Good Evening: After early losses in the wake of Thursday’s very poor unemployment report, the major U.S. stock market averages rallied back this afternoon to finish mixed. Shares of financial companies and traditionally defensive names made for odd bedfellows in leading today’s comeback, but economically sensitive sectors like materials were heavy for most of today’s session. A decent ISM services survey and a potential upgrade for Brazil’s sovereign debt were the most commonly cited reasons for this afternoon’s levitation in the Dow and S&P, but I wonder whether the details of Thursday’s jobs release are being given their proper due by market participants. As PIMCO’s Bill Gross points out in his latest Investment Outlook, adjusting to the “New Normal” will be a slow and painful process.
Markets overseas were heavy overnight as foreign bourses continued to adjust to the less than happy reality that the employment situation in the U.S. continues to deteriorate. Not only were more jobs lost in June than had been forecast, but the 9 in 10 still clinging to a source of a regular paycheck saw their hours worked decline to a record low while their average hourly earnings stagnated. Toss in another highly dubious assumption by the BLS that small businesses are still cranking out tens of thousands of new jobs on a monthly basis, and it didn’t seem unreasonable that foreign markets concluded the “consumers of last resort” in the U.S. would remain sidelined with their pockets turned inside out.
Our stock index futures were likewise heavy before this morning’s open. Many commodities (e.g. grains) were also down, casting a pall over the companies for which bread and butter are, for lack of a better term, their bread and butter. After opening 0.5% lower, the main indexes briefly tried to rally before finding themselves down 1% or more inside of an hour’s trading. The ISM services survey results were just ahead of expectations, but the media played up how today’s reading represents the best one since last autumn (see below). This data point helped prevent a further slide in equity prices, and when Moody’s announced Brazil’s debt might be in line for an upgrade, investors took the news as a cue to by financial stocks. Though perhaps more important, a report that China is now letting select companies settle foreign contracts in yuan (as opposed to dollars) was given far less fanfare.
That this move by China is yet another crack in the crown of King Dollar didn’t seem to register with most market participants, and stocks began a slow and steady move higher after those early lows held. A small push higher during the final minutes left the Dow, S&P 500, and Dow Transports sporting small gains, while both the NASDAQ and Russell 2000 never did manage to turn positive. Treasurys were also mixed, as a large purchase of 2 year notes by the Fed helped those yields drop 4 bps, while yields on the long end rose a like amount ahead of this week’s supply. With what used to be “quarterly refunding” on the long end of the curve now closer to “semi-monthly” bond auctions, I can’t see how the Fed’s continued intervention in the Treasury market will do anything but lead to an even steeper yield curve down the road. When risk appetites were ebbing this morning, the dollar enjoyed a bounce. But as equities recovered, the greenback retreated until it, too, finished mixed. No such reversal visited commodities and their associated equities, however. Energy, grains, and the metals were all on the defensive as the CRB index was hit for a 1.75% loss.
Ever since the advent of mainframe computers, economists have sought to create ever bigger and better econometric models to use in predicting the future course of the U.S. economy. Unfortunately, more than four decades of tinkering with more than six decades of economic data left these so-called econometricians woefully unprepared to predict the onset of the Great Recession. I forgive them, though, since it took them almost 20 years of calibrating to finally adjust their models for all the easy money and debt creation during the Greenspan years. Now that the recession is visible during the come-uppance phase caused by all those distortions and imbalances, the dismal science of econometrics simply plugs in historical data from previous post-WWII recessions in predicting what will come next. Though the Great Recession has no parallel with normal, inventory-based downturns, this crowd would have you believe — without apologies to the Hoover administration — that a “recovery is right around the corner”.
Not so fast, says PIMCO’s Bill Gross in his latest “Investment Outlook” (see below). Mr. Gross admits some inventory building may lead to some scantly positive GDP readings during the second half of 2009, but he and colleague Mohamed El-Erian remind everyone that this is no ordinary business cycle. Mr. Gross thinks it is virtually impossible for the vaunted U.S. consumer to go back to his or her free spending ways. According to Gross, “U.S. and many global consumers gorged themselves on Big Macs of all varieties: burgers to be sure, but also McHouses, McHummers, and McFlatscreens, all financed with excessive amounts of McCredit created under the mistaken assumption that the asset prices securitizing them could never go down. What a colossal McStake that turned out to be”. (source: Gross article below)
Of further concern to those who claim to be able to model the economy, what if the unemployment rate goes from being a traditional “lagging indicator” to one which could be called “coincident”, or even “leading”? As Mr. El-Erian states in an article on the PIMCO website that originally appeared in the FT last week:
“The unemployment rate is traditionally characterized as a lagging indicator and, as such, is viewed as having limited forward-looking information. After all, unemployment is a reflection of decisions taken earlier in the cycle so the rate always lags behind the realities on the ground – or so says conventional wisdom.
“This conventional wisdom is valid most, but not all of the time. There are rare occasions, such as today, when we should think of the unemployment rate as much more than a lagging indicator; it has the potential to influence future economic behaviors and outlooks.” (source: El-Erian article below).
Former Merrill Lynch economist, David Rosenberg, agrees with both PIMCO CIOs in his latest pieces. Mr. Rosenberg now hangs his hat at Toronto-based Gluskin Sheff, but he takes to task his former colleagues at BAC-MER for calling an “end to the recession”. Mr. Rosenberg cites the numerous ways (numbers of jobs lost, time to find a new job, and deflating wages) as all being post-WWII records. I don’t have permission to forward Mr. Rosenberg’s work to readers, but it is safe to say he joins Gross and El-Erian in thinking it truly is different this time when it comes to predicting the future course of the U.S. economy. Since Messrs. Gross, El-Erian, and Rosenberg all saw our troubles coming when the models were all saying “full speed ahead”, I think I’ll side with them and let the econometricians continue to tinker.
For his part, Mr. Market has also seemed to be on edge of late. In at least one session during each of the past three weeks, we’ve seen large declines with very poor signs of internal health (e.g. 90% of volume belonging to declining issues). Maybe the old gentleman is telling us that he, too, will have trouble adjusting to the “new normal”.
— Jack McHugh
U.S. Markets Wrap: Equities Rebound on Credit-Market Outlook
U.S. Economy: Service Industries Drop at Slower Rate
Brazil Ratings Put on Review for Increase by Moody’s
Shanghai Companies Sign First Yuan Settlement Deals
Investment Outlook: “Bon” or “Non” Appetit? by Bill Gross, PIMCO
American Jobs Data Are Worse than We Think by Mohamed El-Erian
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