Show Me the Numbers

by Deidra Krys-Rusoff Senior Vice President

The S&P 500, Dow Jones Industrial Average and NASDAQ ended the week nearly flat from last Friday, despite a volatile trading day today. The financial sector retreated 1.4 percent, as investors’ hopes of a Federal Reserve interest rate hike dwindled on the release of today’s nonfarm payrolls report. Utilities and phone stocks rose this week, benefitting from the prospects of lower rates. The Bloomberg Commodity Index rose to a seven-month high and is nearing a level marking of a 20 percent advance from the gauge’s January bottom, close to meeting the common definition of a bull market. The dollar dropped and ended the day trading at $1.14 per euro. International markets were mixed, with European stocks slightly down and the MSCI Emerging Markets Index advancing 1.5 percent to a one-month high. The benchmark 10-year Treasury rallied, with rates falling 15 basis points over the week to yield of 1.70 percent.

What’s in a number? A lot, when the number is the nonfarm payrolls reporting significantly weaker than even the most pessimistic economist expected. May’s payroll numbers rose by a mere 38,000 versus the consensus estimate of 160,000. The report further muddied the economic waters by revising the April increase downwards to 123,000 from 160,000 and March’s numbers to 186,000 from the robustly reported 208,000 increase. The Verizon strike temporarily played into these numbers, subtracting roughly 40,000 from the overall job growth that should reverse after the strike ends. This boost, up to what would have been a gain of 78,000, is still shockingly low. The report shows that the labor market deceleration was widespread. Private-sector hiring was at 25,000 versus 130,000 in April and government hiring added a scant 13,000 jobs to the May numbers. Job losses were seen in construction, manufacturing and wholesale trade. Hiring in the paid professional and business sectors also showed slowing.

Markets initially took the news hard: The S&P 500 Index initially dropped as much as 1 percent from a recent seven month high, the dollar sold off against the euro, and bond prices increased dramatically – dropping the yield of the benchmark 10-year Treasury to 1.70 percent from 1.80. However, U.S. equities pared the early losses to around 0.2 percent as commodity producers extended gains.

The unemployment rate fell to 4.7 percent, but this is unfortunately attributed to declining labor force participation or labor force dropouts. This year’s earlier rebound in jobs participation may be stalling out. One good piece of information from the government report was that the broader U-6 unemployment rate (which reflects underemployment) remained steady at 9.7 percent. Another positive note is that average hourly earnings advanced last month by 0.2 percent, which resulted in earnings 2.5 percent higher than last year’s levels.

The weak jobs number almost certainly takes a Federal Reserve rate hike off of the table for June. The Fed governors have repeatedly stated that their policy decisions will be data-dependent and we didn’t have to wait long to hear how the Fed governors feel about the number. Federal Reserve Governor Lael Brainard spoke to the Council on Foreign Relations this morning and stated, “In this environment, prudent risk management implies there is a benefit to waiting for additional data to provide confidence that domestic activity has rebounded strongly and reassurance that near-term international events will not derail progress toward our goals.” Prior to the jobs report release, the market was pricing in one to two hikes for the remainder of the year. Now the market is placing odds of a hike below 50 percent for July, September and November.

One stand-alone jobs number does not make a trend and this could easily be a one-time blip on the radar. As noted earlier, unemployment numbers are often revised in months following releases and this extremely low number may be revised upwards in coming months. While predicting unemployment numbers is a fool’s game, we can confidently predict that everyone will be watching and waiting for the June unemployment numbers release on July 8.

Our Takeaways for the Week:

• Despite a volatile trading day, markets ended the week nearly flat from last week
• May jobs number shocks economists; however, employment numbers are often revised
• Low payrolls growth likely takes June Fed hike off the table

Disclosures

Putting It All Behind Us

by Brad Houle, CFA Executive Vice President

More than anything, the financial markets dislike uncertainty and the most recent source of angst was the election. With the mid-term elections behind us, the market participants are free to focus on economic data and not political minutia. One of our research partners, Cornerstone Macro, published a great summary of likely legislative change and probable market impact from the change in control of the U.S. Senate.

