The Start of Summer Driving Season


“All things are ready, if our minds be so.” – William Shakespeare, Henry V

Though the markets were mixed last week – the S&P and Dow edged down, while the Nasdaq was unchanged and small caps rose – on a relative basis, it was a good showing by equities. June typically gets off to rough start, so a decline of less than one percent in the S&P is hardly unusual – swoops in the mid-single digits are common.

It’s a theme that will probably run through much of 2015 – stocks aren’t doing great, but they could be worse. The Dow finished last week barely above this year’s starting point, with the S&P still clinging to a gain of a couple of percent. The transportation stocks are down about 10%, leaving many veteran traders and technicians uneasy, given the sector’s reputation as leading indicator. A good explanation for the sector’s weakness is that the rebound in oil prices hit an overbought group, but there are always good explanations. The ends of cycles are usually signaled by certain groups, particularly cyclicals, becoming immune to further gains because there just isn’t any more profit growth left to be squeezed out of them. Hence the worry.

Absent the Grexit (Greek exit from the eurozone), though, June will probably not see the beginning of some end. More volatility is likely to pour forth, certainly, but Friday’s jobs report (see The Economic Beat below) will calm low-growth fears for a while, and marketmakers will look for more excuses for soft GDP growth. Next week’s retail sales report is probably not going to help the growth cause, but that could conceivably work to the market’s short-term advantage by prompting a subdued Fed statement the following week. Even so, there is still a very good chance that the major indices will see break-even or less for the year before this month is over.

The financial markets remain fixated on Fed policy, and many would make the claim that the reason for the lackluster performance of equities (or even the economy) is the end of QE and the prospect of an imminent rate increase. Add in headwinds like the potential for the Grexit and other geopolitical problems, and one could make a case (and many do) that the markets could be much higher, if only policymakers would do their job (whatever that is, not being a subject of universal agreement).

Yet S&P 500 profit growth remains nearly zero, as do estimates for the rest of the year after the usual fourth-quarter optimism is discounted. Not only is that a difficult base to build on, it should be cause for greater concern, coming as it does in the seventh year of the cycle. The fourth quarter of 2007 marks the last peak, and the eight-year anniversary is looming. In the face of zero profit growth, the focus for the rest of the second quarter should revolve around Fed statements and Greece, with benign outcomes leading to rallies in spite of the weak profit situation. Adverse outcomes would probably not mean the end of this bull market, though, not quite yet, even if prices were to get pretty bumpy. Market enthusiasm has gotten weaker, but it takes months and quarters to turn the herd around, not days and weeks. That doesn’t mean the cycle isn’t running out of gas – it is.

The Economic Beat

The report of the week from the media point of view was the jobs report. For a couple of days anyway, it is inspiring abrupt reversals in popular accounts of the economy. Jobless claims data had been pointing to a good report, and indeed I was tempted several times on Thursday to tweet something to that effect, but the report’s ability to make people look foolish restrained me. Had I done so, the report would probably have been weak, so perhaps the markets owe me a vote of thanks.

The good news: the May number of 280K was above consensus for about 225K, and does point to a rebound from the first quarter slump. The year-to-date totals remain slightly behind last year at this time, which suggest 1) little change in trend ever occurred anyway, just the usual amount of month-to-month variation; yet 2) the employment segment of the cycle has plateaued. Jobs are a lagging indicator and will continue to grow past the point the business cycle begins to contract, but we are also too late in the cycle to expect the kind of sustained breakout data the stock market has yearned for.

The second-best piece of news was that the not-in-labor-force (NILF) category actually contracted. That rare event led to the unemployment rate ticking back up to 5.5%. To put it into context, the BLS says that over the last year, the civilian labor force has grown by 1.8 million, of which 1 million have been put into the NILF category. That kind of arithmetic will certainly keep the unemployment rate down!

The diffusion index (breadth of hiring) also moved up smartly, though it may represent nothing more than a catch-move, from 58.4 to 61.6; the downside of is that the manufacturing category declined to 48.8 (50 is neutral) and is well down from a year ago (63.1), as is the total (down from 67.5 in May 2014). For a change, year-on-year hourly earnings growth also showed a little life, rising to 2.3%.

The downside of the report included the lion’s share of growth being (as usual) at the bottom end of the wage scale, with the two categories of “leisure and hospitality” and “health care and social assistance” contributing about 115K, or 41% of the total. Retail positions were another 31.4K. I don’t know if it was sloppy or deliberate, but the Wall Street Journal’s front-page characterization of the report as “the economy also added more jobs in April and March than the Labor Department first reported” is both inaccurate and misleading. Although March was indeed revised back up to 119K from 85K, temper your enthusiasm, because it was first reported as 126K, then revised down to 85K, and finally (sort of) back up again – still a net loss from the “first” report. April was revised down by 2K, and while that number can obviously change, the direction of those revisions remains marginally negative, though you would not guess it from reading the BLS report either (“With these revisions, employment gains in March and April combined were 32,000 more than previously reported”). It’s one thing for the government agency to put a positive spin on things, quite another for the leading business paper to mischaracterize the data.

There wasn’t much surprise elsewhere in the week. The May ISM surveys weren’t significantly different from consensus or the month before, with the manufacturing survey coming in at 52.8 (consensus 51.8) and non-manufacturing at 55.7 (consensus 57.2). The growth diffusion in both sectors was very good and the responder comments were on balance positive. Modest-to-moderate growth might best characterize the two surveys, the same as the Fed’s Beige Book, released on Wednesday.

A datum that is worrisome came out of May factory orders. The year-on-year change in business cap-ex spending is down for the fourth month in a row, historically a precursor to recession. One can make some allowance for a more service-oriented economy, as well as the slump in energy investment, and one sector does not a recession make. That said, it’s a mistake to start making excuses for a weak sector this late in the business cycle. That’s how they end – first one sector weakens, then along comes another.

Personal income rose by 0.4% in April, more than the expected 0.3%, according to the Bureau of Economic Analysis. Consumer spending rose less than expected, unchanged vs. consensus estimates for 0.2%. Year-on-year personal income growth eased back to 3.6%, the third consecutive month of slippage, but benign inflation data helped push real per capita disposable income growth to 2.7% from 2.5%. The numbers do fluctuate quite a bit, but 2.7% is near the top of the post-recession range.

International trade gave a tiny lift to first-quarter GDP and a bigger one to second quarter GDP, thanks to downward revisions to imports and a port-stoppage related drawdown that led to a whopping 3.3% monthly drop in imports. Productivity fell at a sharp (-3.1%) rate in the first quarter, following a negative fourth quarter (-1.9%). Upward pressure on wages could cause corporations to behave even more abysmally than the Disney Corporation (DIS). If the report in the New York Times about the company abusing the skilled-worker visa process to replace domestic employees with cheaper help is accurate, old Walt must be spinning in his grave. Disney should get a hefty fine for such blatant and heavy-handed cheating; otherwise there will be more abuse across the corporate sector.

Next week’s retail sales report, due out on Thursday, ought to raise stock market hopes for a delay in rate increases, if Redbook reports are to be believed, as well as throw some cold water back on the growth story. Auto sales appear to have been good in May, but the rest of the category didn’t look good. Redbook doesn’t always match up, but it’s reasonably good at indicating where the total number is going.

More employment data is out on Tuesday with the labor turnover survey (JOLTS), followed by wholesale trade. The Fed’s labor market conditions index is out Monday, and while it hasn’t historically been a market-mover, it has come in for more attention lately after references made by Fed chair Janet Yellen. Import-export prices come out on Thursday, producer price inflation on Friday, and of course there is the day-to-day drama of Greece.

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