What’s an Early Look Worth?

Back on January 22, we noted several factors which were making us increasingly cautious, and released a commentary titled “Market Flashes Yellow Caution Light.” Since then, the Nasdaq has pulled in smartly, registering the first 5% drop since the rally began in March 2003. The Nasdaq dropped 6.5%, while the Dow and SPX both lost about 2%.

Additionally, we noted that the Fed was likely fighting one of two inflation fears: A growing asset bubble, or an improving economy, which could cause price inflation. The data so far has neither confirmed nor denied either possibility.

This led us to ask the following question: Did the Fed get an early look at the employment data? Is that what prompted them to change their language?

The Bond market thinks so. The 10 Year has moved to a trading range of 4.10 – 4.25 yield since the Fed changed their language. Spreads have widened, despite weak vehicles sales numbers earlier this week.

Recent economic data also provides a clue: Productivity gains cooled dramatically from the 3rd to 4th quarter, plummeting from the unsustainable 9.5% to a more reasonable 2.7%. Yes, Jobless Claims came in +17,000, a reversal of the recent improvement in trend. But any weekly Jobless Claim data can be aberrational.

The decrease in productivity bodes well for the Employment Situation report – especially since there has not been a drop in output or ISM data. Productivity is going down because more bodies are being used to produce widgets.

Wall Street has been awaiting this data. Consensus is for non-farm payrolls to show a gain of 165,000, with the unemployment rate staying steady. We would not be astonished to see an upside surprise from the December Employment Data, even as high as 225,000 new jobs. Further, the anemic 1,000 new jobs created in December could be revised upwards. Both of these would be welcome (and long overdue) developments.

With the Nasdaq now off its highs, there is significant upside potential if the Employment Situation report beats consensus. Further, it would start to validate the still unproven thesis that this is a self sustainable recovery. Traders (but not investors) should recognize the upside risk from tomorrow’s data and plan accordingly.

UPDATE: 2/5/04 5:07PM
Please note that today’s note contains a mathematical error:

While figuring out the weekly closing data, we erroneously confused a column of SPX data with the same for Nasdaq. Measured by the weekly close, there were indeed at least 2 prior 5% pullbacks — 5.1% on August 8, 2003, and another 6.3% on September 16th, 2003. And, it looks like there were additional peak to trough drops of that much also.

We apologize for the error, and regret any inconvenince this may have caused.

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