Friday’s weak employment report is the latest in a line of disappointing US data…..
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Paul Jackson – Head of Research | András Vig -Research Associate
In our opinion, the worst possible scenario for a stretched US equity market would be a rollover in the economy (even if it means no Fed rate hikes). We think there is enough evidence to suggest this will be avoided and still expect the Fed to move later this year.
60 second review
Don’t worry, you haven’t missed a day – we are sending it out early this week to avoid Easter Sunday. If you want to keep modern religion out of it, remember that the word Easter derives from Eostre, the ancient Greek goddess of Spring.
The Asset Class Total Return suggests that equity markets outperformed bonds last week but most were closed when the disappointing US employment report was published on Friday (10 yr treasury yields fell 7bps to 1.84% in the short time the US bond market was open and EUR/USD added around 1 cent to 1.10).
Negotiations about Iran’s nuclear capabilities seem to have come to a satisfactory conclusion. The agreed framework needs to be fleshed out over the coming three months. Many challenges remain.
We know that China is in focus when commentators report the number of brokerage accounts opened per week. The rise in this indicator could suggest a return of speculative excesses (the FTSE China A50 is up 80% in a year). However, the historical P/E on this index is only 11.4, compared to 17.4 for the S&P 500 and remains at the lower end of the 10yr range (according to Bloomberg data). With the PBOC last week sounding worried about deflation, at the same time that disincentives to buy second homes were reduced (deposit cut from 60% to 40%), the shackles are being removed from the Chinese economy. “A” shares may have further to run.
The main news from the US next week will likely be contained in the minutes of the last Fed meeting. In light of Friday’s weak employment report it will be interesting to get more detail on the apparent softening of the policy stance. The BoJ has a meeting next week and some hope they will loosen further. We doubt it.
Perhaps the most interesting data of the week will be the German trio of factory orders, industrial output and exports (all for February). There is no doubt that Eurozone data flows have improved of late.
Five minute focus: US payrolls: time to panic?
US non-farm payrolls increased by only 126k in March, the weakest gain since December 2013 (109k) and well below the consensus 250k. Adding to the gloom, January and February payrolls were revised down an aggregate 69k, giving a three month average gain of 197k, compared to 324k in Q4.
In our view this removes any risk that the Fed will hike rates in June (we have always suggested September to December). Many investors would no doubt prefer a weaker economy with no Fed rate hikes but Figure 1 suggests recent employment and stock market cycles have been closely correlated. Were employment to start falling in a meaningful sense, the current equity bull-run could be over. The ideal scenario would appear to be that of goldilocks – an economy growing but not enough to push the Fed to tighten. Luckily, employment is still growing.
However, Figure 1 also suggests that equity turning points seem to come before those in employment (equities lead the cycle, employment lags). Any comfort that employment is still on the up should be tempered by the knowledge that equities will already be down by the time it starts falling.
Worryingly, the employment slowdown is not the first sign of economic deceleration (we recently wrote about this in My worst nightmare ). The weak data started with durable goods orders, which have fallen for five consecutive months since September. Even worse, retail sales stalled around the turn of the year, despite the boost to spending power from lower gasoline prices.
The ISM-manufacturing survey has also fallen five months in a row (something which has happened on average around every four years since 1950), though it was still at a relatively elevated level of 51.5 in March (the ISM themselves say that 43.2 is the level below which the economy is in recession).
Of the previous 14 occasions since 1950 when the ISM has fallen five months in a row, half have been associated with recessionary conditions (ie the index falling into what is considered recession “territory”).
That same ratio applies to the four episodes when the index remained above 50 in that fifth down-month, as is the case now. So, the odds seem fairly even as to whether the ISM is telling us something dramatic or not about the future course of the economy.
When it comes to linkages to the stock market, Figure 2 gives a number of messages: first, the best time to buy stocks is often when the ISM is weak (the S&P returns over the next 12 months tend to be strong); second strong ISM levels are often followed by weak stocks; third, in recent decades, declines in the ISM such as we have just seen tend to be associated with moderate stock market gains but the picture is far from clear.
Before throwing in the towel on the US economy and concluding that the Fed will not raise rates, consider the following: initial jobless claims have fallen again in recent weeks to 268k and are about as low as at any point since the early 1970s (they are usually a good guide to what is happening in the labour market); within Friday’s employment report there was a positive surprise in hourly earnings (+0.3% mom and 2.1% yoy), with an annualised gain of 4.1% in the last three months; auto sales rebounded in March to 17.05m, after a lull in previous months. This latter point fits with strong consumer confidence, as does the fact that new home sales have accelerated over recent months.
Worrying though some signs have been, we think there is enough evidence from the labour market and elsewhere to believe the consumer remains in good health — we expect a re-acceleration of activity during Q2. We still think the Fed will hike between September and December (though cannot rule out that it will be later). Unlike many other commentators, we think the US stock market will do better if the economy is strong enough to prod the Fed into tightening. We think stocks would react negatively to a sharp economic slowdown and wonder how many times the markets can react positively to the need for QE.