Recent worries over the end of QE were erased on Friday when the payroll numbers imploded.
The Nonfarm Payrolls for March proved to be a market moving report. The Dow declined to a session low of -171 at the open after the payroll report showed a gain of only 88,000 jobs compared to estimates for a gain of 200,000 jobs. The sharp decline in jobs came after a disappointment in the ADP report on Wednesday and a loss of -54,500 jobs in Canada. Having all three reports show sharp declines proves it was not just a blip in the BLS data.
Even worse and underreported, the related Household Survey showed a loss of -206,000 jobs. I bet you did not hear that on the news. The Household survey is where we get the unemployment rate.
The last three weekly jobless claims reports have seen sharp increases with last week's 385,000 the highest weekly claims since November 24th. Analysts tried to spin it as the Easter effect but that simply does not add up.
Jobless Claims Chart
The decline in jobs was not directly related to the sequester. Government cuts only amounted to -7,000 jobs and right in line with what we have been seeing on a monthly basis. The government has to give a 30 day notice on layoffs. That means anyone that is going to be terminated as a result of the sequester was still at work in March. That will change next month and we should expect another significant decline in jobs.
The Congressional Budget Office said the economy would lose -750,000 jobs in 2013 as a result of the sequester. Those government layoffs start in April. This did not stop private employers from trimming staff in anticipation of the government spending cuts. Uncertainty is a powerful motivator. When faced with billions in spending cuts the private employers probably took the attitude of an airplane pilot losing altitude over water. Everything that is not tied down goes out the door in an effort to lighten the load and make it to shore.
Remember, the administration warned daily ahead of the March 1st sequestration on how bad it was going to be. Facilities were going to be closed, airport control towers shut down, TSA workers laid off, parks closed, defense projects shuttered, meat inspections cancelled. Even the White House tours were cancelled because of the cost for security personnel. It was the end of the world as we know it if you believed all the warnings. Business owners took the warnings to heart and they quit hiring. Next month we will find out how many jobs were actually lost as a result of the sequestration panic.
There is a bigger problem than the 88,000 headline number for new jobs. The unemployment rate declined to 7.65% because another 496,000 people left the workforce. They got tired of looking for jobs so they gave up. The labor force participation rate sank to 63.3% and a 34-year low not seen since May 1979. If the labor force participation rate was at the same level it was in January 2009 the unemployment rate today would be 12.2% not 7.65%.
More people have gone on disability in the last four years than there have been new jobs created. The government said there were 276,482 applications for disability payments in March. That compares to 496,000 people who left the workforce. Where did those people go? The Bureau of Labor Statistics said it was not baby boomers retiring. It was middle aged workers that left. The participation rate for men ages 45-54 fell to 85.3% and the lowest rate since 1948. Older people over 55 have actually been moving into the workforce as a result of living longer in better health and having their retirement accounts crushed over the last five years.
This is very bad because this trend continues to suggest the employment problem since 2009 is structural not cyclical. In a cyclical economy jobs rise and fall as sectors rotate into and out of favor. In a structural failure the available jobs require training and skills the unemployed no longer have. Either the economic needs have accelerated away from the skill set of the unemployed or the jobs that are capable of being filled by the unemployed have gone elsewhere. Mexico, China, India, etc are the beneficiaries of the exporting of our jobs.
There are regional challenges as well. Companies are moving out of high tax areas like California and into low tax states, which welcome business. The employees in California no longer have jobs and while there are plenty of workers in the new states they may not have the skills required to do the jobs. The companies have to undertake a long term training posture in order to rebuild the workforce. Salaries in California may have been the equivalent of $50 an hour where the same job in Texas may pay $20 an hour. The company benefits but the California workers are now trapped out of a job. They need $50 an hour to pay their bills but those jobs have left and that means long term unemployment until they finally lower their expectations to the reality of lower pay.
The economy is slowing down. The Q1 GDP will probably come in at the range of 2.0% to 2.5% but it is a technical blip caused by inventory data rather than an actual surge from the +0.38% in Q4. The second quarter GDP could be back under 1.0% again. The Congressional Budget Office claims the sequestration could reduce GDP by a half point in 2013 but some analysts believe it will be more.
