Bumpy Beginning


“We must give advice, but we cannot give conduct.” – Benjamin Franklin, Poor Richard’s Almanack

The year 2013 saw an improbably good rally in the stock market, characterized by low volatility and two long central bank-fueled climbs, with neither the economy nor corporate profits required to do anything more demanding than be positive. In 2014, the economy and profit growth were about the same, but growth in our central bank’s balance sheet slowed – volatility picked up and the rally was less than half as good. 2015 looks set to continue this trend, with diminishing accommodation – though at an ever so slow pace – by the Fed, and thus increasing volatility and smaller gains.

While the end of 2012 saw a feverish, QE-inspired rally that ran all the way into April of 2013, the end of the latter year had to struggle instead with the threat of political paralysis and government shutdown. There was enough price momentum to finish the job in a breakneck move the last two days, but not enough to stop institutions from rebalancing away from equities in January after a banner year. This year there was barely enough momentum to keep the last quarter even, but not enough to keep the S&P positive in December, historically the second-best month for returns. The diminished momentum is definitely not enough to handle another January bout of portfolio rebalancing.

Thus we are starting out 2015 much like a year ago, only with more volatility, less accommodation and more uncertainty. As I’ve been writing, expect more volatility this year, though that does not necessarily translate into a decline. While the increased turbulence is surely a symptom of the bull market’s advanced age, 2015 could still go either way, even if returns will struggle to do any better than notching half of the prior year’s gains.

As for some of last week’s daily action, much of it was typical market stuff, ranging from yet another rally tracking the release of FOMC minutes (Wednesday) and the ADP payroll jobs estimate beat, to the disappointment of the Bureau of Labor Statistics (BLS) jobs data failing to come near the whisper number of +300,000 (Friday). The latter miss might have mattered less on another day, but a steady live feed of lamentable tragedy, death and armed lunatics from France cast a pall over trading and everything else.

The ADP number of 241,000 net additions in December represented a substantial increase from its November report of 201,000, the latter number also being revised upward to 227,000. The BLS had reported 321,000 jobs in November, so there was considerable anticipation of a number that would not only top 300,000, but perhaps 350,000 as well.

There was indeed a BLS print of 351,000, but it came in the form of a revision applied to November. ADP is constantly rejiggering its own report to better match the former’s data, and this time it succeeded, to the chagrin of traders: the BLS reported 252,000 for December. Commentators were left to forlornly repeat that the number had beaten the consensus estimate, but the latter was a couple of hundred of Dow points out of date: Thursday’s big rally wasn’t in anticipation of any 252K print. Something much bigger was expected, and when it failed to materialize some of the gains were given back. The fact that hourly earnings also posted a small decline served to amplify the disappointment.

January could well echo last year’s performance of an anxiety-laden rebalancing fall rescued at the last minute by earnings season and the Fed meeting rally that comes late in the month (the statement is due on the 29th). Thanks to weakness in the energy sector, estimated earnings growth for Q4 has been cut all the way down to 1.1% in the aggregate, according to FactSet, implying actual expectations of 4%-5% growth. Naturally the Street will emphasize earnings excluding energy, but nevertheless about half of the ten sectors are expected to struggle.

The standard bull-market reaction to this kind of event is for increased anxiety and gloom in anticipation, and then a rally to new heights when the worst fears do not come to pass. I don’t expect a different pattern this time around, but as the bull ages I will be looking for somewhat deeper, perhaps more frequent spells of anxiety and somewhat smaller relief rallies, making gains harder to keep in the bank. Volatility in the oil sector and the heightened focus on the will-they-or-won’t-they issue of quantitative easing at the European Central Bank (ECB) will add to the swings. The current market cycle’s obsession with central bank policy should still last until the business cycle ends, but the ride is set to be bumpier.

