Now What?


“A Change of Fortune hurts a wise Man no more than a Change of the Moon.” – Benjamin Franklin (ed.), Poor Richard’s Almanack

The story of the previous week (ending April 28th) was not the first round of the French election, as much of the business media suggested, which showed far-right nationalist (and anti-EU) candidate Marine LePen second but with only 21.3% of the vote. Many commentators wondered why the markets would stage such an impressive relief rally over a widely expected result, but the answer is simple – it wasn’t about France or LePen (who lost quite handily the following Sunday). To be sure, there might have been a bit of extra impetus from the disaster-averted theme that is always popular with traders, but the main reason – as I had written about for most of April – was that the April options expiration date was finally in the rear-view mirror, and the following Monday is historically the real lift-off for the traditional spring rally. Traders were impatient to get going on the rally, and the later-than-usual expiration took off the restraints.

After an initial two-day burst, equities subsided back into a sideways range. The real question now is of course where do we go in May-June, which usually – but not always – includes a significant giveback period for equities. One group of traders is already lying in wait looking for any signs of trouble, like weak data, more Washington drama, or just a lack of faith in an already expensive market. Another group is lying in wait to try to squeeze the former group. Everyone knows the calendar is problematic now, so longs will look for shorts to build up in anticipation and then try to squeeze them on any positive development. As earnings season winds down, the preferred buy candidate would be more positive news on tax cuts, regardless of whether there’s a vote on the schedule.

Beyond that, there isn’t much on the calendar to work with until the next employment report on June 2nd. The Fed isn’t scheduled to meet and while the economic calendar will have some useful data, as always, the big show stoppers have mostly come and gone, with only Friday’s retail sales report remaining. The direction of the market will probably most depend on the winds out of Washington for the rest of May. And while I continue to maintain that the market is too expensive for new investments (unless you’re a day trader), that doesn’t mean it will go down. Valuations don’t move stocks. The end of the business cycle will end this bull market, but it will be many months after its ending before the concession speech is finally delivered.

The Economic Beat

The report of the week that ended May 5th was of course the jobs report. The initial estimate of 211,000 (211K) new jobs was somewhat above consensus for 185,000, where it has more or less been every month this year. March was revised downward to a weak-looking 79K, the lowest in quite some time, but it was really a case of seasonal adjustments and timing, as the jobs lost in the March column were pulled back into February, revised upward from 219K to 232K.

Despite the drop in the unemployment rate to an impressive-looking 4.4%, the rate of job growth continues to slow. The year-over-year twelve-month growth rate in the unadjusted data (there is no reason to adjust twelve-month data) fell to 1.45%, the lowest such reading for April since 2011 (1.15%), when employment growth was accelerating as the recovery took hold. I would love to tell you how many more months of growth are left, but the changes can be slow or abrupt as the cycle ends. A good rule of thumb is that when the rate declines below 1%, the end is near.

Some special factors at work in the drop in the unemployment rate are one, a growth in the not-in-labor-force category; two, a very small change (+12K) in the civilian labor force. The participation rate edged down to 62.9%, little changed from 62.8% one year ago. Hourly earnings are up 2.5% year-on-year, while weekly earnings are up by the same amount. The quality of hiring remains weak and focused in low-wage sectors like home health care and social assistance (+37K), or leisure and hospitality (restaurants and hotels, up 55K). On the plus side, the number of workers with part-time work for economic reasons continues to decline and is sharply lower than last year.

Overall it wasn’t a bad report, with the key reports still to come in May and June, when the Labor Department will have had time to digest its quarterly census data.

The two national purchasing manager surveys (“ISM”) were in good form in April, with the manufacturing survey reporting a diffusion rating of 54.8%, down from 57.2% in March, and the non-manufacturing survey reporting a result of 57.5%, up from 55.2%. Both had very good expansion-contraction scores, with manufacturing at 16-1 and non-manufacturing also reporting 16 growth sectors, though for the second consecutive month the survey neglected to mention how many sectors were unchanged or contracting. Comments were upbeat overall, but it bears repeating that the surveys have been nearly giddy all year with no change in activity growth to speak of. By contrast, the Markit manufacturing survey was unchanged from the month before at 52.8, with far less optimism in the report. That’s still a reasonable number, and more in tune with measures of activity and output. The Markit services index came out at 53.1, a small improvement from the previous month’s 52.8, but the change is not statistically significant.

