I’m on vacation this week but just wanted to make sure and comment about the last week’s events.
While the big news of the week was obviously the employment report Friday which triggered the big stock market selloff, the economic data actually continues to show pretty steady improvement. Whether that will continue is of course what the market is focused on, but for now the data is solid if slightly mixed.
The ISM surveys this week both showed continued strength. The manufacturing index fell slightly to 59.7 and new orders clocked in at 65.7, the third month in a row over 60. Even the employment index shows solid growth at 59.8. A very solid report. By the way, in looking at this indicator in the past, it tends to lead the stock market. Generally by the time stocks start to fall in earnest, the ISM has already dropped below 50 indicating contraction. A peak in the rate of change has not, at least in the past, meant the beginning of a bear market.
The non manufacturing ISM survey also showed strength coming in at 55.4. The employment component finally moved above 50 to 50.4 and new orders continued to show strength at 57.1. In addition, backlogs continue to print above 50 indicating good future activity. Inventories continue to strengthen indicating some confidence in future sales.
One area of continued concern is the housing market and while the backward looking reports last week were positive, the one forward looking one was pretty miserable. Construction spending was up in April by 2.7%, much better than expected and primarily concentrated in private residential spending. Low inventories in new homes seems to be providing some level of comfort to homebuilders. Whether that lasts or not is a giant question mark. Pending home sales in April also surged as buyers pushed to capture the tax credit. Unfortunately, the mortgage bankers association reported another drop in purchase applications last week. May will not be a good month for home sales, but it is possible that, like the cash for clunkers program, only a few months of sales was brought forward. We will find out soon enough. And by the way, what a colossal waste of taxpayer money the home buyer’s tax credit was all in the name of pulling sales forward by a few months so the politicians can make things look better before the election. Talk about public campaign financing. <sigh>
Of course, the big news of the week was the employment report on Friday and it was taken very badly by the market. Frankly, I’m a bit mystified as to why anyone is expecting robust job growth right now given all the uncertainty facing employers. Furthermore, expecting a smooth acceleration is just plain crazy as that never happens coming out of recession.
The big news was the lack of private job creation in the report with the vast majority of the new jobs being temporary census jobs. Since everyone else has already beaten the bad news to death, I’ll point out a few positives in the report that didn’t get much play. The good news was in earnings, workweek, production hours and temporary help. Average hourly earnings were up a robust 0.3% month to month and the workweek rose to 34.2 hours. Production hours were up 0.3% as well. For manufacturing the jump was even more dramatic with production hours jumping 1.1%.
From the household survey we find that the number of unemployed actually dropped by 287k although the number of employed fell by 35k. The unemployment rate fell to 9.7% but that was primarily due to more people dropping out of the labor force. The largest rise in unemployment rate was among teenagers which shouldn’t be surprising since Congress saw fit to raise the price of hiring them by raising the minimum wage last year. As a teenager would say, duh. Here’s another interesting tidbit that no one else seems to have reported; the number of people employed part time for economic reasons fell by 343,000. Could it be that companies are allowing part timers to become full timers before hiring new people? Sure sounds reasonable to me.
Those of you who know me know that I’m not one to blow sunshine up your skirt about the economic situation. We still have some serious problems with our economy and I don’t think the politicians are doing a damn thing to make it any better. In fact, I think they are doing their damdest, possibly without knowing any better, to make things worse. We will not solve our debt problems by borrowing and spending more no matter how many times President Obama’s economic team tries to convince themselves and the public of the efficacy of paying off their campaign contributors. But having said that, I believe deeply in the natural healing power of the capitalist system – even one as damaged as the one we operate – to heal itself. As the productivity report showed last week, unit labor costs continue to fall and one thing I’m fairly sure about is if you reduce the cost of hiring, companies will do more of it eventually. Anyway, this employment report was not that bad and not atypical of what we’ve seen in past recoveries. Don’t panic – yet.
Markets were on track for a slight uptick until the employment report on Friday which precipitated a 300+ point down day and a roughly 2% drop on the week. And so we find ourselves now slightly above the February lows amid sentiment that is much more gloomy than we saw back then. Again, as nerve wracking as this correction has been, it isn’t anything out of the ordinary yet. We are about 12% below the peak of late April; in other words a pretty run of the mill correction. Volatility is a little higher than normal and that certainly has everyone on edge but as I said last week, I think that is nothing more than memory of the 2008 meltdown getting to people.
More worrying to me is the recent drop in the price of commodities. Copper dropped hard last week and it is generally considered a leading indicator. Of course, copper is a leading indicator because it is used in construction and with the uncertainty surrounding the housing market it perhaps isn’t surprising to see it come down now. Also worrisome is the recent drop in TIPS spreads; in April the spread between the 5 year nominal Treasury and the 5 year TIPS indicated an inflation expectation of about 2%. During the recent correction that has dropped to 1.7%. Just to be clear, that isn’t anywhere near as big a problem as we faced back in late ’08 when the TIPS market showed an expectation of outright deflation but it is a problem the Fed needs to watch. Falling inflation expectations – when expectations are already low – are also an indication of falling Nominal GDP expectations – falling growth expectation in other words. That, in a nutshell is why the market has corrected in that time. Lower growth in nominal GDP means lower growth in earnings and as we’ve seen recently, lower stock prices.
For now, I still believe this is nothing more than a correction but that assumes no major policy mistakes. If the market drops through the February lows the last line of defense will be around the 1000 mark on the S&P. That is the point where technicals will have to win out over current fundamentals and I will be forced to do more selling for safety’s sake. I don’t think we’ll get there but if we do, don’t hesitate to take some more off the table; as volatile as this market is you might not have a lot of time to get the job done. By the way, assuming it is nothing more than a correction, there are some pretty enticing bargains in high quality stocks right now for patient investors. I don’t think you need to be in a rush but you should definitely have a list of favorites at hand.
