A Pause in the Big Easy


“There’s no such thing as bad weather, only unsuitable clothing.” – Alfred Wainwright

The question on everyone’s lips at the end of last week was whether or not the red ink was the start of the long-awaited, long-scorned correction, or just another dip to be bought. From a technical perspective, there was some real damage, as the S&P 500 index that everyone takes direction from sliced right through its 50-day exponential moving average (EMA) for the first time in three months. The Dow is now down about half of a percent on the year, and perhaps most worrisome is that the Russell 2000 small-cap index is now down 4.2%.

The S&P is also down 4% from its closing high of only 8 days ago, when it made its first flirtation with 2000 by poking its head above 1990. Now the question is whether or not it holds 1900 – while it is oversold short-term, it is by no means oversold on an intermediate or long-term basis, and hasn’t been so in nearly two years. Just as the index would work off short-term overbought conditions by pausing for a few days during recent months, it’s possible to see similar sideways action again before trades are faced with the true test of the 150-day EMA, at 1885. The 150-line was the bottom of the January-February pullback, the resistance level for the May-June Fed panic last summer, and has not been pierced since November 2012 (the last time the 200-day average was tested either). That may seem like a lot of technical talk, but this is not a market running on earnings growth, despite the cheerful assurances of brokerage-house bulls.

I think a test of the 150-day is plausible, but prices are going to need a bigger excuse to get past that. Last week’s action was a confluence of factors – the last day of the month, post-Fed meeting sell-off with taper worries, contagion worries (Argentine default, Portuguese bank stumble), growing violence in the Ukraine and Middle East, anxiety over growth being too high or too low, some weak corporate guidance, the calendar, and of course plain old fear that this dip was for real.

It’s also common for stocks to rally through the first half of earnings season and then begin to sell off as it winds down – the two-week intervals that begin at the end of April, July and October are well-traveled weak spots for stocks. There’s no law about it, but it’s familiar enough behavior that another episode shouldn’t surprise anyone.

All that said, not enough has happened to really get the market to doubt itself. Even many of the short-term bears that were popping up at the end of the week were avowing their long-term bullishness. A genuine break-down past the 150-day average – and yes, everyone will be watching it – is going to require some fresh horror, be it the credit markets, Fed, or the battlefields. Markets quickly get bored with yesterday’s carnage and mere tension

There are always a multitude of things that can go wrong, and places like the Ukraine and the Middle East are real hot zones. But the market only stops to heed the very worst events. Going forward, the market’s most immediate worry is the tide going out from either the Argentine default or Portuguese banks and revealing some over-leveraged clown that scares the credit markets. Barring that, it would be open warfare in the Ukraine. If neither of those happen – and they don’t seem odds-on – without some big ugly to take their place, the markets will find a way to start rallying again as soon as it looks like the selling has tired itself out. Keep in mind that the last 10% correction was occasioned by a surprise downgrade of the U.S. credit rating that came rating against a backdrop of stalling recovery. Today’s worry situations don’t have to get better to appease stocks – they just have to stop getting worse.

At the risk of sounding like I want to have it both ways, the above shouldn’t be construed as the all-clear siren. Valuations are still quite rich across both stocks and bonds, and when the reversion to the mean does finally come, it will mean serious pain. The breakdown of the Russell 2000 is the classic kind of genuine warning sign that we are in the fourth quarter of the game. But markets never heed the first bells, and in fact prices nearly always go on to make defiant new highs first. It’s just the nature of the beast.

One soothing remark from a Fed governor would stop any decline in its tracks. On the other hand, a burst of hawkishness could be the trick that rattles our policy-obsessed markets into the dreaded 10% zone. It’s a sign of just how tied to easy money asset prices have become.

The Economic Beat

It’s hard to say what was the highlight of last week from the economic calendar – 2nd quarter GDP, the FOMC statement, or the employment report? The former two seemed to contribute to the market sell-off (I wouldn’t blame all of it on them) and the last probably had more of a calming effect than anything else.

The jobs report is the headline that most people see, and it was immediately pronounced “Goldilocks” at CNBC (and elsewhere) the rest of the day. In at least one way, it was. At 209,000, the initial estimate of additional non-farm payroll jobs was below the estimate for about 235,000, well below the whisper number of 300K-plus, yet still above some sort of scary-slippage number like 180K. You might think that a number over 300K would be good, but coming on the heels of a 4% quarterly GDP print on Wednesday, it would have revived tightening fears in our policy-besotted stock market.

Despite the GDP print that was much higher than expected, there was still a lot of anxiety about growth during the week. Bellwether companies like Visa (V) and UPS haven’t been very enthused about the second-half outlook, and the Chicago purchasing manager index took a terrific plunge on Thursday, with its largest single month drop since 2008. The number wasn’t really bad at 52 – still above the neutral line of 50 – but the roughly ten-point drop might have done as much as anything to rattle markets on Thursday. If the Chicago number, which is heavily influenced by auto sales, does reflect auto inventories that are too high, then the implication is that the inventory boost from the second quarter may already be receding.

But we were talking about employment. Much of the report was more of the same – no growth in weekly hours and puny growth in wages. Some parts were a tad more interesting – the participation rate edged back up one-tenth of a percent, immediately hailed as a sign of the strengthening market. Now, the household data is pretty volatile and it’s only one month, but I didn’t hear anyone mention that the 881K increase in the “not in the labor force” (NILF) category – people not working but not counted in the rate because they are not “actively” unemployed – dwarfed the increase in employment of only 131K. As I said, the household is swingy and there’s a lot of seasonal adjustment going on, but there is more than one side of the picture.

