“When I waked, I cried to dream again.” – William Shakespeare, The Tempest
There was a small silver lining in the ugly clouds that Sandy lambasted the northeast quadrant of the country with last week: The stock market elected to stay closed the first two days of the hurricane’s arrival.
That’s not to be snide nor as existential critique, but a realistic assessment of the possibility of something going very, very wrong had the exchange stuck with its original plan of running an all-electronic session. Given the recent disasters of the flash crash, the Knight Securities software upgrade, the Facebook IPO and others, the exchanges would have been inviting disaster to attempt the madness of debuting an all-electronic session in the middle of a hurricane the week before a presidential election. It would be like moving LaGuardia airport to the southern tip of Manhattan and using Broadway as the approach route. It could be done. It would be breathtaking to watch. It would also be incredibly reckless.
The abbreviated session seemed to leave the Street confused. Wednesday was supposed to see massive pent-up volume and big price volatility, but the indices barely moved after a modestly contested tug-of-war. Thursday spiked higher on a typical combination of first of the month and a reversal trade, partly started by a rally in China. But Friday’s good news was too good, and the markets handed it all back again. It certainly did not leave me regretting the Monday and Tuesday closures; if anything, the markets would probably have been better off taking off the entire week and staying shut until after the presidential election. Even the fiscal cliff.
I was fortunate enough to pick the over in my Seeking Alpha column the day before the jobs report, where I posited that the jobs number would be closer to 150,000 than the 120,000-125,000 consensus. The 171,000 number was a welcome surprise, but the market reaction was not. Markets rose sharply at first, then sold off even more sharply upon two currents of thought, one legitimate and one the sort that makes the rational investor despair.
The legitimate worry concerned absentee balloting in Ohio, which for the first time mailed absentee ballot applications to all registered voters. The story making the rounds is the result might be a very large number of provisional and delayed votes, large enough to leave the official result in doubt for ten days after the election. It would not be market-friendly if the presidency is left hanging in the balance.
On the other hand, the good news on employment started a rally in the dollar and traders fretting that no more sugar might be forthcoming from the Fed this year. Why the Fed should be expanding its balance sheet yet again next month after it has just launched “QE-infinity” is beyond me, but one bad day of trading recently had the primary dealers – who act as middlemen between the Fed and the public – almost unanimously predicting that the Fed would double up on its quantitative easing as soon as December, this time buying Treasury securities. You can’t make this stuff up. Dollar up equals stocks down isn’t new, but a wearyingly tedious correlation that I had hoped would leave the scene.
One certainly can’t make the argument that earnings should have the markets begging for more. Despite the usual tedious pablum about earnings beats (as if there is ever a reporting season when most companies don’t beat estimates, really, the North Koreans could take lessons from Wall Street when it comes to scripting reality), the truth was that it was a dreary quarter. The number of revenue shortfalls was unusually high (over 60%), and too many companies are reporting negative year-on-year comparisons in both sales and earnings.
Guidance has been the real drag, though, with management lowering guidance across a broad spectrum of companies and earnings estimates for the fourth quarter plunging (you can be sure that they will quietly fall again around the second week of January). It’s difficult to make cases for a multiple of earnings growth when they’re not growing.
Slowing global trade is a drag on the S&P 500, prompting a flight to US-only sectors such as homebuilding. It does conjure an intriguing speculation about a potential parlay from Sandy and the winter. While the former will briefly depress activity, the ensuing rebuilding and aid nearly always ends up boosting sales and GDP. Add in another mild winter – admittedly a crapshoot – and we could end up with another over-hyped period of growth and talk of the economy reaching “escape velocity.” Another spring rally based on nothing more than a passing bit of weather.
But this time we will have to get past the election and the more formidable obstacle of the budget deadline known as the fiscal cliff. While I make no predictions on the former, an Obama victory is priced into the market, so it shouldn’t mean a sell-off, despite the market’s rightward bias. One might think a Romney victory would provoke a reflex rally, and it may very well do so, but strategists have started fretting that markets would quickly fall afterwards in anticipation of a possible Bernanke resignation and budget cuts that would fall hard on the economy. Either outcome seems set to invoke the kind of budget-cutting that has worsened the lot of economies in Europe.
I try to avoid political commentary, but there is one outcome I am worried about and would very much like to avoid: a hung election. If we don’t get a clear winner next week, it will be a bad start on the budgetary deadline at the end of the year. A repeat of Gore-Bush, with either a split of the popular and electoral vote, and/or a counting process that drags on for weeks afterwards, would weigh heavily on the markets. So please get out and vote!
The Economic Beat
In some ways, the November jobs report seemed to nicely sum up the economy: still chugging along at modest speed, with something of a divergence between manufacturing and the consumer. The stronger parts of the report included some rather impressive revisions – the August change, originally reported at +96,000, has now doubled to +192,000 (!) after two revisions. September was lifted to 148,000 and of course the initial estimate of 171,000 was well past the consensus of 120K-125K. The figure was also close to the ADP payrolls calculation of 158,000.
