Avalon's MarketWeek

Spring Break

“For the times, they are a-changin’.” – Bob Dylan

It was a surprise, but not a shock.

Let me qualify that: For the stock market not to rally on jobs day is highly unusual, but not something that most Americans would be aware of. It was not exactly front-page news for the New York Times or the Wall Street Journal. Indeed the latter preferred to lead with the positive aspects of the report, which showed that private-sector employment had finally reached pre-recession levels. The jobs report itself looked satisfactory, at least on the surface, and was initially given a warm reception by the tape: Futures rose, Goldilocks was invoked (not too hot, not too cold, etc.) and an hour after the market opened, all was well. The S&P 500 was about 40 basis points higher, echoing the rise I had wanly predicted two days earlier for an in-line report on Seeking Alpha.

But a funny thing happened on the way to the market’s record close. The S&P got near 1900, but didn’t really make a serious attempt (the high was 1897.28; short of 1899 isn’t serious). What happened instead was that the serious money sold the rally, instead of buying the dip.

While that did surprise me, it wasn’t a shock, though it surely was for the many traders and pundits of a less skeptical bent. For traders, selling a jobs report is not only unusual, but historically a sign of danger that momentum is shifting. So far as the pundits go, the stock market is supposed to warmly embrace every possible glint of silver, predestined steps on the path to the Emerald City.

Note that I said that money sold the rally, rather than people. If I want to sell 100 shares of Facebook (FB) and buy a telecom stock, it’s a simple, meaningless trade for the market that can be executed in a few seconds. If I want to get out of a $10 million position and put it to work elsewhere, that’s a different story. It takes time. There has been a steady rotation out of high-beta stocks into low-beta stocks (i.e., high-flyers vs. safety) by some real money for about a month now, one that gathered speed in mid-March, right after the last meeting of the FOMC (the Fed’s monetary policy committee). It’s not that lots of traders are giving up, it’s more that a lot of money is shifting sectors into things like utilities and telecom stocks. It isn’t out of ebullience.

For at least one group of big money, the payroll report was not good news. If anything, it was anti-Goldilocks – not weak enough to slow the Fed, not strong enough to get excited about an accelerating economy, ergo an opportunity to sell the short-lived new high. It’s a shift in sentiment (and positioning) that overlaps with some other cautious views and left equity holders a bit more nervous, keeping the market off-balance. Many had predicted a much stronger report during the week, and were clearly let down by the lack of a bigger bounce, even as they gave it a passing grade.

Just as higher prices beget higher prices, so does selling beget selling. When bond yields rallied Friday morning and momentum stocks began to resume their downward course, a lot of fast money headed for the exits. It was probably a good short-term trade, as the economic calendar is pretty empty for most of next week, a phenomenon that usually leaves the market on whatever track it was on the previous week. So despite the Dow and S&P 500 being up last week, even with Friday’s sell-off, stocks rate to have a bumpy ride next week.

So are we done for the year? Not necessarily. I’d say a test of the 50-day moving average on the S&P is in store, with an outside chance at a run down to 1800, depending on Wednesday’s FOMC (Fed policy) minutes. More likely is that the market loses another percent or three, more damage is done to momentum stocks, more defense of the “solid” economy rises to the fore, more people go on television to explain why the market is wrong, and then sometime the week after the first-quarter earnings rally begins anyway. Even the bad years of 2000 and 2008 couldn’t cancel that event.

But there is trouble brewing, make no mistake about it. I certainly don’t exclude an April-May run back up to the 1900 level on the S&P 500; if next week’s pullback is mild, I will even expect it. But the underpinnings of the market look a lot shakier now. The second half of this quarter could see some tough times for equity prices.

Looking ahead, the first half of May looks to be the real crucial test for the market. That will bring the April jobs report – which simply must deliver a bigger bounce – the May meeting of the European Central Bank, widely expected to deliver more easing in one form or another, and the April retail sales report. That last item is the first edition unencumbered by cold weather since October, with the added benefit of an Easter (April 20th) sales bump thrown in. Easter is one of the three times (Christmas, back-to-school) that Americans are guaranteed to go shopping.

The bar for earnings is, as ever, set very low, and the seasonal earnings rally is a virtual certainty. Some weather rebound should be expected, and the drums about the accelerating second-half could get louder later in the month. But I don’t think you should heed the music until you hear what the Fed has to say next month.

The Economic Beat

Business TV commentators, who tend to be evangelists for the stock market and ardent exponents of any wisp of good news, insisted throughout Friday what a solid, sound, All-American report the jobs report had been. What was wrong with that stupid stock market?

The jobs report did indeed show no change in trend, with modest upward revisions to January and February being minor positives. The year-on-year estimated increase for establishment payroll currently stands at 1.64%, about in-line with 2013 (1.69%) and 2012 (1.72%). The decline in real jobs since the end of the year (1.13mm) is a little higher than last year (1.02mm) or the year before (744K), but can easily be explained by the weather. My characterization of the labor market has been the same for over a year now, because that’s what the data reflects – the rate of growth simply isn’t changing, monthly variations notwithstanding.