William Dudley, President of the New York Federal Reserve said, "The increase in payroll tax, the rise in high income tax rates, the increases in taxes associated with the Affordable Care Act, and now the sequester---if sustained---will result in fiscal drag of about 1.75 percentage points of GDP in 2013."
I think we should prepare ourselves for some job reports that show a loss of jobs this summer.
I believe the recent talk of tapering off the current QE program has probably evaporated. If the pace of job creation continues to decline the QE program will be with us for a long time. The March payrolls report probably cemented the current $85 billion a month program until at least early 2014.
If the pace of people leaving the workforce continues at this rate we could see that 6.5% unemployment target in 2014 but I guarantee the Fed is not going to end QE because of falling unemployment for that reason. Having 496,000 people leave the workforce in a single month is a warning shot across the Fed's conference table. This is a structural problem that QE is not likely to fix. Pushing the stock market higher is not going to convince those workers to hunt for a job.
I don't mean to be so negative here but the outlook is worsening. The recession in Europe is increasing. Unemployment there is at a record high of 12%. More than 80% of the companies in the S&P derive a large portion of their earnings from Europe. We export 15% of our goods to Europe. China exports 35% to Europe. A worsening recession in Europe as a result of the continuing debt crisis and the Cypriot bank robbery is going to weigh on the U.S. and China.
The rise in the dollar is going to crimp earnings in the U.S. in Q1. According to a Bloomberg survey S&P earnings are now expected to decline -1.9% for the first losing quarter since 2009. Falling earnings are not conducive to hiring.
There are currently 143,286,000 people employed in the USA. There are 89,913,165 people of employment age and "not in the labor force." There are 11,742,000 officially unemployed and 18,745,000 working part time because they can't find a full time job. There are a record 48 million people on food stamps.
Over the last year those "not in the labor force" rose by 2,069,000. Over the same period the number of people hired rose by +1,266,000. This is a serious problem when 63% more people dropped out than found a job.
A single parent with two kids making $28,000 a year can qualify for $80,000 a year in government assistance. Why work?
Nonfarm Payroll Chart
The increase in taxes from the Fiscal Cliff resolution and worries over the impact of sequestration has hit the retail sector hard. Retailers cut 24,000 workers in March. If the CBO estimate for a loss of -750,000 jobs is accurate the retail sector is going to be hit even harder.
The miss on the ADP Employment on Wednesday started a feeding frenzy in treasuries and that continued through the Nonfarm Payrolls on Friday. Treasuries were push to their high for the year and yields closed at the low for the year. The potential for a move by the Fed to taper off on their current QE program has declined to the low for the year. Expectations are now for the current QE program to last into 2014 unless the data were to suddenly improve. Bernanke said he wanted to see "months" of positive data trends before he would consider slowing purchases. With the potential for economics to worsen over the summer that would keep the Fed on punchbowl duty for the rest of the year.
Ten Year Treasury Yields
A bit of positive economic data came from California. The California Purchasing Managers Manufacturing Survey for Q2 rose sharply from 52.9 to 59.8. The high tech component rose from 51.6 to 57.5. New orders rose from 54.9 to 63.9. The only component that did not rise was commodity prices, which declined from 69.8 to 66.5.
This index had declined for the prior two quarters so the sudden rebound was well received. However, high tech equipment production declined in Q1 and this could repeat in Q2 with the large number of defense contractors in California. They are not likely to be buying a lot of new computer equipment until the sequestration fades.
The economic calendar for next week is headlined by the FOMC minutes on Wednesday and the start of the Q1 earnings cycle. The FOMC minutes will be scrutinized for signs of tapering off on QE even though the odds are significantly lower after the payroll report. The minutes could still cause trouble for the market.
The first Dow component to report is Alcoa (AA) on Monday. Estimates are for a profit of 9 cents. The next set of important earnings is Friday with JP Morgan (JPM) and Wells Fargo (WFC) reporting. The commentary from JPM will be of the most interest. Analysts will want to know how much their incoming overseas cash flow has picked up since the Cypriot bank robbery. JPM is thought to be the best positioned to reap the rewards of cash leaving Europe.
JPM was upgraded to outperform at Evercore on Friday.
