The market sold off the first four days of December on fear of a strong Nonfarm number. The fear was misplaced.
Last week was a perfect example of a sell the rumor, buy the news event. Investors and fund managers were hit with several better than expected economic numbers and as the week progressed the conventional wisdom was to expect a QE taper in December. The stronger than expected ISM started the ball rolling on Monday and the New Home Sales and ADP Employment on Wednesday fueled the fire. Then the weekly Jobless Claims came in under 300,000 for only the second time this year. The GDP was a blowout at +3.6% growth and the stage was set for a whopper of a Nonfarm Payroll number on Friday.
The official estimate had been for a gain of +185,000 jobs but after the strong economics earlier in the week there were whisper numbers over 300,000. That would have been almost a guarantee of a December QE taper announcement. Equities sold off the first four days of the week as various Fed speakers implied there could be a December taper as a result of the economics. The stage was set for a Friday disaster.
Traders breathed a sigh of relief on Friday when the Nonfarm Payroll headline number came in with a gain of +203,000 jobs. That was slightly above estimates but right in the Goldilocks zone where it was not too hot and not too cold. Revisions to prior months were also minor with October revised down -4,000 and September revised up +12,000. With the revisions it bought the past three month average to +193,000 and three of the last four months were over 200,000. Various Fed members had said they wanted to see sustained employment over 200,000 per month before they cut QE. With some volatile Washington events scheduled for January and February the +193,000 average was not hot enough to convince the Fed that the economic recovery was accelerating. The target date for tapering is still March according to most analysts. The Fed will have to consider possible economic disruption from the January fiscal follies in Washington when they meet in December. The current funding resolution expires on January 15th and the debt ceiling comes back to haunt us in early February.
The unemployment rate ticked down from 7.3% to 7.0% and not because of the shrinking labor force participation rate (LFPR). That actually rose +0.2% from the 35 year low in October to 63.0% in November. The labor force declined -720,000 in October and rose +455,000 in November. Household employment declined -735,000 in October and rose +818,000 in November. Analysts claim these distortions were the result of the government shutdown in October and the rebound in November removed that bit of volatility. There was also a change in the reference week for the survey due to the holiday calendar.
I could drone on for several more paragraphs on this but the key was the lack of a major upside surprise for jobs. This was a Goldilocks report and shorts were forced to cover and traders waiting on the sidelines jumped back into the market.
There was some difference of opinion on when the Fed would taper with some now thinking December, some January and the majority in March. The quote I keep coming back to was Yellen's "We should not be in a rush to end QE" until there is a clearly sustainable economic recovery in place. We are not in a "clearly sustainable" recovery. Even with the strong reports there were an equal number of reports that showed declining conditions. When asked if the jobs number put the taper on the table for December Chicago Fed President Charles Evans said he was "open minded" but he would rather see several more months of job growth over 200,000 before taking action. Evans is a voting member of the FOMC. Translated that means only a minor chance of a taper in December.
Far too much importance is applied to the Nonfarm Payrolls and we should believe the Fed heads when they say a taper announcement will be data dependent.
I believe the market attaches too much significance to the flawed Nonfarm Payrolls numbers. The Nonfarm Payrolls are setup to put the best spin on the numbers submitted. Consider this.
Establishment Survey, Nonfarm Numbers: If you work one hour a week that counts as a job. There is no difference between 1 hours and 50 hours. If you work two jobs you are counted twice. There is no check for duplicate social security numbers. If your full time employer cut you back to 30 hours and you were forced to get a part time job for 10 hours to make up for the pay cut you are counted twice. By your employer cutting your hours the BLS actually gained a job.
Household Survey, unemployment rate, labor force participation rate: if you work 1 hour or 80 hours a week you are employed. If you work 35 hours a week you are considered full time. If you work 20 hours for one company and 15 hours for another you are considered a full time employee with one job.
This is why the data from the two reports never matches. The Establishment Survey (Nonfarm) mechanics and definitions have been changed by nearly every president for the last 30 years to reflect a more positive outcome.
According to the Household Survey over the last year the number of people not in the labor force rose by +2,418,000 while the number of people employed only rose +1,109,000. Twice as many people dropped out than those who found jobs.
