Avalon's MarketWeek

Steady State


“To what purpose, April, do you return again?” – Edna St. Vincent Millay

What’s up with the stock market? seemed to be the common refrain at the end of last week. The US launches cruise missiles into Syria, Fed governors say that equity valuations are “quite high,” the jobs report disappoints and more terrorist attacks occur abroad. Yet stocks simply crabwalked their way through another week.

I won’t pretend that I hate to say “I told you so,” though I did tell you so. It’s what pundits are supposed to do, after all. For that matter, the near-term outlook is for more of the same crab-walk with the same proviso – unless policy shocks occur.

You might think that launching cruise missiles in the MIddle East might have ranked a priori as a geopolitical shock, but it isn’t, not by a long shock. Markets shrug that kind of stuff off all the time. Fire them at Moscow or Beijing, now you’re talking some excitement. But Syria? Come on, what am I supposed to do, miss the spring rally?

Oh yes, the spring rally, one of the most important underpinnings of the current market. We all know we’re going to get it, we all know it should start soon. And for that reason, no one is going to get too crazy with selling. Some tactical bobbing and weaving is okay, to be sure. Maybe some managers (and a lot of algorithms) will try to earn a little beta by doing some quick tactical selling that can be reversed the next day or so, or maybe the next fifty basis points. You can see it in the daily trading, when every modest wave of selling is met with some buying as traders and algos try to improve their position for the rally.

So even a disappointing jobs report (see more below) isn’t that much to worry about. It was hardly disastrous, after all, and maybe it’ll slow down the Fed. Plus the unemployment rate fell two ticks to 4.5%, and how can you not like that?

At some point soon, stock prices are going to begin to pivot around options expiration (very late this month, the 21st), earnings reports and the widespread, unshakable conviction that the related spring rally will occur. The pivot should be higher, though not unduly so. The real interest should be in what happens in May-June, a period which has seen some heavy selling over the years. But we’ll get to that after our annual spring celebration. Happy Easter!

The Economic Beat

The report of the week would of course be the March employment report and its disappointing headline total of 98K jobs, seasonally adjusted (SA). It was roughly half the consensus guess, which had been about 180K until the ADP report came out two days earlier projecting gains of 263K. ADP will no doubt be scouring the BLS report to see how the formula changed, as the former tries to anticipate the latter, not outdo it in some way.

Regular readers might be forgiven for expecting me to jump on the number as something definitive, as I have been talking about the end of the business cycle for some time. Certainly the number isn’t an example of mid-cycle gains and is more characteristic of late cycle data, but the biggest factors in the number are most likely the weather and the time of year. First quarter data is trickier for the BLS to estimate, given the January effect of annual 2% shrinkages in the raw estimate. If the labor market is moving at a steady pace, the estimation process works fairly well, but if it is accelerating or decelerating, it can take time to capture in data samples. The first quarter employment census results are due in May-June and will help focus the picture.

In the meantime, the low March total looks like payback of sorts for the high February total. I wrote in the wake of that report, originally reported as 235K and now revised to 219K, that unusually warm weather had probably boosted the total. The earlier estimate of 235K was well ahead of the consensus guess of about 170K and helped boost stock prices, but averaging the two out gives a result of about 160K/month, a number about in line with the thinking of most Street strategists. Difficult mid-March weather in the sample week might also have played a role.

We shouldn’t overlook the drop in the employment rate either, from 4.7% to 4.5%, a number largely due to the much higher increase in the household survey (+472K), as well as a smaller-than-expected increase in the civilian labor force (+145K). All well and good, but the household survey numbers are far more volatile, being based on smaller samples. At any rate, even Janet Yellen is now conceding that we are virtually at full employment.

Hourly earnings increased by 2.7% year-on-year (y/y), better than the trend that has prevailed of late, but weekly earnings are still only up 2.4%, a number that might have been better in view of the favorable weather comparisons. The most worrisome data point for traders, though, might have been the fact that both February and January (from 238K to 216K) were revised downwards, along with the rather large March miss. It’s an old trading maxim that the direction of the revisions is more important than any initial estimate, so the troika of the three negatives could weigh on stocks until the earnings rally can get under way. For me, the largest concern is the y/y growth in the labor force, currently at 1.49% through March. That’s the weakest March total since 2011, when it was a virtual dead heat at 1.46%. It’s also the third consecutive decline in March comps, which peaked at 2.1% in 2015.

Weekly claims have been steady, however, with the latest week looking remarkably good. It all suggests that we are in the slowing-growth mode rather than the contraction mode, still off in the future. It is only the latter that will upset the Street.

Released the same day as employment to almost no fanfare was the February wholesale trade report. Rising oil prices continue to drive the sales number, with monthly sales up 0.6% seasonally adjusted and year-year sales up an impressive 9.9%. The change is due almost entirely to the energy sector, however, with the oil category up a staggering 61% year-on-year. It’s almost entirely driven by price. The trailing-twelve-month (TTM) total for ex-petroleum sales has also been improving, though, and is now at 1.4%, down from last month (1.65%) but up from last year’s multi-year July low of (-0.9%). The improvement in the ex-petrol category coincides neatly with the beginning of the oil rally, as one might expect: more oil extraction is going to mean higher related sales. However, the 1.4% gain is in nominal terms, below the prevailing 1.5% y/y gain in the producer price index, suggesting that unit sales are nevertheless about flat overall compared with last year.

Divergence continues in the manufacturing surveys, with the March ISM survey virtually unchanged at 57.2 (February 57.7) and survey respondents broadly enthusiastic. The growth-contraction score was a near-perfect 17 out of 18, with one sector reporting no change. Yet the Markit Economics PMI survey, which has a larger percentage of smaller companies, reported a result of only 53.3, down from 54.2 the previous month. Year-on-year construction spending edged down to 3.0% from 3.1% the month before in data released the same morning. It ought to be allowed that construction spending is subject to large revisions, but production and activity data continues come up well short of survey data. The ISM report had very high readings for employment and new orders, but the BLS estimate for March manufacturing jobs was 11K, the lowest so far this year. Factory orders were up 1% (SA) in February, but only 0.2% excluding defense, while the business cap-ex category was down slightly Visions of sugar plum tax cuts seems to be dazzling survey respondents.

The non-manufacturing report was less sanguine, but still decent with a reading of 55.2, narrower than the 57.6 reading in February. Price growth (53.5 vs. 57.7) and employment (51.6 vs. 55.2) both shrank noticeably, with the service employment component proving to be a better barometer of the jobs report. The survey respondents were generally upbeat in their comments, though not at all as ebullient as their manufacturing counterparts. Comments about policy uncertainty stood out, particularly with respect to health care. The Markit PMI for non-manufacturing shrank to 52.8 from 53.8.

The FOMC minutes were also released. Besides stocks not liking the “quite high” comment, markets didn’t like the plans about shrinking the balance sheet either. It had to come, but it amounts to a de facto shrinking of the money supply.

Next week features the retail sales report on Friday (when the financial markets will be closed), as well as the latest inflation data: the CPI on Friday, the PPI (producer price index) on Thursday. Earlier in the week we’ll get the labor turnover report (JOLTS), but the focus will begin to shift to earnings.

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