about 150k for February, 140k for March) suggest an employment market in the early stages of flattening out.

The second reason is the number of actual jobs – that is, unadjusted – and here’s where we think the weather has played a role in flattering some of the data. The week before, we watched a fund manager – creatures bullish by definition – reply rather smugly that what with the economy having created “almost 800,000″ jobs this year, things were obviously in good shape. If only it were true.

The manager was probably betting on a good March report that would put the quarterly total in the neighborhood of 750,000, maybe even higher with a favorable revision or two. However, that is not the way the economy works. Businesses run on quarters and years, mostly calendar ones. The shopping season of Christmas comes in the last month of the year, adding a surge in seasonal help. The effect of this is that in unadjusted terms, the January workforce is, on average, about 2% smaller than December’s. In absolute terms, that comes out to about 2.5 – 3 million jobs lost every January, as contracts end, seasonal workers get let go, and workforces get trimmed.

Not all of the jobs are really lost – many people simply change jobs with an offer in hand, and the January count can’t accurately capture the turnover. Excluding recession years, roughly a third of those losses are recaptured by February, and roughly another third is recaptured by March. Going back to 1980, at least, the number of actual jobs is nonetheless always smaller in March than December, by about half of the January loss. In a normal year, the progression continues until June. By then the actual headcount has (usually) grown larger than the previous December; then the mid-year axe falls, and there is another drop-off.

The seasonal factors do a good job of smoothing out these fluctuations and presenting a more accurate picture of underlying trend. Better, for example, than reporting a loss of 2.5mm or so jobs every January. However, it can be worth the time to study the changes in the raw data. In the current case of 2012, the January decrease was below average, the smallest in percentage terms since January 2006 (don’t get excited, though, as 2012 was the same percentage decrease as the bubble-peak of January 2000, and a really low number is a sign of an overheated economy). The February increase was above average – that’s good – and the March increase about average. The intriguing bit is that the March increase was smaller than February (and should stay that way regardless of revisions). That doesn’t often happen – the last time was in 2001.

It isn’t a recession indicator. However, we do think that it’s another strong piece of evidence that says preceding jobs data were somewhat flattered by the warm weather. Fewer people were let go, particularly in retail sales, when warm-weather apparel sales were apparently pulled forward. Usually it isn’t easy in the northern half of the country to go out and shop throughout January and February, but it was this year. Fewer work days were lost, too. So it’s not quite that the trend is reversing, but that a smaller-than-usual decline is being balanced by a smaller-than-usual rebound.

There are pockets of relative strength: manufacturing has been adding jobs steadily. Unfortunately, it’s a much smaller sector than it was twenty-five years ago. Health care is a steady grower, and leisure and hospitality have been additive of late as well, though one has to worry there too about a rebound effect.

So we haven’t really added 800k jobs yet this year, nor the 635k BLS to-date seasonal total, nor finished recovering the January loss. Not yet anyway, not so far as can be counted. What the seasonal totals tell us so far (in case you’re wondering, everything does balance out by the end of the year) is that based upon historical patterns, that would be the underlying trend rate. Neither we nor the Labor Department, though, know yet how the warm weather has wiggled the trend, and we won’t really know until the second half of the year, probably September. But the March report is a strong suggestion – we won’t say it’s definitive quite yet – that the wiggle was real, and lines up with the nearly-forgotten February assertions that the warm weather was giving us a tilted view of the economy.

The ISM surveys also appeared to support this. The national manufacturing survey came in slightly better than expected, at 53.4. That was a few tenths better than consensus, depending on who you listened to, while new orders were a few tenths worse. It doesn’t really matter, for the truth is that a few tenths are pretty meaningless in these diffusion surveys. More useful are the year-on-year changes.

In 2011, the ISM manufacturing readings through the first few months were 59.9, 59.8, and 59.7. This year they were 54.1, 52.4 and 53.4. That’s a big fall-off from the preceding year. A caution: the surveys don’t say much about levels of activity and are based on monthly changes, not annual. But that said, such large year-on-year drops in the ISM are unusual (though unhappily, a bit less so since the turn of the century). They have preceded every recession, but do not necessarily signal one. For that matter, the ISM isn’t a reliable leading indicator for the stock market.

However, it does lend added weight to our premise (and of others, of course) that we are exiting another period of inventory accumulation that also happened to pick up some warm-weather benefit on its way out the door. Not the stuff of recession by any means, but not escape velocity either. A feature of the ISM non-manufacturing survey that had floor traders buzzing was the drop in backlog orders – maybe the warm weather did pull forward some orders that would have happened anyway.

Prices, which we consider the best leading indicator in the services report, did slow noticeably. The general tone of the commentary was definitely positive in both reports, which seems hard to argue with, but the dark lining is that sentiment peaks in the these surveys, usually measured by the six-month outlook, are excellent contrary indicators.

Construction spending fell in February – by the first estimate, anyway – and January was revised downward. Those data feed directly into GDP calculation, unlike diffusion surveys, as Dave Rosenberg wryly observed. Consumer credit grew in February, thanks to another big increase in student loans, but revolving credit (plastic) balances fell again. Car sales also weakened. However, the early Easter this year (Sunday) should save the March retail sales report from harm.

Looking ahead, the really big numbers are out of China next week: GDP, industrial production and retail sales. It’ll be interesting to see what the authorities decide to report. Here in the US, Wednesday’s Beige Book should get more interest than usual after the disappointing jobs report. There’ll be some trade and inventory data, but the bond markets will be watching the price data: import-export prices on Wednesday, producer prices (PPI) on Thursday and consumer prices (CPI) on Friday.

Alcoa (AA) starts the quarterly earnings season on Tuesday; expectations are low. The Google (GOOG) report after Thursday’s close, and the Wells Fargo (WFC) and JP Morgan (JPM) reports before Friday’s open, will be of far more interest to the market. Along with the Chinese data that comes out late Thursday night, Friday should make for an interesting day.

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