The Omens Darken


“By the pricking of my thumbs, something wicked this way comes.” – William Shakespeare, Macbeth

The financial world has lost its way this month, or so it would appear. The first flub came when the stock market suffered a decline through the first five trading days of the year – clearly a mistake, as the market had almost universally been tabbed to finish up this year, and up years usually start out by being up those first days. It’s a good sentiment indicator, though not infallible.

The second mistake was the December jobs report, which I wrote up in the January 10 MarketWeek (“That Can’t Be Right”). It was easy to find pundits characterizing the report as a mistake, prominently including Moodys.com analyst Mark Zandi, whose immediate reaction was to dismiss it with the recommendation to forget the whole thing.

HSBC bank appears to have stumbled as well. It released a “flash” (preliminary) version of its Chinese purchasing manager index (PMI) during the week that reported a result of 49.6, below the magic 50 line that shows no change. Since the World Bank and International Monetary Fund (IMF) had both upgraded the global economic outlook this month, that couldn’t be right either. Not to mention all those misguided souls dumping the emerging market ETF (EEM) this month, down 8% since the first of the year.

It should be noted that the above-mentioned financial bodies are counting on the developed world to lead growth this year, rather than the emerging group, but I find that unsettling. In my opinion, China and most of the emerging markets are still leveraged plays on the West. For the latter to grow without the emerging markets growing faster implies structural problems below the waterline in those ships of state (or possibly in the Wall Street optimists). Those kinds of problems usually manifest themselves most of all in the currency markets, as is the case this week, with the Turkish lira, Thai baht and Russian ruble among the more prominent victims. Developing market currency crises have a way of infecting other shores, including our own, in this not decoupled world.

Corporate officers appear to be making lots of mistakes too. FactSet reported that through January 24th, the scorecard for companies lowering fourth-quarter guidance, compared to those raising it, was a startling 96-15. For Q1 guidance, the to-date score is 18 negative to 7 positive. With the S&P forward earnings multiple already about 15% over its five year average and more than 10% above the 10-year average, this clearly represents bad math. Any Wall Street economist can tell you that the economy is clearly accelerating this year. Again. No, really, this time they mean it, and the key is because (drum roll, please): Corporate officers are more confident.

After last week’s carnage, we now appear to be on the verge of making an even more ominous mistake – a down January, harbinger of a down year. The S&P has fallen over 3% going into the final week, and while a rally to recover all of that can’t be ruled out, it’s getting to be a tall order. If Monday adds to the damage, as many feared heading into the weekend, it’s going to take some kind or relief rally to repair the damage.

Looking at the calendar only, however, the possibility for such an event is there. The Fed’s statement – the last one with Ben Bernanke at the helm – comes Wednesday afternoon , and is followed the next day by the first estimate of fourth quarter GDP, along with earnings reports from a slew of 2013′s sexy big-cap tech names – Google (GOOG), Amazon (AMZN), Facebook (FB). If the right kind of noise from the Fed were to be followed by a day of reassuring growth chatter, it could set up one of those shocking rip-reversals the Street loves so much, squeezing the shorts all the way.

That begs the question of what would be the right noise out of the Fed. Some are fearing an additional $10 billion will be added to the taper (i.e., spending is cut from $75 billion a month to “only” $65b), some are fearing that the Fed pauses, some fear that the Fed will backtrack and go back to $85 billion. The normally even-keeled Bob Pisani from CNBC was probably repeating what was on many traders’ lips Friday when he said that he certainly hoped that a 3% decline wasn’t going to stop the bank in its tracks. I wonder what people will think if the decline stretches to 5 or 6% by Wednesday – or if the Fed seems to panic in the face of such an event.

The one thing I am sure of is that I don’t know what the FOMC (monetary policy committee) will do. They need to cut the taper for a variety of reasons, including the mammoth size of its balance sheet (headed for $5 trillion) and the tiny size of what it has left in the way of policy tools – namely, more guidance or restore the taper. Both of those tools seemed to have lost much of their effectiveness, and the latter action could seriously weaken the bank’s image. The committee has been highly sensitive to stock prices and showing symptoms of fine-tuning disease, but the rumor mill has them staying the course on the taper. I certainly hope so, as fine-tuning is one of those classic hubris plays, and we all know how that sort of thing ends. Wings melting, plunges into the sea, watery graves, etc.

The reaction to China’s mid-week PMI release – 49.6, or just into contraction territory – was remarkable. It was below the 50 dividing line as recently as July, and indeed strayed into that area several times last year without engendering panic. Questions about the country’s credit bubble have been around for so long that many seemed inured to it, but an add-on story about Big Four accounting firms having their Chinese subsidiaries barred from auditing US-listed companies fueled the flames of fear over a credit event. China watchers are ramping up predictions of an imminent failure of one of the wealth management products so popular with its “shadow” (outside regulated channels) banking system.

