“Little strokes fell great oaks.” – Benjamin Franklin, Poor Richard’s Almanack
It was another odd week last week. Markets were up in the face of a surprisingly weak initial GDP estimate that widely missed consensus, then sold off on Friday despite a jobs report that crushed estimates, even as it left markets groping for explanations of its contradictions.
The first part of the week started off completely according to form: rally into the FOMC statement. It’s been one of the most reliable trades of the last few decades. But a rally on jobs report day had also been a reliable rally, certainly one of the most reliable ones of this recovery. Until recently that is – it was the second jobs report in a row that stock markets failed to rally, and that is something that students of momentum should not fail to notice.
The rally failures have been sparked by the tensions in the Ukraine, and further muddied by weakness in high-multiple stocks having nothing to do with the former. There is considerable debate about how much traders ought to really be worried about the Ukraine; by normal standards, the market isn’t taking the Ukraine seriously at all. However, by stock market standards, a mild sell-off on jobs day is about as worried as it gets until the tanks are rolling. In Manhattan.
Yes, stocks tend to jump a little at the first scare and then resist until the worst comes to pass. It’s probably just a reflection of human nature not to want to believe in the worst outcome. The main concern in financial sectors is not so much that the Cold War is about to restart – though it might – or that Russia and the US (or more likely, NATO) might start exchanging gunfire (a genuine possibility, if not imminent). If Russia does attempt to seize the Ukraine, though, economic sanctions will surely follow, whatever German businessmen may think, and that would deal a potentially lethal blow to the miniscule European recovery – not to mention complicating the geopolitical situation around the world.
But it really is impossible to predict what may happen, certainly from this corner. Though many are comparing Putin’s actions to the early territorial aggressions of Hitler – and there are similarities – there is nowhere near the sense of aggrievement in Russia today that existed in post-WWI, post hyper-inflation Germany. Putin’s actions to take back the Crimea have been wildly popular in Russia, and the Ukraine remains at risk – many consider Kiev to be the ancient spiritual capital of the Russian nation. The Baltic states should also feel uneasy. But there is no chance that Russia wants to go into Poland or Hungary: It isn’t interested in a Third Reich-style campaign of general military conquest. However, a few more painless Crimean-style annexations would suit Putin and his supporters very much, and therein lies the danger. Where does the line get crossed, and who draws it?
The tricky political situation adds to the vulnerability of a stock market that is running on very high valuations and a very modest economy. Despite the anemic first quarter, I would argue that the economy’s underlying trend is still about the same – that is to say, annual nominal GDP growth in the 4% range, give or take a half-percent (leaving real GDP with a likely two-handle). Despite the annual ritual of the usual suspects beating the usual second-half recovery drums, there are really no signs at all that the economy is about to break out of this range – and I cannot offer any rational reasons why it should.
The stock market is vulnerable right now, and still lacks real direction. Without some external help, such as a fresh program of global central bank liquidity (not a sane thing to do, but stocks would certainly welcome it at first) or a sudden resolution of the Ukraine, Chinese economy and other festering problems. we are at considerable risk of a ten-percent-plus sell-off in the coming weeks. The natural upward direction has been running on fumes and got no help at all from a lousy first-quarter earnings season. Throughout 2014, I have steadfastly maintained that the markets should keep struggling towards new highs and that the first-quarter earnings rally would not be denied. So far, so good. But the calendar and earnings-season props have been removed now. Watch out, because stocks are going to need both help and luck to avoid a real correction.
The Economic Beat
After studying the April jobs report in some detail and sifting through the many voices clamoring in its aftermath, the strongest conclusion I can reach is that it has been a really long time since I can remember seeing a jobs report that was a great one. and not shot through with contradictions and problems. Perhaps that that will be the most enduring characteristic of this recovery’s business cycle – never a period of truly good employment growth.
To begin with, the headline increase of 288,000 jobs may have been the biggest increase since 2008, but it was not at all matched by the household survey, which recorded a net loss of 73,000 jobs. The latter report is subject to considerable volatility and is much less accurate on a month-to-month basis than the payroll survey, but that wide of a discrepancy is rare and not something to simply brush off. In my own experience, it’s the kind of phenomenon you get when an economic cycle is in the late stages.
