A Teflon Time


“If this is the best of all possible worlds, what are the others?” – Voltaire, Candide

And so another week comes in as expected – above all, with prices moving up. The ISM manufacturing survey, though hardly robust, beat expectations and set off yet another round of stories about how this time, the economy is taking off. The Ukraine relief-rally came as well, albeit a day late, making the ensuing short squeeze even more dramatic. Then the market spent the week rallying on excuses for a weak jobs report it didn’t get, but after some confusion decided to rally anyway, though it needed the usual last-minute Friday surge to pull it off.

Even the talking heads are starting to talk about a Teflon market, though the conversation doesn’t get far – a rhetorical question or two, and some fund manager is brought on to earnestly assure us that the market can only go higher, should only go higher, will only go higher, “though there is always the chance of a pullback.” The fact that the February jobs report was more than 100,000 jobs short of last February’s report got no mention that I could see – instead the talk was about this was yet another sign that this time the economy is going to take off. No, this time we really, really mean it.

Is a pullback in the stock market imminent? Yes. How much will it be? A very good question. Pullbacks of more than a percent or two need a catalyst – in January, it was the idea that growth wasn’t going to be as advertised, until a mass mania about the weather took wings on the notion that Janet Yellen (any Fed chief, for that matter) was standing ready to fix any and everything.

If the Ukraine situation gets going, things could slip into the five percent range. Despite the stock market’s quick promotion of the Ukraine to being another tedious sideshow, there was a bit of gauntlet-throwing this week that seems to promise another act or two. The new provisional Ukrainian prime minister said “no way, not ever” to the question of Crimean secession – set to be voted upon a week from Sunday in Crimea itself. It will surely be a vote that will fall conclusively in favor of Russia, regardless of how the ballots are marked, and play the role of another tactical chip to put on the table in the regional poker game. The situation could simply drag on for months and fade into a compromise after the West has mostly lost interest, or it could slip on one of those unexpected blunders that wasn’t supposed to happen and turn ugly indeed. I can’t predict these things, and don’t really know of anyone who can.

A notion that seems to be gaining traction in the investment community is the idea that the stock market will keep going, perhaps with a bump or two along the way, until sometime in the fall – October, or after the elections perhaps – and then the bottom will fall out. A rerun of 2007 isn’t implausible – a spring top, summer turbulence, final fall top, deluge. The year 2007 was similarly and typically characterized by a child-like faith in the Fed to deliver the markets from all evil – every time a Fed meeting came and went with no interest rate cut, the markets would rally furiously on the notion that the next meeting had to have a rate cut. One can easily imagine something similar with the taper. Momentum does funny things to people’s minds.

We have reached a zone of long-term extreme overvaluation in equities, one that makes the forward outlook for the next five years quite unappealing – if one were to buy today and hold throughout. Prices typically don’t immediately fall out of these zones, though, due to the momentum effect. Before that, we almost have to get to 1900 on the S&P, one way or another, unless geopolitics intervene. Then there’s the matter of getting the Dow Jones back up to its own new high. These moves have nothing to do with earnings or the economy and everything to do with making money trading. Once those milestones are out of the way, we’re apt to continue seeing more volatility than last year.

I had thought that the Sornette wave – essentially, a blow-off top trend – the market has been on since was broken in January, but that didn’t turn out to be the case. It’s a pity, because the longer the wave goes on, the harsher the final payback. Lord knows what the eventual ramifications of that will be, and how little we can afford it. But until then, enjoy the show.

The Economic Beat

After being prepped for something much worse headed into the February jobs report – many were predicting a number somewhere in the 80,000 range – markets were caught off balance by the print of 175,000 new jobs that came with a tick up in the unemployment rate to 6.7%. That was in contrast to the month before when it was the jobs number (113K) that disappointed, but the rate dropped another tenth anyway. It also was much better than the ADP payroll number of 139,000 – below consensus of 150K, though the market hardly cared – released two days before. Those poor folks at ADP (where they try to anticipate the Bureau of Labor Statistics (BLS) number, not report a superior measure) have been trying to chase the BLS number around for several months now – they must really be wondering what adjustments the department is using.