The Q3-GDP was revised from +2.85% growth to +3.6% growth. On the surface that appears to be a blowout number. However, 1.68 of that was due to inventory gains. This is severely negative for Q4. Inventories can rise for two reasons. The first would be rising demand and manufacturers accelerating production to increase inventory levels to handle that demand. The second reason could be lack of demand. Inventories rise unexpectedly because demand unexpectedly declines and manufacturers are left with unsold goods. Given the various economic reports over the last month and the very weak retail sales for Q4 I would bet it is due to the second reason. Demand weakened significantly and resulted in excess inventories.
A Bloomberg article put it this way. "Q3 GDP rose faster than initially projected as unsold merchandise piled up at the fastest rate since 1998, setting the stage for a possible slowdown in Q4." Also, "Household spending, which accounts for 70% of GDP rose only +1.4% and the slowest rate since Q4-2009."
Analysts were quick to lower their GDP estimates for Q4. The general range of estimates vary from flat to a gain of as little as +1.0%. The government shutdown also reduced Q4 GDP by about $20 billion or half a percentage point. They have another chance to cause economic harm if they don't agree on the budget by next Friday's deadline. While nobody believes there will be another government shutdown you never can tell what will result from the political maneuvering in Washington.
Another major surprise on Friday was the major rebound in Consumer Sentiment. The headline number spiked from 75.1 to 82.5 and the highest level since July. Expectations were for a minor decline to 74.2. The present conditions component surged from 88.0 to 97.9 and the highest level since July. The expectations component rose from 66.8 to 72.7 and the highest reading since August. The drop as a result of the government shutdown has been erased and consumers appear to be charging full speed into the holiday shopping season.
Unfortunately that is not the case. Of the 112 commonly followed retail stocks 49 have warned for Q4 and that number is growing daily. The holiday shopping season may be setting records for Walmart and Amazon but the brick and mortar retailers are struggling. I would discount this sentiment report as the result of a rebound from the government shutdown and not a clean read on current sentiment.
The economic calendar for next week is devoid of material reports. The retail sales for November could be volatile since that includes the Black Friday weekend. Post weekend anecdotal reports have suggested it was lackluster for many companies so the sales numbers could be disappointing.
Monday is speech day with four speeches by Fed members, actually Fisher speaks twice.
Friday is the soft budget deadline. When the House, Senate and President Obama ended the government shutdown in October they agreed to turn the budget over to a bipartisan committee with instructions to come up with a budget solution by December 13th that could be passed by both the House and Senate. The concept was to satisfy the Republican desire to cut spending, the Democrat desire to raise more revenue so they can add spending and the desire to cancel the annual sequestration cuts.
As part of the negotiation process the bipartisan committee is supposed to come up with a package that will eliminate the $100 billion a year in sequestration cuts and replace it with targeted declines in spending. The sequestration cuts are the equivalent of chopping at the budget with a dull machete and lawmakers are trying to replace that with targeted cuts made with a scalpel. I am not holding my breath.
On Friday a spokesman for the committee said "No budget deal yet" and conference leaders have left Washington for their home states. Reportedly they are working on a two year deal that sets spending levels and tries to handle those critical items that are deal killers. One of those is the end of extended unemployment benefits for 1.3 million workers at the end of December. Nancy Pelosi said the democrats would not support any budget deal that does not extend those benefits once again. After this was called a poison pill by committee members Pelosi backed off to some extent and said if it was not included in the budget deal they would bring it up as a separate item in regular business in January.
The targeted spending for 2014 is slightly over $1 trillion but less than the $1.058 trillion sought by democrats. Both numbers are well above the $967 billion level mandated by the Budget Control Act of 2011, which included the sequestration.
The bond market was just as confusing as the equity market on Friday. You would have thought that a strong payroll report would have pushed yields higher as we move closer to an eventual QE taper. Yields did spike to 2.93% at the open but then fell to 2.84% by midday as bonds were bought. Since buying bonds ahead of a taper announcement would be the equivalent of financial suicide the midday buying was very confusing. Several analysts pointed out that the Fed had a scheduled buy of $5 billion in treasuries for Friday. They speculated the Fed jumped into the market after the payroll report in an effort to blunt the rise in interest rates. If that was the case it worked for a couple hours. Starting around noon the yields began to rise again as sellers overcame buyers and yields closed the day at 2.88%.