The European Central Bank (ECB) met this week and the takeaway from their meeting is the ECB is still poised to take extraordinary measures to keep the Eurozone economy from lapsing into a recession and possible deflation. Mario Draghi, the ECB president, reiterated the ECB's commitment to do whatever it takes to keep Europe's economy staggering forward. He did not go so far as to announce quantitative easing which just ended in the United States. The ECB has been doing some bond buying on a smaller scale and keeping the possibility of a large scale quantitative easing program on the back burner in the event the European economy goes from bad to worse.

The employment data for the month of October was released today. The unemployment rate declined to 5.8 percent and nonfarm payrolls increased 214,000 jobs. In addition, there was a 31,000 revision to the September employment report. While the absolute number of jobs was a bit behind the consensus number, this is a very solid report and continues to demonstrate that the labor market is healing.

Takeaway for the Week

• The equity markets traded around all-time highs this week as the labor markets continue to improve and the uncertainty of the election is behind us

Disclosures

Sympathy for the Weatherman

by Ralph Cole, CFA Executive Vice President of Research

Sweater Weather

As economic and market forecasters, we have a great deal in common with meteorologists. We know forecasting daily moves in the stock market is a fools game, but that over longer  time horizons, our forecasting accuracy improves greatly. Weathermen face the difficult task during snow storms of forecasting snowfalls and temperatures minute-to-minute, and hour-to-hour – to which we say... “No thanks!”

The East Coast has been battered by several snow storms over the past month, and this has had a negative impact on high frequency economic data. The reason that this has such a large effect on government data is because the Northeast megalopolis that spans from Washington D.C. to Boston is responsible for 20 percent of the nation's GDP. Largely due to poor weather conditions, retail sales in the month of January were down .4 percent. Similarly, industrial production also came in weak for the month of January, down 1.4 percent.

We believe the current slight weakness in economic data is a blip on the Doppler radar, and economic growth should accelerate as, literally, the snow thaws.

Welcome to the Jungle

One of Janet Yellen’s first duties as Federal Reserve Chairwoman was the semi-annual report to Congress. Timing of the report was helpful to both Congress and the markets because both senate and house leaders are trying to determine and understand the likely pace of tapering to expect in 2014. More specifically, what indicators will the Fed be relying upon, and are there any hard and fast rules governing the pace of tapering? As any good Fed Chairwoman would do, Janet left answers to all of those questions up in the air. Yes, she would like to continue tapering at this pace, but she is not tied to a $10 billion monthly reduction. Yes the Fed will be monitoring the unemployment rate, but it is not the only indicator they will be considering.

Despite the lack of specifics in her answers, the Fed Chairwoman’s performance was received very positively by the markets and as of this posting the S&P 500 was up 2.4 percent for the week.

Takeaways for the Week

• Despite several weak near-term economic statistics, the economy continues to expand at a reasonable pace
• The new Fed Chairwoman assured Congress and the markets that she will be a steady hand at the helm of the Fed

Disclosures

Synchronized Global Expansion?... Far From It

by Shawn Narancich, CFA Executive Vice President of Research

Dawn of a New Era

Amid heightened turbulence in the global economy and capital markets, Janet Yellen was sworn into service as the Federal Reserve’s first chairwoman this week. Although she has a dovish reputation as an economist focused on the labor market implications of monetary policy, she ascends to a position requiring the optimization of full employment and low inflation. In this spirit, and acknowledging the faster pace of U.S. economic expansion at present, we do not expect this morning’s surprisingly weak payroll report to throw the Yellen Fed off its course of continuing to taper QE3. The headline number of 113,000 net new jobs created in January is anemic but, like December’s similarly weak number, unusually severe winter weather could be at play. More importantly, the underlying detail is encouraging – more private sector hiring and less competition from the government, which continues to shed jobs. After retreating nearly 6 percent year to date, blue chip U.S. equities shook off the weak payroll headlines and rallied back into positive territory for the week.

Decoupling

While retailers cut back following a choppy Christmas selling season, construction and factory jobs surged in January, providing more anecdotal evidence of a renaissance in U.S. manufacturing. Combine that with the surge in U.S. energy production and low inflation, and what we see is a relatively healthy domestic economy that appears able to withstand an increasingly uneven outlook internationally. The global purchasing manager surveys out this week demonstrate that economic activity globally is far from the synchronized global expansion that some would claim. Consider China, where the manufacturing sector is teetering on the edge of contraction, and contrast it with Europe, where despite 12 percent unemployment, factory output is growing at a faster clip. While China is still growing, its rate of expansion has slowed, taking the punch out of commodity prices and serving to help developed nations worldwide, whose lower bills for gasoline and agricultural commodities are helping boost consumers’ disposable personal income.