The earnings cycle ahead could be rocky. There have been 107 negative guidance warnings on the S&P-500 or roughly 4:1 over positive guidance. That is the worst record in 12 years according to Thomson Reuters. Earnings estimates for Q1 are all over the map. S&P is predicting earnings growth of +0.58%. Thomson Reuters is predicting growth of +1.6%. A Bloomberg survey of analysts found consensus to be a decline of -1.9%. If earnings do decline it would be the first negative quarter since 2009.
The Bank of Japan said on Thursday it was going to inject about $1.4 trillion into the economy by the end of 2014. This would almost double the monetary base to $2.9 trillion. (270 trillion yen) Japan has been in deflation for more than 20 years and this is a radical ploy even for Japan in an effort to rekindle inflation. To put this in perspective the Fed is injecting $85 billion a month or roughly $1 trillion a year at the current rate. Japan is going to do about $800 billion a year so nearly the same rate as the Fed BUT Japan's economy is one-third the size of the USA, which makes their effort significantly larger in terms of relative size.
Their target is 2% inflation at the end of the program. The Nikkei stock market jumped +2.5% on the news and the yen fell -3% against the dollar and -4% against the euro. The 10-year government bond hit a record low. The BOJ buys more than just bonds. They will buy 7.5 trillion yen of long-term government bonds per month or roughly 70% of bonds sold in the public market. They will increase purchases of ETFs by one-trillion yen per year and REITs by 30 billion yen a year.
Analysts said the aggressive QE program could create a currency war and fuel a giant asset bubble in Japan. Kuroda, the head of the BOJ said, "I don't see the risk." Let's hope he does not have to eat those words in the future.
With the Bank of England (BOE), Bank of Japan (BOJ) and the Federal Reserve competing to see who can inject the most stimulus the global equity markets should move higher. The ECB did not commit to new stimulus last week but said they would continue to maintain a very accommodative economic policy. The ECB has a different set of problems with the banking system in the euro zone on the verge of collapse and unemployment at a record high of 12.0%.
Italy is officially the next country likely to levy a tax on deposits. The CEO of UniCredit, Italy's largest bank, said "Cypriot style haircuts on bank deposits are acceptable." He also said the practice should become a model for all eurozone countries AND those outside Europe. He suggested the practice be made a standard for all countries governed by the Basel accords. That would include the USA. He said it must apply to ALL banks otherwise speculators could arbitrage the weaker banks.
The unofficial run on Italian banks has begun. Vehicles leaving Italy are being searched for "contraband." Border police searched the family car of an Italian resident of Switzerland and found a cache of gold bars under the floorboards. The businessman was traveling with his wife and three kids when the car was searched. The gold was worth about $6 million. It was confiscated and the man is under investigation for money laundering. The obvious question is "Why did they confiscate gold?" This was not euros that are currently restricted for withdrawal in some countries. The answer is "because they can." Money in euro zone banks, safe deposit boxes or even vehicles now belongs to the state not the individual. This is why the euro is going to fail. When private property is confiscated to pay the debts of others the end result is the demise of the financial system.
Some Gold Bars from Car Floorboard
In stock news F5 Networks (FFIV) warned on Thursday that fiscal Q2 results would miss expectations because of weakness in buying among North American customers and some overseas customers. The company said earnings would be in the range of $1.06-$1.07 and analysts were expecting $1.23. There were at least four downgrades by Piper Jaffray, Citigroup, Topeka Capital markets and William Blair and more than a dozen firms cut their price targets.
FFIV claimed it was not losing market share but research firm Gartner said their market share in the ADC market was 50.7% but that was the lowest market share in over six years. FFIV said there was some hesitancy from government contractors ahead of the sequester and government purchases had slowed. FFIV shares fell -19% on the news.
On Thursday Best Buy (BBY) said it would be putting 1,400 Samsung kiosks in its stores and it was discounting existing Apple iPads by 30% to move them out. With Samsung battling Apple for supremacy in the smartphone market the deal with Best Buy was a blow to Apple and a win for Best Buy. Apple already had a premium position in every Best Buy store and the deal with Samsung suggests there is a battle heating up and BBY is going to be the winner regardless of which of the phone makers comes out on top.
