We have previously described the Fed as having painted themselves into a corner. Their desire has been to avoid smothering the nascent recovery in the crib by crimping the most robust sector – the Real Estate Complex – while at the same time, preventing another full-blown bubble from erupting. I guess this means they have reversed their prior position that “bubbles cannot be discerned in real time.”
Perhaps we might better describe the Fed’s new position as having moved from the “corner” to between a rock and a hard place, stuck between slowing growth and inflationary pressures: Fearing a downturn, cautiously alert for price pressures, while tightening rates. Be it a corner or worse, this explains why most equity indices have dropped below their prior 6 month trading ranges. The lone exception being the S&P500; we credit the energy sector for keeping that index just above its November breakout.
As the Fed and the Markets come to terms with the demise of the “Goldilocks economy,” they find themselves digesting a different kind of Fairy Tale – one that’s halfway between Sleeping Beauty (slowing GDP) and Jack and the Beanstalk (increasing prices). The recent market reflects the reading of this tale, one which we fear may lack a happy ending.
And speaking of Fairy Tales: We couldn’t help but notice some elements of Friday’s Non-Farm Payroll report were, shall we say, less than meets the eye. After we drilled beneath the headlines, it seems that many of the newly created jobs were concentrated in mining, retail, food services, construction, and health care. McJobs and -Mart retail positions pay relatively low wages. But what were particularly intriguing were the many new construction jobs. Why? We hear tales of contractors moving workers to sub-contractor positions. It turns out cheaper for them not to have to pay FICA – good for everyone, except Uncle Sam.
Lastly, we would be remiss in the telling of any story involving Fairy Tales if we failed to make mention of the BLS Birth/Death adjustment of 257,000 new jobs. This relatively new tweak (since 2000) attempts to capture the impact of newly created firms (births) and those that succumb to competitive pressures (deaths). How this is actually accomplished remains something of a mystery, but suffice it to say that without this adjustment, April would have shown significantly weaker numbers of new positions created. For sure, nothing on the order of blowing away estimates like we saw on Friday.
The Brothers Grimm would be proud.
As such, we remain unconvinced that this is the start of a happy ending. We would become aggressive buyers if we saw stocks much cheaper and a lot more oversold than we saw in April. Until then, we remain neutral.