The Economic Beat

The report of the week was the jobs report, thought it might have only tied the FOMC minutes two days earlier. The media spectacle of the week might have been CNBC’s “Squawk on the Street” co-anchor Simon Hobbs fumbling his fulminations over the jobs report and the subsequent market reaction downward. I wish I could post a link to the video, but the network has wisely seen fit not to archive the segment in which Hobbs, extolling the numbers, was nearly shouting over why the market wasn’t reacting better to “these…great jobs,” including “50,000 construction jobs!”

Hobbs has something of a habit of putting his foot in his mouth with this kind of thing, making me sorely miss his late, great predecessor Mark Haines. The truth is that the number of 48,000 additional construction jobs (I’ll forgive the rounding) is only a seasonally adjusted artifact: the economy doesn’t really add construction jobs in the month of December, it loses them. This year’s November-December drop was about 160,000, about the same as 2012′s loss of 154,000 but better than 2013′s (-222,000). Last year’s loss was exacerbated by frigid weather and above-average snowfall, while this year’s result was aided by above-average temperatures and below-average snowfall. Hence the increase in the estimate of the seasonally adjusted rate, though it doesn’t really amount to anything substantial and especially doesn’t represent increased spending power, Mr. Hobbs. Those placeholder numbers don’t draw real checks.

The miss in the jobs number – as noted above, never mind the outdated official consensus – contributed to emphasis on another miss, in this case a monthly decline in hourly earnings. I wouldn’t go so far as to call it a one-off, as continued low oil prices would lead to more layoffs in higher-paying oil-field work and keep downward pressure on the number, but it doesn’t represent a bigger trend than that. It does belie both the notion of the lower unemployment rate putting upward pressure on general wages and the Fed’s ability to accomplish the same via monetary policy. To be sure, there is without a doubt upward wage pressure in selected sectors and regions, but the many corporate conference calls I endure make it quite clear that companies are as focused as ever on cutting labor costs and headcount. The bulk of job gains have come in low-paying work.

As for the unemployment rate, it did indeed fall to a seasonally adjusted 5.6%, the lowest December rate in seven years (5.0% in 2007). But temper your enthusiasm, as the participation rate (percentage of civilians classified as in the labor force) is at 62.9%, the lowest in nearly forty years (1977 = 62.7%). In addition, the “not in labor force” category that excludes adults from the rate calculation continues to grow, posting a startling, outsized gain in December alone of nearly one million people before adjustments, or 450K adjusted. That’s no recipe for inflation, nor broadly accelerating wage gains.

Another notable number Friday was wholesale sales and inventories. The latter grew 0.8% in November, seasonally adjusted, even as sales fell by 0.3%, leaving the inventory-to-sales ratio at a five-year high of 1.21. Some tried to be hopeful about the effect of the month’s increase on fourth-quarter GDP, but this kind of build is unwanted and the number is quite likely to be followed by GDP-dampening drawdowns.

Motor vehicle sales were somewhat below expectations and Redbook’s reporting of weekly chain-store sales in December also pointed to weakness for the month, leading to lowered expectations for the month’s total. Some of the brick-and-mortar losses are of course going to online sales, but the other numbers don’t bode well for the December retail sales report due out Wednesday. Consensus has been set appropriately low, to a beatable (-0.1%), but even that lower bar may be a challenge.

As to the FOMC minutes themselves, they can be summed up by saying that the Fed still resembles Lady Macbeth’s cat, being caught between “I would” and “I dare not.” Improving unemployment and positive GDP releases point to less accommodation and eventual increases in the funds rate, but the bank’s obsession with financial market stability remains clearly evident, a sentiment always welcome in the equity markets. Chicago Fed governor Charles Evans weighed in again against any increase at all this year; maybe he needs to watch more CNBC (excluding Rick Santelli) before he can catch some “very strong economy” fever.

Next week’s focus should be on the retail sales report, unless of course some other number can be much better. Alcoa (AA) kicks off the quarterly earnings season on Monday, the labor turnover report (JOLTS) is on Tuesday, JP Morgan (JPM) and Wells Fargo (WFC) start the mega-bank results on Wednesday, with Citigroup (C) following on Thursday. The latter day also features the Philadelphia Fed survey, with the national Fed’s December industrial production report on Friday.

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