The year-to-date increase in actual non-farm employment, using the non-adjusted establishment data, is 1.37%, the best rate since 2006 (also 1.37%). Since the current increase is occurring under tight credit conditions, as opposed to a bubble, one could argue that it’s also a sounder base.
Also in the plus column: The goods production, manufacturing and temporary help categories all grew (seasonally adjusted) after a couple of months of losses. The unemployment rate for the college-educated fell to 3.8%, the lowest since December 2008. The biggest weakness remains in the less educated, with an unemployment rate of 12.2% for those lacking high school diplomas and 8.4% for those with a high school diploma and no college. On the other hand, it compares fairly well with the latest EU rate of 11.6%.
On the weaker side, the unemployment rate did inch back up a tick to 7.9%, but this time for a good reason, as the participation rate grew (more people entered the potential workforce). Against that, the comprehensive U-6 rate – which measures “under-employment” – fell by an equal amount to 14.6%, and the not-seasonally adjusted U-6 rate fell to 13.9%, the lowest it’s been since December 2008.
That growth is less than stellar can be seen in the fact that weekly hours are unchanged from the same level they were a year ago. Average hourly earnings were unchanged and are only up 1.6% from a year ago, which isn’t keeping up with inflation. The payroll index, which closely tracks personal income, fell 0.2%. There simply isn’t any demand pressure in the labor market. Lay-off announcements have risen sharply. That isn’t unusual in the fourth quarter, but it certainly isn’t going to help individual earnings.
Employment is also a lagging indicator. Despite the improving tone of the last few months, manufacturing has stalled while the consumer has kept going. I don’t rate that as a flashing red light, because in a low-growth, low-inventory economy, manufacturing is going to have some pauses. The budget fiscal cliff has a lot of spending on hold, and exports and global trade are headwinds right now. It is a warning however, and if the cliff process goes badly the first quarter will stink.
The economic calendar was also thrown off by Hurricane Sandy, with some reports late and some on time. The October national manufacturing survey, the ISM report from purchasing managers, had the good fortune to come out on the first day of the month and in the middle of a rally. The modest number of 51.7 (50 is neutral) was past the consensus estimate of 51.5, which was also September’s result. The press dutifully noted another “better-than-expected” economic release and thus it is filed in the “positive economic surprise” index.
However, conditions actually weakened from September and the number was boosted by seasonal adjustment. While that is indeed normal for this time of year, it’s also perhaps out of synch after several months of zero growth. More telling is that the score of industries reporting growth versus contraction fell to eight-eight from eleven-six last month. The Markit PMI index, a newcomer, reported 51.0 and the JP Morgan Global PMI came in at 49.2, below 50 for the fifth month in a row. The Chinese PMI was unchanged, with the official number slightly above (50.2) and the private version slightly below (49.5). You might find it difficult to believe that China could deliver another 7%+ GDP verdict for the fourth quarter with such numbers and do it with a straight face, but the government is quite capable of it.
The US regional indices were also clustered around the no-change mark. The Dallas Fed survey was positive at 1.8, but new orders dropped to a negative 4.5. The Chicago purchasing manager survey (PMI) came in at 49.9, largely unchanged from the previous month’s 49.7. While both numbers are close enough to 50 to be thought of as no change, new orders definitely slipped in October to 47.0 (50.6 seasonally adjusted).
The factory orders number that came out Friday showed an increase of 4.8%. Like the durable goods order, most of the increase came from aircraft and defense, so the report was largely overlooked. One thing that might have cheered the market would have been an upward revision to the business investment category (new orders for non-defense capital goods excluding aircraft), but it remained at no change. The year-on-year numbers have been negative for several months running.
Personal income and spending for September came out on Monday in spite of Katrina. It was not a surprise, as the totals were largely known after the GDP report a week ago. Income rose 0.4%, spending 0.8%, and the year-on-year price indices by 1.7%. The interesting part was that real disposable personal income fell again, this time by 0.1%. Sandy will most likely boost consumption in the fourth quarter, but there is going to be some substitution effect.
Home prices rose nationally in August by 0.5%, according to the Case-Shiller survey, making for a 2.0% increase year-on-year. They weren’t up everywhere, though, and co-author Professor Shiller took some pains to make it clear that the recovery is at slow speed.
Another example of the split-track economy came from the September construction result. August was revised up to a loss of only (-0.1%) from (-0.6%), and September reported a healthy gain of 0.6%. It was all in private residential spending – non-residential slipped, along with public spending. In a similar vein, institutional investor confidence fell from 87.3 to 80.6, while consumer confidence rose from 68.4 to 72.2. I regret to add that the last three trips above the 70 level for the confidence survey were followed by sharp market declines. Sandy will probably put a dent in confidence the following month – and a problematic election would make it worse for both confidence and the economy.
The earnings calendar is beginning to slow, but there are still many companies reporting next week. The focus will shift to health care and consumer-related stocks (e.g., Disney (DIS)), but they will be overshadowed by the election. The biggest economic report of the week is the ISM non-manufacturing report, which for good or ill comes out on Monday, election eve, and thus will not be overlooked. After that the calendar is light and consists mainly of trade data, exports and imports on Thursday, their prices on Friday, and wholesale sales and inventories the same day.