“Is this the real life, or is this just fantasy?” – Freddie Mercury (Queen), Bohemian Rhapsody
The rally is indeed looking tired to us at this point, and one of the questions you should ask yourself is how much longer the markets can rally on Greece not defaulting, or on promises of more Fed liquidity.
The sharp turnaround in the middle of last week was set off on Tuesday by a Wall Street Journal story that speculated on what the Fed might do if it decided to embark upon further quantitative easing. We thought the headline was odd, because Fed governor Richard Fisher had rebuked the markets only a couple of days earlier for being too focused, if not addicted, to thoughts about more Fed easing. While governor Fisher is certainly one of the leading hawks at the Fed and not representative of the more dovish majority, it certainly appeared to be bizarre timing for a governor to say “stop looking for more money” one day and the central bank to be promising more within hours.
It hadn’t, as it turned out, and the author of the article found himself doing a second video interview soon afterwards in which he stressed that it was only a hypothetical rumination. He mildly complained about people not reading the whole story, and perhaps justifiably so, but it’s hardly a new development that traders pull the trigger on the headline first and read the story later. For its own reasons (hello, Mr. Murdoch?), though, the publication first ran the headline as a fait accompli: “Fed Officials are considering a new type of bond-buying,” and only later (about midnight that day) added the “if.”
The second stage of the rally came on the astonishing development that once again, Greece failed to default, bringing to mind South Park’s comedic device of feigning mock horror in every episode over killing Kenny. The unfortunate part for the markets is that one, Greece’s problem – and by extension, the eurozone’s – hasn’t really been solved, only postponed again, and second, with no impending default to avoid, what is going to drive the market higher? Heaven forbid we should start to pay attention to the deteriorating economic data coming out the eurozone and China.
So yes, the jobs report on Friday did narrowly beat estimates, allowing traders to step in around the usual mid-morning time (about 10:30 AM has been the rule in 2012) and start leaning on a few key tickers: Apple (AAPL) of course, and one or more of the three index ETFs representing the three market segments – SPY (for the S&P 500), QQQ for the Nasdaq, IWM for small caps (Russell 2000). Then the reporters write their stories about investors being cheered by the strengthening economic data, when what is really happening is trading money playing the momentum rally.
The challenge for investors remains the same: the markets are overbought and prices supported by agnostic money that has no commitment to anything but the momentum trend. Against that, that money will stick around to dally with the trend so long as no story appears capable of breaking it, and with April looming (the market’s favorite month) it is just possible that we could bridge the intervening period without a correction. Not likely, certainly, and there are plenty of eyes on the exits, but it is certainly possible and would not be a miracle by market standards.
The flip side is that as with any bender, the bigger it gets, the more painful the payback headache is afterwards. The jobs report isn’t as good as it appeared, as we discuss below, and neither is the economy here or around the globe. But as they like to say on the Street, worry about today’s move today and let next week worry about next week.
The Economic Beat
Through the first full week of March, there isn’t much indication that this quarter is any different from the first quarter of 2011: after a decent fourth quarter that includes some restocking, growth slows. The end of 2011 had a little flourish from the expiration of the accelerated depreciation credit, a fillip largely overlooked in the excitement of the stock market’s mini-stampede (when half of the cattle are sitting it out, it’s hard to call it a real stampede). Otherwise it doesn’t look like this installment is any different at all, really, especially when the weather is factored in.
We have studied the February jobs report at some length, probably more than we should for own health, and there were some nice aspects. Temp employment increased, the December and January revisions were positive, the January number was the best in some time and at 227,000, the February report was mildly ahead of expectations (though not the whisper number of 230k).
However, there was a lot to worry about too. As much as we would like to say otherwise, it looks to us like the base case is that employment growth is peaking, and may already have peaked.
Perhaps we should never mind that manufacturing job growth fell sharply, or that more than half of the new jobs were low quality: temps, health care, leisure and hospitality. After all, it’s only one month.
We looked at the raw and adjusted monthly jobs data over the last ten years. The growth in January and February, on a seasonally adjusted basis, are the best for those two months since 2006. That sounds great, except that 2006 is when job growth peaked in the last cycle. Looking at the unadjusted data, the monthly changes for January and February are nearly exactly the same as they were in 2006.
More worrisome is the year-on-year pattern. We are coming off one of the warmest winters ever, yet the February 2012 number is almost exactly the same as February 2011. Where are all the jobs? One can reasonably argue that, given the recent direction of revisions, that will improve with time, but it’s going to take a substantial revision to catch up February 2012’s private payroll change (+233k) to that of February 2011 (+257k).
Turning back to the adjusted data, the percentage changes in payrolls for February 2011 and February 2012 were identical at +0.17% (the unadjusted numbers virtually so), while the January numbers were very close. If the expansion is finally gaining traction, shouldn’t the numbers have been a lot better with one of the warmest winters on record, and virtually no workdays lost? Looking at the last post-recession period of 2003-2007, one can see that job growth peaked in the 2005 and 2006 years, or years three and four. Comparing 2003-2006 to 2008-2012, the comparable numbers are lower (and the unemployment rate is in fact higher), with 2006 showing a better pickup over 2005 than 2012 has over 2011. The recovery is weaker.