Emerging Market Contagion?

With the sun beginning to set on another reasonably constructive earnings season, we observe corporate earnings for the fourth quarter of 2013 that in the aggregate appear to have risen by about 8 percent. But with emerging equities already down as much as 11 percent year to date, investors are concerned that the relatively modest pullback U.S. stocks have already experienced could turn into something more sinister. So far, the interest rate hikes in nations like India, South Africa, and Turkey that are being used to help stem currency weakness and capital outflows appear localized to such economies disadvantaged by current account deficits that are driving up inflation. In contrast to the late 1990’s when currency devaluations in countries like Thailand were exacerbated by foreign currency debt obligations (making those obligations more expensive to repay), emerging market challenges today center around the more common but less pernicious problem of stagflation, a combination of slowing economic growth and rising inflation. As emerging market countries adjust to higher interest rates, we expect their growth to slow and in turn, dampen the level of global economic growth. But just as it did against a strong domestic backdrop amid the Asian Financial Crisis, we expect the U.S. economy and capital markets will weather the storm. Acknowledging the near-term challenges presented by emerging markets, we recently reduced our allocation to this equity style.

Our Takeaways from the Week

• Janet Yellen became the Fed’s first Chairwoman, amid an increasingly turbulent global economy
• Stocks bounced back, defying disappointing headlines on the jobs front and mixed manufacturing data

Disclosures

Off to the Races

by Shawn Narancich, CFA
Executive Vice President of Research

 Ohhh, the Weather Outside Is Frightful

Rubber hit the road this week for investors as traders and money managers returned to work after what for many turned out to be a nice two week break. Stocks appear to be consolidating gains realized over Christmas and New Year’s, with a plurality of economic data pointing to faster U.S. growth in 2014. A fly in the ointment was this morning’s December employment report which showed the economy producing just 74,000 jobs - albeit in a month where bad weather seems to have had a disproportionately negative impact on the headline number. Nevertheless, if one excludes construction job losses and cases where people were counted as unemployed because they couldn’t get to work, the job numbers still fell short of estimates. And while the unemployment rate dropped to 6.7 percent, it fell primarily because more of the jobless gave up hunting for work. Indeed, as we look back to year-end, the labor force participation rate has fallen to a new cyclical low of 62.8 percent - that is the percentage of “employable” people either with a job or looking for work.

Gaining Momentum

Will one month of relatively poor employment data dissuade the Fed from its planned tapering of QE? We doubt it. Q4 retail sales picked up, the renaissance of U.S. manufacturing and energy is going full steam ahead, and capital spending by companies flush with cash appears on the verge of inflecting upward. In related fashion, this week’s monthly trade data was bullish. The November report showed U.S. imports exceeding exports by a four-year low of $34 billion. Increasingly positive trade flows are being driven by two key trends: rapidly falling oil imports resulting from new domestic production and surging exports of gasoline and diesel being refined from the crude. As a result of these encouraging trends, GDP growth estimates for the fourth quarter are being revised upward, and for the first time in recent memory, the U.S. economy may have grown in excess of 3 percent for two consecutive quarters. With fiscal headwinds waning, 2014 is shaping up to be a year of faster economic growth domestically.

The Dawn of Another Earnings Season

Alcoa unofficially kicked off the fourth quarter reporting season by reporting weaker than expected profits that left investors disappointed and shareholders with lighter pockets. Other early reports from seed and herbicide producer Monsanto, US beverage producer Constellation Brands and chipmaker Micron were more encouraging, and each of these cases resulted in nice stock price gains afterward. Overall, investors are expecting blue chip earnings growth of 6 percent for Q4, on flat revenues. These estimates could prove conservative if fourth quarter GDP growth was as strong as the 3 percent rate we expect. Next week, several big banks including JP Morgan and Citigroup will come to the earnings confessional, as well as industrial conglomerate General Electric. Let the fun begin!

Our Takeaways from the Week

• Stocks are taking a breather, consolidating some of their heady 2013 gains
• Despite a hiccup in the monthly employment report, the U.S. economy appears to be gaining steam

Disclosures