Before we delve into the more lugubrious household side, though, I’m also a bit skeptical about the establishment data. You may recall my writing in last week’s column that weekly jobless claims behavior had been quite favorable during the April measurement period, which suggested favorable adjustment factors lay in store for the headline number. That seems to have been the case, but the claims trend has since come undone. It’s too early to say definitively whether early April or late April was the better representation of the jobs market, but one early piece of evidence is that the data from late April is more consistent with the rest of 2014. Personally I suspect that the claims weakness in the first two weeks of the quarter was more a reflection of subdued hiring earlier in the year than a sudden shift in labor demand. In other words, fewer hires equalled fewer fires.
Earlier in the year I was writing that the Labor Department was overstating labor market weakness with its seasonal adjustment factors, a trend it now seems bent on reversing. April came with revisions of an additional 36,000 jobs for the prior two months, a result that was almost entirely due to changes in adjustment factors.
Taking that into account with the rest of the year’s data doesn’t inspire confidence. The year-on-year change in January payrolls was 1.79%, a decent number (2013 was 1.7%) that fell into the 1.55%-1.65% range during the prolonged spell of adverse weather. The April report returned to a 1.75% year-on-year increase, but I wonder if it will hold up. In addition, recent years have been characterized by stronger numbers in the early part of the year and weaker ones as the calendar wears on. I saw one analyst dismiss the twelve-month average of below 200,000 as being too stale, preferring to dwell on the more recent three-month trend of 238,000 as being a superior indication of current trend. That ignores the fact that last year’s early three month trend failed to signify any sea change either.
Other problems with the establishment survey include the construction payroll data, which is at odds with the Commerce department data on construction spending; the heavy mix of low-pay jobs (retail, leisure and hospitality, health care) and the near total lack of wage power and/or job pressure: average weekly hours were unchanged from March (34.5) and are up only one-tenth from a year ago, while average hourly earnings were also unchanged and are up only 1.9% from a year ago. The employment cost index tied its record all-time low – there is no pressure in the labor market. Yet the headline number of 288K will make as many people wrong about it now as were wrong four months ago.
Without a doubt, the household survey produced the strangest part of the report, and was just strange, period. The big discrepancy in the employed count – a loss of 73K versus the payroll survey’s gain of 288K – wasn’t even the oddest part. That honor went to the big drop in the unemployment rate, a plunge to 6.3% from 6.7% in one month that was based on a dramatic decline in the participation rate (back to 1978 levels) and a spike of nearly a million people classified as “not in the labor force” (NILF). It’s going to take some time for the two surveys to come back together again.
The rebound in manufacturing seems real enough, though the question remains of how open-ended it will be. Most of the manufacturing surveys in April produced strong readings, above all the Chicago PMI which came out with a reading in the low sixties. The national PMI reading came out with a result of 54.9, a good reading and slightly better than the previous month. New orders were in the same range, about 55. Comments were guarded about the weather, but the ratio of expanding to contracting industries was an impressive 17-1. The report was on par with the March factory orders report, which had new orders rising 1.1% and business capital spending rebounding 3.5% from a March decline. The 12-month total is up 4.97%.
The other highlights of the week were the first estimate of first-quarter GDP, and the FOMC’s (Fed monetary policy committee) latest statement. There isn’t that much to say about the latter – the committee blamed the winter weakness on the weather, was hopeful about the rebound thereof and trimmed its bond purchase program by the expected $10 billion. Nothing new emerged. The quarterly GDP estimate, by contrast, was a big downside surprise at 0.1%, coming in well below consensus estimates for 1.1%. The construction report the next day indicated an additional downward revision in store, such that the current tracking estimate is at (-0.1%). Consumer spending picked up, as measured by the PCE category, but much of it appears to have been energy spending forced by the weather – and has anyone noticed the spike in gasoline prices in April?
The Wall Street reaction to the weak GDP report was typical – blame it on the weather and put it in the rear-view mirror. Many seemed to even take it as some sort of benefit, leading inexorably to an even stronger rebound in the second quarter. There is no negative momentum on Wall Street, only the positive sort. Yet weekly retail sales reports were more modest than I would have expected in April, given the Easter holiday.
Pending home sales rose for the first time in months, but mortgage-purchase applications hit a new 2014 low of a 21% year-on-year decline. Prices remain about 13% higher than a year ago. It appears that housing has entered a more expensive, less active stage.
Next week will start off with the ISM non-manufacturing report, then subside into a series of global surveys (PMI measures) and lower-profile reports, primarily international trade (Tuesday), wholesale trade and the labor turnover report (JOLTS) on Friday. The European Central Bank meets later in the week, and the Ukraine could overshadow everything.