It is already a given that we will see ten-year yields over 3% in the coming weeks. Numerous analysts believe we will see 4% once the taper has begun and that is just the start of the rise in rates over the next several years. If the economy is really going to grow and the Fed is going to stop buying $85 billion a month in securities then rates are going to rise and rise a lot despite the Fed's promise to keep the Fed Funds rate at zero until 2016. Bond owners beware! Remember ten-year yields were 5.25% in 2007 before the financial crisis hit. If the economy is going back to normal over the next couple of years then expect rates to return to normal as well.
The high print for the year was 2.99% in September when it was assumed Bernanke was going to announce the taper in September. The closer we get to the taper the higher the yields are going to be.
The payroll numbers and the market response pretty much overshadowed any stock news on Friday. However, there were some standouts. Big Lots (BIG) reported a loss of 16 cents on $1.15 billion in revenue. Analysts were expecting a loss of 8 cents and $1.16 in revenue. Same store sales declined -2.5%. If the earnings miss was not bad enough the company said it was shutting down its Canadian operations in the first quarter. They currently have 73 Liquidation World stores, five Big Lot stores, two distribution centers and an office. That is a major change in posture and it is going to happen rapidly. BIG said they had been unable to gain the necessary traction in Canada and throwing more money at the problem would not be beneficial and they are going to cut their losses and just leave.
They guided to Q4 earnings of $1.48 and full year earnings of $2.48. This compared to analyst expectations of $2.11 and $2.94. They projected same store sales in the U.S. to decline -7%. Shares declined -13% on the news. The chart for BIG shows how volatile earnings have been in the past.
Ulta Salon Cosmetics & Fragrance (ULTA) reported earnings of 70 cents compared to estimates of 74 cents. The guidance was even worse with Q4 now projected to be $1.07-$1.10 and analysts were expecting $1.24. The company said it planned to maintain its market share gains during a "highly competitive and promotional holiday selling season." That suggests they are going to cut prices and launch promotions of their own that will lower margins and profits. Investors raced to the exits faster than a customer with a bad perm and shares fell -20%.
JC Penny (JCP) fell for a third day after a major hedge fund manager said he exited his position and the company said the SEC is looking into the surprise stock offering in September. Hedge fund manager Kyle Bass said in a Bloomberg interview he exited his entire position in JCP. When investors throw in the towel on a position it creates a lot of follow on sellers.
In a SEC filing on Thursday Penny said the SEC had launched an inquiry into the company's share offering, details of the company's liquidity, cash position and debt and equity financing. Back in September the company told a group of analysts they saw no reason to raise money through an equity sale and then the very next day reported they sold $800 million in shares. This riled the analyst community and caused a selloff in the shares. You don't tell analysts one thing in a meeting and then do the opposite the next day.
JCP shares have fallen from $10.30 to $8.09 in three days as these scenarios play out in the market.
Bitcoin has had a rough couple of weeks. After soaring to a high of $1,226 on Thursday it fell to $576 on Saturday after China said it was prohibiting its banks from dealing in the electronic currency. China said the fluctuations made it impossible for the banks to protect their users from significant losses. If you had some bitcoins in your electronic wallet their value was just cut in half. Holding bitcoins for investment is going to be a risky proposition. If you want to speculate in the currency I would put in bids at ridiculously low prices and then hope there is a bounce after you are filled. You can't short them so going long is the only play. There is a physical limit of 21 million bitcoins because the complicated electronic signature of each is limited to 21 million combinations. That means it is a pure supply and demand market and eventually demand will outstrip supply and prices could rise a lot. That assumes the currency is not outlawed. BIDU suspended bitcoins as a form of payment for services on Saturday.