The latest read on factory orders did show some improvement, though the gains are concentrated in the aircraft sector, where current new orders won’t mean anything activity-wise for a couple of years. Orders were up 0.2% in March, seasonally adjusted, and business capital spending is running 2.2% ahead of a dreary 2016. That isn’t much when adjusted for inflation, though (and the Commerce Department numbers are not inflation-adjusted); if oil continues its recent weakness that number may slow some more. Construction spending contracted by 0.2% in March in the initial reading, but that number is prone to large revisions. February was revised from +0.8% to +1.8% (and it’s not the final revision), while the year-on-year is thought to be somewhere around 3.6%. It’s probably between 3% and 5%, but those estimates will get revised for months to come.

Personal income rose by 0.2% in March, seasonally adjusted and annualized, with February marked down a tick to 0.3%. Spending was unchanged, with the previous month also revised down from 0.1% to 0.0%. Despite the unimpressive numbers, year-year spending rose from 2.5% in February back to 2.8% in March, while real (inflation-adjusted) disposable personal income edged back up to 2.4% from 2.2%. The numbers are about in the middle to low middle of the range they’ve been in for the past couple of years.

Productivity fell in the first quarter by about 0.6% in its initial estimate, but is another number subject to significant revisions (Q4 was revised up from 1.3% to 1.8%, and that one isn’t done either). For now, the combination of higher wage growth and low output, combined with weak investment the last two years, should be expected to keep a lid on productivity, whatever the number may be.

Oh yes, the Fed met and did nothing, as expected, and said the economy wasn’t quite as weak as it looked. What a surprise. All in all, the week’s data suggest that we continue to move along at more or less the same subdued pace we’ve been on for quite some time, with jobless claims signaling no woes in employment. The coming week will feature retail sales on Friday, inflation data, the labor turnover survey (JOLTS) and wholesale sales.

For the week of April 28th, the report of the week was surely the initial estimate of first-quarter GDP. The low print (0.7% annualized and seasonally adjusted, or SA) was well below consensus for something just over 1%, and provoked considerable conversation, if not visible reaction in the markets. Stocks were off slightly on the day, but it might be better put that the print was more lack of a reason to buy than providing a reason to sell. GDP is rarely much of a clue to the jobs reports that traders do like to trade on (but you know, only because everyone else does). That said, it didn’t make any case in favor of a big number the following week.

Had the GDP report occurred in the coming week, it would have run a distant third anyway to the impending jobs report and FOMC announcement. While the figure is a reasonably good, though certainly imperfect, indicator about the strength of the economy, the equity markets really don’t care that much about it. Even Wall Street’s favorite, the jobs report, faces an uphill battle every cycle in convincing the Street that a recession is beginning or ending.

March new orders for durable goods was the next most interesting report. They rose by 0.7% (SA), which looks good, but when excluding aircraft orders, fell by 0.2%. Orders for aircraft are certainly not a bad thing, being one of the last major technology sectors still to manufacture in the U.S. (though many of the parts come from abroad). However, they have zero impact on the current economy, as the lead times for starting new orders are generally a year or more. When aircraft order books are as well-stocked as they currently are, the waiting time can be 2-3 years or even longer, making them vulnerable to cancellation or deferral should times get difficult.

The business investment category that goes by the unwieldy name of non-defense capital goods excluding aircraft rose by 0.2% (SA), below consensus. At least it was still positive, and on an adjusted year-on-year basis, was actually up over 3%. The trailing-twelve-month rate (NSA) improved to (-2.0%), the best it’s been since August 2015. The brunt of the slump and current recovery is due to changing fortunes in the oil sector, but not much is happening outside oil, either.

Industrial activity and surveys continue to be tales of two cities. The Dallas Fed index was virtually unchanged at 16.8, close to multi-year highs, while the Richmond region rose to 20 from 16. The private-sector Chicago purchasing manager index rose to 58.3 from 57.7, leaving the Kansas City Fed regional index as the lone survey not to rise, falling to 7 from 20 in March. The Chicago Fed’s national activity index for March, which unlike the others is quantitative rather than qualitative, eased in March to a mere 0.08 from a downwardly revised 0.27 in February (the index has a neutral value of zero and is designed to have most readings within plus or minus one). The more reliable three-month moving average moved down to 0.03. Not exactly great readings, but not terrible either.

Over in housing, sales of new homes rose in March to an annualized rate of 621K homes (SA). The trailing-twelve-month (TTM) rate rose to 576K, a 14% increase over March 2016. The subdued level of housing activity this cycle implies that growth should be able to maintain its pace until the cycle rolls over again. Home price growth appears to be picking up from the middle-5% range it enjoyed in 2016, with February moving up to 6.4% year-year in the Case-Shiller price index (which excludes new homes) and January revised upward to 5.9%.

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