However, Wall Street is expecting an 8.2% drop in same store sales for the current quarter so don't back up the truck on BBY shares just yet. As for those discounted iPads, don't bother looking for them, they are already sold out. That just proves you can sell anything if you sell it cheap enough.
Best Buy Chart
The first quarter is over and by all accounts it was outstanding as long as you are not talking about earnings. The Teflon market shook off all the negativity and closed at new highs the prior week. One of the reasons for this performance was fund flows. On Thursday TrimTabs.com reported that funds saw inflows of $52 billion in Q1 compared to outflows of $87 billion for all of last year. Bond funds took in $65.7 billion and the highest inflows since 2006.
Gold and silver rebounded on the decline in the dollar, worry over weak economics, the guarantee of QE for the rest of 2013 and the massive QE announced by Japan. Suddenly the need for a hedge against the economy came back into vogue. Gold rallied +$29 to $1581 and silver gained 50 cents to $27.28.
More saber rattling out of North Korea (DPRK) also helped to lift gold prices. The DPRK told countries with embassies in North Korea to leave before April 10th because Korea would not be able to protect them after April 10th. Russia and the U.K. said they had no plans to leave but were considering their options.
North Korea transported two medium range missiles by train to the east coast where they were installed on mobile launch platforms and hidden in underground facilities near the coast. Analysts claim the move may be preparations to launch a test flight in mid April to celebrate the 100th anniversary of Kim Il Sun's birthday. He was the founder of the DPRK in 1948 and the grandfather of the current leader, Kim Jong Un. They could be planning to exit the crisis with a face saving show of force and launch a missile over Japan and into the sea.
North Korea has a population of 25 million. They have 1.1 million in active military service and 8 million in the reserves. They have 17,000 artillery pieces with 14,000 pointed at South Korea. They have 70 submarines. They are the largest counterfeiter of U.S. $100 bills.
Talks with Iran over halting their nuclear program failed again after two days of meetings with the six nations. The talks are never going to succeed as long as Iran refuses to talk about anything important. They refuse to discuss a halt to enrichment or inspection of their nuclear testing facilities. Iran uses the talks to delay further actions against them while rushing to complete their weapons research. They have been holding talks for years and nothing has ever been gained by the six nations. Normally the parties agree to meet again 3-6 months into the future. This time no further meetings were scheduled.
Israel has said repeatedly that this summer would be the deadline on halting Iran's progress on the bomb either by negotiations or by military action. The lack of any further talks with the deadline only months away suggests the only way out of this problem is military action. The U.S. followed a path of sanctions and tough talk on North Korea for 20 years and they still managed to develop nuclear weapons. Another couple years and they will have them on long range missiles and become a real threat. The same thing is happening with Iran. After a decade of talks and sanctions they are only months away from acquiring a weapon and that will change the balance of power in the Persian Gulf and Middle East. Is the world ready to let that happen? Is Israel prepared to start a war to stop Iran from getting a bomb that could destroy Israel? Sounds like a good time to buy some oil futures or own the USO ETF.
Airlines declined last week on profit taking after earnings warnings from multiple carriers. They blamed the slowdown in travel by government contractors and government employees as a result of sequestration. The government spent $30 billion on transportation in 2011. That is a big pot of budget money each department can use to smooth out the sequestration cuts.
International carriers also declined on news of the new outbreak of bird flu in China. As of Friday there have been six deaths and birds with the virus have been found at three different markets. Tens of thousands of birds have been killed and live bird trading has been halted. The human mortality rate of the new H7N9 virus is currently around 30% of those infected. That will improve now that hospitals are looking for the illness. The flu drug Peramivir, developed by BioCryst Pharma (BCRX) has proven successful and has been fast tracked for approval in China. Tamiflu made by Roche Holding AG (RHHBY) has also proven to be effective if used early in the treatment.
What we need is an antibiotic for the markets to prevent the spring slump virus. Over the prior three years there was a big rally in the first quarter that was followed by a correction in the second quarter. While there is nothing that says we are going to follow that pattern in 2013 the declining economics and weak earnings could be setting the stage for the fourth consecutive year of Q2 declines.
The pattern over the last several years has been for weakness in the first week of April and then a rebound into the earnings cycle before a sharper decline in May. The weakness in the first week was right on schedule. The big rebound on Friday appeared to be setting up for a return to gains next week.