The biggest factor in all of this hubbub plainly remains the Fed. The catalyst for emerging market anxieties turning into a stampede is the long-bruited winding up of QE finally getting started. I’ve seen many a talking head this week strenuously remind all and sundry that the bank is still providing extra liquidity to the market, as indeed it is. But the taper means that the direction of policy has undeniably changed, and the perception matters as much as the money. Last year’s gains were based on sentiment and liquidity, and it should come as no surprise that a change in sentiment puts those gains at risk.

Down Januaries don’t always presage down years, but the exceptions to the rule have usually come when stocks entered the year already in the grip of a bear market that ran out before the calendar did. That won’t be the case this time around.

Prices could still come back in the back half of next week, but it’ll need a lot of mistakes to be fixed. Yet even if equities can’t quite pull off the trick of a positive January, don’t expect the bulls to go quietly. The beginnings of bear markets are usually spread out over several months and marked by counter-rallies that can even lead to new highs. Remember as well that the decline so far this month is long overdue and still mild – we’re just not used to them anymore, especially in January.

The Economic Beat

It was a light week for data, so I had some time to spend crunching employment data, specifically weekly jobless claims. They tend to capture trend changes earlier than the monthly jobs reports from the Bureau of Labor Statistics (BLS).

The first piece of news to emerge was encouraging, and I wrote about it in my weekly Seeking Alpha column (right, if you’re on the website). The late Thanksgiving holiday combined with early frigid weather to produce an unusual anomaly in the claims data. On a four-week basis it had generally been running about 10% lower (unadjusted) in 2013 than 2012. However, the holiday-weather effect resulted in claims rising over 5% during the critical two-week sampling period that the BLS uses in coming up with its initial monthly estimates. As I’ve written earlier, the implication is that the November jobs count was overstated and the December one understated.

In the January 2014 sampling period, normalcy returned: Claims (unadjusted) were down 8.6% versus the year-earlier period. Deviations can have an outsized impact on the seasonal adjustments and hence the headline number – the December 2013 initial estimate of unadjusted establishment jobs was 1.64% higher than December 2012, within the central tendency on the year. It also compares well with other recent Decembers – the 2011 increase is currently given as 1.60%, and last year as 1.69%. Compare that with September, which had a year-on-year increase of 1.67% (unadjusted) and currently sports an adjusted jobs increase of 175,000.

Since the revisions have tended to raise the initial year-year rate, that raises the possibility of a very large upward revision to December to go with a January number that is back in the 175K-200K range. So Zandi was probably right in that sense, but even a 100% upward revision to 150,000 is going to be well short of the expected 250,000. I don’t try to guess the BLS numbers, but these are promising clues nonetheless.

However, a deeper dig into the claims data produced something disturbing, though perhaps not for the December and January jobs reports. Two lesser-known data points from the weekly claims reports are the insured unemployment rate and the total number of insured workers (“insured” meaning contributing regularly to Social Security in their paychecks). The unemployment rates are calculated weekly, fluctuate with claims, and are produced in both adjusted and unadjusted form. The size of the insured workforce is updated quarterly.

Employment is a lagging indicator – the workforce will continue to shrink after a recovery has begun, and to grow after a recession starts. But some of the data have value in terms of trend indication, and one of those trends is the quarterly change in the covered workforce. When the changes are becoming more favorable – in other words, declines are shrinking, or increases growing – it’s a promising development. Changes in the other direction are not promising. Last quarter, the size of the increase narrowed for the second quarter in a row. It’s no death knell, but it leads me to further doubt hopeful talk about real GDP accelerating to 3% in 2014.

The other datum that gives cause for concern is the change in the insured unemployment rate – specifically, the change in the not seasonally adjusted (NSA) rate from the end of August, when it’s near the annual low, to the beginning of January, when it nears the peak. It’s a measure of employer willingness to do end-of-year payroll cuts. This year it was an outsized 90 basis points, from 1.9% at the end of August to 2.8% the first week of January. That’s the biggest jump since 2008, though the latter was much larger (220 basis points). The labor turnover (JOLTS) report for November was anemic as well, making me wonder if the peak in the labor market hasn’t already passed – there have been several large-scale layoff announcements recently.

The rest of the week’s data was mixed, with a bias towards disappointment. Weekly chain-store sales data have been weak this month. Existing home sales were below consensus and declined on a year-on-year basis for the second month in a row. The leading indicators shrank to a gain of 0.1%, and the Markit Economics flash PMI came up short of expectations, as well as showing a lower level (53.7) than last month and/or expectations (both 55). The Chicago Fed national activity index eased from its recent bump up.

Next week is quite busy, what with tech earnings, the FOMC meeting, and a batch of significant fresh data to test the Fed governors, beginning with new-home sales on Monday and new orders for durable goods on Tuesday (with shipment data that refines quarterly GDP estimates). Consumer confidence and Case-Shiller home-price data come later that morning.

While the first estimate of fourth quarter GDP is due out Thursday morning, surely the FOMC will have gotten a peek before its statement. Later data include pending home sales Thursday and the initial estimate for December personal income and spending on Friday, followed by the influential Chicago PMI. There’s quite a bit of information, and it will probably all be looked at in the shadow of the Fed.

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