Maybe hedge funds should start investing in Bitcoins. Their returns would be better. The $2.5 trillion hedge fund industry is about to turn in its worst performance since 2005. Through November the industry was returning about 7.1% compared to the +29.1% gain in the S&P when adding in dividends. Bloomberg claims the hedge fund industry is underperforming for the fifth consecutive year. The industry earns more than $50 billion in management fees per year. This is why many analysts are expecting a strong December. Funds are desperate to produce profits and will likely chase stocks higher for the rest of December.
Is good news actually good news now? Over the last two years every economic headline was weighed against the potential to impact the Fed's QE stance. Good news was bad news when it had the potential to accelerate tapering. Has that trend finally ended? Is good news really good news or was Friday's rally just a onetime event?
I personally believe it was a onetime event. The market had pulled back from very overextended conditions as a result of profit taking and some fear of improving economics. However, like in nearly every market event traders tend to go too far too fast as they sell the rumor. When the news was not as good as expected the shorts were forced to cover and we saw a giant short squeeze.
The odds of that continuing are slim. The Fed meets on the 17th and there will be plenty of hand wringing ahead of that meeting. This week there is a distinct lack of any material economic reports so the market should be free to move higher if it so wishes.
However, the market breadth is still declining. The number of S&P stocks above their 200-day average is declining and has been since May. The deterioration is not dramatic but it does exist. With the markets setting new highs you would expect the 200 day numbers to be climbing.
Historically the first few days of December are typically weak as a result of tax loss selling and portfolio restructuring. The Stock Trader's Almanac has documented the last 21 years and they show weakness in the first two weeks with strength in the last two weeks. The last trading day of December is normally down.
While historical seasonality is interesting to study, every year is different. This year we have the budget battle starting next Friday. If a miracle occurs and a two-year deal is actually reached the markets should rejoice. If they come down to the wire and don't get a deal done the threats and accusations will begin to fly and the market will probably react negatively.
The S&P closed down less than 1 point for the week and hardly in correction territory. At this point it was just a bout of routine profit taking. The index dipped to decent support at 1,780 and then rebounded but not immediately. The initial dip was lightly bought ahead of the payroll report. It was only after the report that the shorts were forced to cover and the rally began.
The S&P is still facing major resistance at the 1810-1812 level and we could test that next week. The talking heads on CNBC were completely mixed on the outlook although most expected the markets to be higher by yearend. You could gather 20 of the guest analysts together in a room and still not come to a conclusion.
Next week is likely to be choppy. I have no reason to believe the rally will continue at its Friday pace but stranger things have happened. I expect a choppy week with an upward bias. The resistance at 1810-1812 is the key level. If we break above that level then hitch up the sleigh because we could be in for a nice ride. If that resistance holds then the amount of the decline will be the determining factor. If we only drop back a few points it sets up another retest. If we drop back to 1,780 it would be a strong warning.
The Dow fell exactly to support at 15,800 and was rock solid. The rebound of nearly +200 points did close it back over 16,000 but there is strong resistance at 16,100. This is going to be a major test and with retail sales tanking it could sour sentiment.
The Dow range last week gave us some clear levels to watch with 16,100 and 15,800 the outside fence posts that must be honored.
The Nasdaq finished positive for the week at 4,062 and a new 13-year high. The Nasdaq and the Russell 2000 are normally the strongest indexes in December so a new high close by the Nasdaq suggests continued gains ahead.
The Nasdaq never really sold off and the support at 4,000 never tested. It would appear the Nasdaq is going to lead us out of last week's darkness and that should be fine for everyone.
It was interesting that most of the big cap techs and momentum stocks did not participate in Friday's rally. That suggests bargain hunting by fund managers as they look for new horses to lead the sectors in 2014.
The Russell 2000 was not that strong on Friday and that gives me a little reason to worry. The Russell gained +9 points but finished the week with a loss of -11. The recent closing high at 1,142 is about 12 points over Friday's close. It is not out of reach but it is also strong resistance. Watch the strength in the Russell as a sentiment tell for the big cap indexes.
There are no major events next week other than the Fed speakers on Monday and the budget deadline on Friday. The retail sales on Thursday could be a sentiment killer. I expect a choppy weak with a bias to the upside. However, fear of the Fed could come back to haunt us after Monday's parade of speakers. The FOMC meets the following week so be prepared for some worried traders.
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