The S&P hit 1573 on Tuesday and then dipped to touch critical support at 1540 on Friday. That was a minor -2% decline and the S&P rebounded +13 points from the support low to close at 1553.
Despite two closes above 1565 that prior resistance level remains a factor to be considered in the week ahead. It remains clear resistance and 1540 remains as critical support. The S&P closed right in the middle of that range at 1553. A break of support at 1540 suggests a retest of 1495-1497.
The strong pickup in volume when the S&P hit 1540 suggests there were plenty of dip buyers ready and waiting. Until the dip buyers are eventually overwhelmed by sellers the trend will continue. Sometime in the coming weeks there will be a dip that is not successfully bought and that will signal the start of the summer swoon. For me that would be a decline under support at 1540. That is such a clearly defined level it should be easy to defend. That means a breakdown will be easily recognized and traders will bail out when it happens.
S&P Chart - Daily
The Dow spent most of the week over support of 14,550 except for the -171 point decline at the open on Friday. However, the Dow recovered from the big drop to end the day down only -40 points. The strength of the blue chips was evident with the Russell 2000 losing -3% for the week and the Dow losing only -0.1%. Apparently fund managers and investors were looking for the security of blue chips as the market turned rocky ahead of earnings. The big blue chip stocks that report early in the cycle normally beat earnings. It is the smaller stocks that report later that miss estimates. Hiding in the blue chips for the next three weeks is a valid strategy ahead of the sell in May cycle.
Note the RSI has worsened from the prior week and the MACD continues to weaken.
The Nasdaq lost -2% for the week and barely managed to rebound and close back over support at the 3200 level. Tech stocks are getting hammered by earnings warnings such as those from FFIV on Thursday. Analyst downgrades are flowing daily due to slowing PC sales and impact to the networking sector from the cuts in government spending.
The uptrend support from November has failed. ANY further decline below 3200 next week risks a return to stronger support at 3125. The RSI has weakened sharply and the MACD is accelerating to the downside. Tech stocks would not be my choice for long plays in April.
The Russell 2000 gave back -3% and made a valiant effort to close back above light support at 920 on Friday. Any further decline suggests a retest of stronger support at 895.
Fund managers took the opportunity of a new quarter to lighten the load early in the week. This was expected and the Russell is following the game plan almost exactly. Funds are going to be raising cash by taking profits and then allocating that cash to the blue chips ahead of the normal May decline. We could see some dip buying on the Russell ahead of earnings but I do believe we will retest 895 in the weeks ahead and probably a lot lower if earnings are a disappointment.
Russell 2000 Chart
The Dow Transports gave back -3.5% for the week. It would have been a lot more but the -2% dip on Friday was instantly bought and the index powered higher to actually close with a decent gain. I believe this is a signal the selling has temporarily passed.
Dow Transports Chart
The big rebound in the Dow and the Dow Transports suggests the initial market weakness for April may be over. The bears had an opportunity to really take the markets lower on the big upset in the payroll numbers but they could not do it.
All the bad news is now priced into the market. That includes the ISM declines, payroll numbers, earnings warnings, Cypriot bank robbery and the impact on the rest of Europe. All of those points still have to play out in the coming weeks but the initial headline shock is behind us.
The Fed is still filling the punchbowl with a fire hose and the Bank of Japan is going to try and out stimulate the Fed. The impact on the dollar and the yen means other central banks will have to step up their stimulus programs or risk their currencies growing too strong to compete on the global stage. This race to stimulate will also create a stealth currency war that inflates equities and commodities. However, the commodities may lag until the economies begin to recover.
Get used to the sequester excuse for earnings misses and declining economics. It is going to be with us for a long time.
The start of the Q2 earnings cycle will be headline news all week and that will drive the market. The FOMC minutes on Wednesday could be the bump in the road but I don't know what they could say that has not already been discussed in the press.
I would key on the Russell 2000 at 917.50 and the S&P at 1540 as the two major indicators for market direction next week. I believe traders have bought the dip to those levels and as long as they don't fail due to some new headline the week should end with a gain.
Enter passively and exit aggressively!
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"He who is not courageous enough to take risks will accomplish nothing in life."