Employment is a lagging indicator, a fact that is often repeated ad nauseum when job growth is negative (the implication being that the worst is already over) or weak (the best is yet to come), but conveniently forgotten when job growth is showing relative strength. A better leading indicator is weekly claims data, and we also looked at monthly claims totals for the last ten Februarys.
February 2012 showed an improvement in actual (that is, not seasonally adjusted) weekly claims of approximately 150,000 over February 2011 (we used the first four calendar reporting weeks of February in our analysis; using the last four instead had little effect). This compares with the approximately 327k year/year improvement in February 2011 and the 655k improvement in February 2010. Looking at the third and fourth recovery years of 2005-2006 again, the improvement was about 194k in February 2005 and only 78k in 2006. The comparison turned negative in February of 2007: the year-on-year increase of 133k in claims was an accurate harbinger of the deteriorating economy.
Two disturbing inferences from this data are that one, the 150k improvement in 2012 looks very much like the 78k difference in 2006, once weather is taken into account. Second, the recovery in the middle of decade was being fueled by the housing bubble and its debt-fueled consumption; nothing of the sort is even on the horizon right now in terms of propping up demand.
The recovery in auto production is nearly complete – while an additional increase to a 16 mm/yr selling rate appears reasonable to us this year, we are already rapidly approaching it and the lion’s share of the related employment gains appear to be behind us. There is something of a bubble in corporate bonds that should be supportive to corporate balance sheets, but little of that is going to make its way into stimulating end demand. Most of it is destined for share buybacks – which enhance executive compensation – and productivity investments.
We reiterate that this isn’t at all a call for impending recession, only supportive of our view that the economic progress has been modest this year, especially in comparison with many of the headlines – on Thursday, the Wall Street Journal ran a full-page story on slowing growth in emerging markets, but deep within the main section; on Saturday, the page-one headline was “Jobs Recovery Gains Momentum,” despite this February being no different from last. The market is setting itself up for disappointment.
Finally, we would add that February job growth isn’t representative of the year to come. When all the data is re-benchmarked a couple of years from now, the monthly data will be smoothed to better fit the underlying annual trend in real job growth. Until then, the maturing arc of the recovery and lagging nature of jobs growth means that the February growth rate runs ahead of the underlying annual trend in real time. Absent a major new development, 2012 job growth is not going to reach a new level of escape velocity, rather it is going to look a lot like 2011. It may well further soften later in the year.
The ISM non-manufacturing report checked in at 57.3, somewhat ahead of consensus. Looking at the subcomponents, the report appears to be nearly identical to last February, with the main difference being that last year’s seasonal adjustment factors produced higher readings. The year ago February produced the same sort of gee-whiz rhetoric before petering out. It was a decent report, notwithstanding, with a growth-contraction ratio of 14-3 and an uptick in prices (the best subcomponent indicator).
Factory orders fell in January, though that wasn’t unexpected after the durable goods report. The decline was probably due to the tax-related surge in December buying, a fact that hardly went unreported. January is a light month anyway for orders and not the best indicator; most of the new budget spending comes in February and especially March. That said, so far as the rest of the year is concerned, the first quarter hasn’t been a reliable guide to the year either in recent times. Wholesale sales and inventories were similarly light.
One of the reports that cheered markets and pushed the envelope on fatuousness in reporting was the consumer credit report for January. It’s necessary to take the preliminary results with a liberal dose of salt, because the revisions tend to be large and, due to the use of quarterly data, the final number isn’t really accurate for a few months. We felt some mighty wind reading some of the glowing talk about the consumer being back, but the first estimate suggests that in fact, consumer credit card usage fell. The increase in auto loans is an estimate derived from the increase in auto sales, so it shouldn’t have come as a surprise. The disturbing part is that more than the entire increase came from growth in student loans, which are increasingly thought to be in a bubble state.
Fourth-quarter productivity data confirms slowing productivity gains and higher labor costs. This shouldn’t come as a surprise to anyone paying attention to fourth-quarter profit margins. The trade deficit grew larger than expected in January, due primarily to rising prices, and will be a drag in GDP quarterly growth.
Next week brings the Fed’s Open Market Committee (FOMC) statement on Tuesday, which will be dissected for how many times “moderate” is used and whether or not it replaced “slow.” No substantive change in policy is expected. Retail sales will come out that morning and should get a boost from a strong month for autos. We’ll be curious to see the ex-auto, ex-gas number.
The week will see the monthly report card on inflation, with trade price data on Wednesday, production price data (PPI) on Thursday, and consumer prices (CPI) on Friday. The last two days will bring March manufacturing surveys on Thursday (New York, Philadelphia) and February industrial production on Friday. March is the big month for industry in the first quarter, so the surveys at least ought to look good. Whether or not they beat estimates is another story entirely.