Household survey employment had a big increase, and its year-on-year increase finally caught up and passed its establishment twin. I would take a wait-and-see approach with both that and the participation rate increase (63.0% to 63.2%). The household survey is much smaller and more volatile, and I think that both catch-up effects and the 1 million-plus people who lost their long-term unemployment benefits in January are working their way through monthly data. The participation rate was 63.3% a year ago, so it isn’t as if we’re talking about a major trend change (although equity advocates will report it that way).

The average work week increased to 34.5 hours – the same as March 2013. The diffusion hire index (essentially an up-versus-down measure) was 58.5, compared to the year-ago 56.1, an effect that can also be partly attributed to weather. The diffusion index in manufacturing is only 50.0, which is neutral, compared to last year’s 52.5. Manufacturing was supposed to have lost 1K jobs in March, but again I wouldn’t read too much into it. When looking at comparisons between March and the end of the year, the unadjusted data appears to be running right on trend. Looking at recent years, the only sane conclusion on manufacturing hiring so far in 2014 is that it’s behaving just like 2010-2013.

Looking at construction jobs, the year-on-year change in the unadjusted estimates for 2014 are below 2013′s rate (2.85% vs. 3.54%), but about level with 2012′s 3.01%, if one makes an allowance for weather. The first two months of 2014 were subdued, as one might expect, though the seasonally adjusted totals for those months inflated what was really happening on the ground. The February-to-March increase was larger than last year (2.37% vs. 2.14%), about what you would expect from a weather rebound. But it was by no means heroic: the average for the last five years is 2.2%.

Perhaps those kind of calculations were taken into account by those funds and/or algorithms selling Friday’s short-lived rally – the report was good, but not good enough when taken in tandem with the diminishing pace of stimulus. At any rate, look for the struggle over whether or not this year will really see any acceleration to continue – even CNBC’s normally sunny Bob Pisani exclaimed in exasperation on Friday whether this year was just going to see another failed second-half promise like the last three (I did see him say it, but couldn’t find the clip).

For once, the Bureau of Labor Statistics (BLS) number (192,000) was a dead heat with the ADP payroll number two days before of 191,000. Weekly claims moved up a bit, but apart from the odd bit of weekly static, the claims trend has looked the same to me throughout the first quarter. Lay-offs after the second quarter will give a better gauge on this year’s hiring intentions.

The ISM reported its two PMI (purchasing manager index) surveys for March, with manufacturing reporting 55.5 on Tuesday and non-manufacturing 53.1 on Thursday. Both numbers were reasonable and both were below consensus, as was the Chicago-area PMI on Monday (55.9). The manufacturing survey was notable for its upbeat comments and decline in customer inventories, which could suggest further weakness in the first-quarter print for GDP. Adverse trade data also lowered the GDP estimate. That led to a somewhat humorous sidelight of CNBC and others trying to blame the Winter Olympics licensing fees for the difference. The $800 million payment was only 20% of the $4 billion miss of consensus, and had nothing at all to do with the decline in exports.

Factory orders were up 1.6% in February, thanks in large part to the aircraft industry, but business cap-ex spending was still in decline for the second month in a row (both already largely known from the previous week’s durable goods report). The two-year growth rate in business cap-ex has fallen to 2.4% annualized (before inflation), the lowest rate since May 2011, yet people still keep running around quoting survey intentions instead of actual orders. The latter are bound to tick up at some point, so one can only imagine the triumphant din when they do. It may turn out to be only another blip.

Construction spending was a bit of a miss with a 0.1% monthly increase in February. That met consensus, but the increase came with a substantial downward revision to January, down 0.2% instead of the original plus 0.1%. Easy comparisons make the year-to-date change look pretty good, about 9%, but the rolling 12-month growth rate is still around 5% and down from higher levels in 2013.

On the retail front, auto sales enjoyed a decent month in March and chain-store sales had a comeback the last week of the month. The report for the full month is still ten days off.

The ECB took a pass on doing anything more than trying to talk down the euro, so expectations are likely to build for more easing at its May meeting. The no-action led to some short-covering in various EU member bonds, leading to the remarkable development of waking up Friday morning to find that Spanish sovereign bond yields were less than U.S. Treasuries. Really? As John McEnroe might say, “you cannot be serious!”

Next week is a light week, as noted, with nothing of note on the calendar until the release of the Fed minutes Wednesday afternoon. The minutes could intensify selling pressure if the market takes them to mean the taper is a done deal, or even reverse the tape if too much fear and selling was already built in. That’s the stock market for you.

For myself, I will take note of the wholesale trade data Wednesday morning, though it is rarely a market-mover. The labor turnover survey (JOLTS) comes out Tuesday, import-export price data on Thursday and producer price data on Friday. We’ll get some same-store sales data too, but the sample is so small now that it tends to escape notice. The Chinese trade data Wednesday night should get more attention.

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