I had written in the wake of both the December and January jobs reports that the labor market was better than what was signaled by the headline job counts – or perhaps better put, the unadjusted data that the BLS publishes was showing more trend consistency than the adjusted data. The February number stayed within the range, but oddly enough, it was weaker year-on-year than the much lower January number.

There does appear to have been a weather effect: The gain in unadjusted payroll count from January to February was the smallest since 2010, and the year-on-year increase in February payrolls was the weakest since 2011. The household survey reported a much more meager addition of 42,000 new jobs, and it’s reasonable to suppose that the response data was affected by the weather. January’s big catch-up in the household survey combined with the smaller February-January increase in the payroll survey to pull the twelve-month numbers much closer together (+1.91mm household vs. +2.07mm payroll) than they had been at the end of December (+1.46mm vs. 2.26mm). It’s a good reminder of how noisy the monthly numbers can be.

There were some anomalies that caught my eye as soon as I heard them, such as the 15K increase in construction jobs. This is inevitably going to be (mis)quoted by economic bulls, but the truth is different. As I wrote last month, declining headcount growth in construction in the second half of the year led to lower layoffs in January, which the BLS translated as an increase in what ought to be called the seasonally adjusted, annualized rate of construction employment. It was instead misquoted left and right as construction adding 30,000 jobs, when all that had happened was that the January decline in actual jobs wasn’t as steep as the prior years.

That seems to have influenced the February number as well. I can’t tell you why February 2013’s monthly change in actual payrolls of +33,000 was given an adjusted print of +46,000, while this year’s decline of 7,000 (initial estimate) gets an adjusted rate of +15,000. February declines in real count are quite unusual in any category, and I wonder why the BLS thought it merited a positive result. Certainly one can attribute some of the weakness to the weather, but the notion that construction did well anyway simply doesn’t wash.

Other data were mixed, but not really different enough to say that anything has changed. Average weekly hours fell to 34.2 – a thirty-seven month low! – but the modest tick downward of a tenth during such a difficult month isn’t much of a signal, except maybe that the underlying trend has remained modest. In the same vein, I wouldn’t take the seasonally adjusted 25,000 increase in leisure and hospitality jobs seriously either.

An interesting construction datum was the estimated January 1.1% increase in private residential construction spending. Given the slowing momentum in starts and sales, it suggests a mix shift towards higher-ticket homes. For the month, construction spending was up 0.1% while the year-on-year rate soared to 9.3%, though this is distorted by last January’s budget-related weakness.

On the survey side, the ISM followed up the previous week’s robust Chicago PMI reading (59.8) with the national manufacturing PMI of 53.2. That compares with February 2013’s reading of 53.3, originally released as 54.2. Responder comments were full of the weather, as was the case in the non-manufacturing survey that checked in with an unexpectedly low reading of 51.6 (50 is neutral). People discuss these measures as if they’re output measures, when they’re not – as far as I’m concerned, a sideways month in services is about one would expect, given the heavy snow and ice in much of the country. The sharp decline in the non-manufacturing employment index to 47.5 led to widespread predictions of weakness in the payroll report (along with pre-emptive excuses), thereby increasing the surprise factor. Monthly data are noisy.

Surveys are surveys. The Gallup consumer spending survey showed a sharp increase in February spending, yet auto sales and chain store sales data pointed to weakness. References to surveys of corporate spending intentions showing planned increases are commonplace at this time of year, but the latest factory orders report (January) showed the two-year annual growth rate for business cap-ex slowing to just above 3%, a rate of descent comparable to 2008. The Chicago PMI survey showed unexpected strength, while the Fed’s Beige Book reported that business activity in the Chicago area declined.

The labor turnover survey (JOLTS) comes out Tuesday, though it isn’t an opinion survey. The main event of the week – scheduled in this country, at any rate – is the February retail sales report. Expectations will of course be low, so it will be hard for the report to disappoint and the notion of a weather pass has become so ingrained that it may only be able to surprise to the upside. Other reports of interest include wholesale trade on Tuesday and price data on Thursday (import-export) and Friday (producer prices), but it may all be overshadowed by incipient speculation about the Fed meeting the following week.

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