The establishment data looked better. Though the initial estimate missed estimates (and who knows, maybe it gets revised back up next month) I was a little puzzled as to why it came up short. The year-on-year increase in unadjusted payrolls is tentatively 1.92%, compared to July 2013′s result of 1.76% and the best showing for the month since 2000. The seven-month percentage increase of 0.29% (unadjusted), even after the inevitable revisions, should still be the best showing since 2005. It looks like the adjustment factors held the headline number back.

Despite this seemingly stellar growth, personal income and wages continue to grow at an anemic pace. At least a partial explanation can be found in the following couple of charts from the BLS that focus on part-time labor. Although June’s controversial jump in part-time labor disappeared, the graphs are still striking: Figure 1 is part-time workers for economic reasons, while Figure 2 is part-time workers for non-economic reasons.

Figure 1: Part-time workers for economic reasons

Figure 2: Part-time workers for non-economic reasons. Source: Bureau of Labor Statistics

We have an awful lot of people working part-time. A Federal Reserve study from last fall addressed the issue and trotted out the usual suspects – aging demographics, potential impact of Obamacare – but concluded that the largest impact was from the slow job recovery. That seems right for two reasons – one is that at 14.1%, the percentage of part-time worker for non-economic reasons (i.e,. want to work full-time but can’t get the hours) has been creeping up slowly the last few years, but is still lower than 2007 (14.5%) and the average since 1990 (14.4%). No doubt Obamacare has played a role in corporate America’s relentless battle to minimize labor costs (outside of the executive suite) along with the other above-named factors, but the strongest conclusion from the data is that one of the main reasons for anemic income growth is the heavy mix of part-time workers.

The other indication that the job recovery has been slow is that the number of officially insured (that is, covered by unemployment insurance) workers at the end of the second quarter is still 1.8 million less than the last cycle’s peak in 2008. That was nearly six years ago; the last expansion cycle took four years to surpass the previous peak. We are at least three more quarters away, and it’s not even certain that we’ll get there: the number of workers added in the second quarter of 2014 was actually a bit less than the second quarter of 2013. The claims survey doesn’t double count workers the way the payroll survey does.

The more moderate July number (which included some mild upward revisions to May and June) will at least be less of a topic of conversation than the hotter June number. The Wall Street Journal bragged up the seasonally-adjusted increase in manufacturing jobs, but the result was from an outdated adjustment factor that still thinks auto factories shut down at this time of year. The actual monthly increase of 6K jobs (estimated) was less than July 2011 or 2012, and may start to head the other way if automakers do in fact slow their mounting inventories. Talk about the domestic economy should start to shift toward third quarter GDP, now that the first month’s auto sales are in, to be followed by July retail sales and industrial production the week after next.

While I covered GDP in some detail in my Seeking Alpha article, the essential was that the longer the time frame, the more you can see there is little to no change in the trend. The quarter-over-quarter rebound gave a good-looking number that was boosted by inventories, but the year-on-year number of 2.4% is just average and the first half of the year remains anemic. Looked at over the last four years, the only thing happening in 2014 so far is a mild easing of economic growth, one that at the moment does not appear to be set to take off in the second half. Recent revisions have been very large to this number, so I wouldn’t take anything to the bank yet.

The FOMC statement on monetary policy was also more of the same. There was a tiny bit of defensiveness in its decision to continue the taper while asserting its right to carry on ultra-low rates for as long as it wants. Considering that the committee almost surely knew that the unemployment rate had edged up to 6.2%, its emphasis on its “dashboard of indicators” might imply that the committee doesn’t plan to wait until 5.5% to take the first step. The market eventually closed down, though that isn’t unusual after the Fed statement, but one had the feeling that the market was a tad less convinced about Yellen’s dovishness. Perhaps she is setting them up for another rally down the road.

The Chicago PMI turned out not to be a harbinger of the ISM survey. The Markit PMI survey did turn lower from its flash reading, but the ISM rose to a greater level (57.1) than expected. The sector ratio was broad too, with 17 reporting expansion versus only one contracting, though the responder comments emphasized the mildness of the growth. That’s the drawback to diffusion surveys, which can give misleading clues about the depth of monthly direction, especially over short periods. Still, it did cheer the market, especially when compared with June construction spending. The latter is another number subject to big revisions – May was revised from +0.1% to +0.8% – but June came out with (-1.8%). That’ll mean a downward drag for the next GDP revision due in three weeks time. the Dallas Fed reported a very good 12.7 reading for its survey.

Pending home sales eased back a bit with a (-1.1%) decline, while the rate of year-on-year sales appreciation also moderated according to the Case-Shiller index that dropped from 10.8% to 9.3%. Buyers may be starting to resist increases. Consumer confidence surpassed 90 for the first time since December 2007. Despite the irony of that, Econoday couldn’t help gushing over it, exclaiming over the “very favorable mix of readings” that “point to healthy acceleration.” That overlooks two points – one is that confidence and spending don’t correlate very well, and the second is that extreme confidence readings are great contrary indicators.

The other highlight of the week was an increase in the Chinese PMI to 51.7 in both the public and private surveys. This has been setting off overstimulated stimulus-buying of Chinese stocks, but the numbers have really been on the soft side since the latest mini-stimulus.

Next week is a light one, with doesn’t augur well for stocks – light weeks tend to follow the direction of the previous week. The first reports of note come Tuesday, with the ISM services survey and June factory orders. Wednesday has international trade, Thursday the very small same-store sales sample from retailers, and Friday has productivity and costs – the latest release of the employment cost index showed a big gain (+0.7%) that stocks didn’t like at all. Wholesale trade on Friday should give a clue to third quarter inventor direction. The back half of the week will also have a good chunk of PMI data from Europe, which is starting to suffer from growth scares again.

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