“We hold these truths to be self-evident.” – From the American Declaration of Independence
There were all kinds of warnings in the business press on Friday and over the weekend concerning the perils of reading too much good into the June jobs report. The stock market was having none of it on the day however, with a big rally that left the market at its highs on the year.
You can add my voice to the ones observing that the report was not as good as it seems (see the Economic Beat below), but perhaps of equal importance is the interpretation of Friday’s trading. It should not be taken as a verdict that all is well, or that traders are now of some unanimity on the glorious state of the American economy, but as a reflection on the market belief that one buys a good jobs report first – especially one that comes as a surprise – and asks questions later. That reflex can even extend to a surprise bad jobs report, because traders are prone to buy those too on the theory that increased central bank accommodation is forthcoming.
All is not well, though the stock market may seem to tell a different tale. We are on track for the fifth consecutive quarter of overall earnings decline for the S&P 500. Total corporate profits declined year-on-year in the last two quarters. Business spending is contracting, business investment is contracting, retail spending is at stall-speed and employment growth is flattening out, whatever the June jobs report may say. But equities are going to wait until more than the writing is on the wall, they’re going to wait until everybody in the room knows the game is up.
In the meantime you will be treated to more stories about any problems being years away and – in this case – the economy is finally ready to take off. I heard a public radio newsreader wonder if the June jobs report would finally lead to “full employment.” We are at full employment (in economic terms) and have been there for a year now. If you think full employment means something like a zero percent unemployment rate, why then I have a bridge to sell you. Prime real estate, too. Right in New York City.
Recall as well that the market nearly always rallies after some big ugly problem surfaces. The market rallied after Lehman declared bankruptcy, it rallied after Bear Stearns went under, it rallies after all kinds of bad events before eventually waking up to reality and heading the other way. The stock market motto might be “what doesn’t kill you makes you stronger – until it kills you.”
The bond market is having none of it. The ten-year bond yield is at multi-decade lows. You can argue it’s because of low inflation, or central bank policy, or the search for safe havens, and there is some room for all of those, but there is no room at all to argue that the bond market is worried in the least that economic growth is about to pick up. The divergence between the stock market and bond market that has been going on for two years now is unprecedented, and someday we will all be wondering how everybody missed it. The answer is the same as every other investing fad – people buy them until they break.
Going forward, the market is not outrageously overbought. Short-term momentum is only a little stretched, intermediate indicators more so, being near a 2 1/2 year high, so some caution is in order. Whether or not we float a little higher first is of little import in the long run, but of much importance in the short turn to true believers. So we might work our way a little higher first before the news flow puts on the brakes, as we are not really in a Goldilocks economy. but most likely we are at or nearly the stock market highs for the year and the cycle, making sticking around for the extra percent or two a foolhardy proposition. Exactly what so many love to do.
The Economic Beat
The highlight of the week, it need hardly be said, was the employment report. The 278,000 (278K) number was well ahead of consensus for about 180K and was the best number since last October. Yet May 2016 was revised downwards to a meager 11K (partly to the benefit of April, revised back up to 144K), leaving the second quarter average (about 150K) well below the first quarter (about 195K). There will almost certainly be revisions, though the direction can’t be known at this point, but it is certainly too early to read too much into the single month.
The stock market seemed to trade entirely on the two headline numbers – jobs at 287K (economy not going into the tank after all) and the increase from 4.7% to 4.9% unemployment (implies no rate increase by the Fed). Ergo, Goldilocks. However, the underlying numbers were not so good.
To begin with, the household survey was well behind with a net addition of only 67K. The household data is more volatile and even less reliable on a monthly basis, but it certainly doesn’t constitute supporting evidence. Wages barely moved, leaving the year-on-year gain in weekly earnings at 2.6%. The unemployment rate of 4.9% was mostly due to an increase in the labor force, which is good news (more people are looking to work) and a decrease in the not-in-labor-force category, also good news, but the participation rate, at 62.7%, is barely changed from the year-ago 62.6%. Most of the gains were in service jobs, with the lion’s share appearing to be seasonal work and lower-paying occupations.
From my point of view, the most important figure is the June over December rate of increase, currently at 0.78% before revision. That is the lowest rate of increase since 2010, when employment was just starting to climb out of the recession, and well below the average of the previous five years (0.99%). It is also remarkably close to the 0.76% rate in June 2007, six months before the last recession began. Not an encouraging echo.
The FOMC minutes were another featured release, with the key phrases seeming to be those that expressed concern over the Brexit vote and a wait-and-see attitude. The market’s silly rally on Friday has now wiped out the Brexit loss, but will that be enough to convince the Fed? Many commentators began raising the possibility of a September move as more of a knee-jerk reflex than anything else. I doubt that the Fed will raise rates again this year or even this cycle.
The other major report was the ISM non-manufacturing survey, which reported a strong overall result of 56.5, up from 52.9 in May. The activity index rose to 59.5 from 55.1. The report was good almost across the board, though prices (the best leading indicator for this report) were unchanged. The Markit non-manufacturing PMI, a competitor survey, was released earlier that morning and was well short of the ISM report at 51.4, virtually unchanged from the previous month’s 51.3. The series is relatively new and I can’t tell you whether it might be better or worse than ISM, but the comparison is curious.
Factory orders were estimated to have fallen by 1% in May, though up 0.1% excluding transportation. Durable goods orders remained down, as did cap-ex (-3.7% y/y), though these results were largely known after the previous week’s durable goods report. Weekly claims were good at only 254K, though weekly chain-store sales were soft. The trade deficit widened in May, putting downward pressure on Q2 GDP estimates.
The highlight of next week ought to be the retail sales report on Friday. Going by the softness in the Redbook reports and monthly auto sales, we are in for a weak June number: estimates are for a 0.1% gain, so the bar is low. It’s a busy day that also features the June consumer price index (CPI) and New York manufacturing survey, also at 8:30 AM, followed by the industrial production report at 9:15 AM, and then business inventories for May at 10 AM.
The week will lead off with the Fed’s widely-ignored Labor Market Conditions index that has been in negative territory all year. Will the June jobs increase pull it out, or will the increase in the unemployment rate keep it down? Will anyone really care? It’ll be followed the next day by the labor turnover report for May (JOLTS), alongside May wholesale inventories and sales. Wednesday brings import-export prices and the Fed’s Beige Book, while Thursday has the producer price index (PPI).