Last week's series of economic releases were the most important of the month and round out the trend of the last month in the quarter. Last Monday in Different Markets Discounting a Similar Conclusion: A Slowdown in Growth
I explained how market prices were pointing to a growth deceleration despite analyst estimates of a weather-related snapback:
As we wind down the quarter, there have been some clear trends that have changed direction. The question for Q2 is whether these are changes in trend or countertrend adjustments... Will companies increase hiring and, more importantly, wages at a time where they are increasing credit lines to finance unsold inventory? If the demand is there they will. If not, then the stage is set for a double dip.
Now that the results are in, the market's discount proved to be correct. Tuesday, the ISM manufacturing index registered 53.7, weaker than the consensus 54.0. Thursday, the ISM services index registered 53.1, weaker than the consensus 53.3. Friday, the most important release of the month, the non-farm payroll report, showed a gain of 192,000 jobs, weaker than the estimated 200,000 and below even higher whisper numbers.
Consider noted economic bull and chief economist for the biggest bank in the world, Deutsche Bank
(NYSE:DB), Joseph LaVorgna
Our current NFP forecast of 275,000 reflects a return to trend job creation of roughly 175,000 with a weather-related payback of roughly 100,000.
Wednesday's ADP employment report that showed a gain of 191,000, weaker than the expected 193,000, was written off as bogus because of inaccuracies, yet it nailed the private payroll report of 192,000, weaker than the estimated 215,000. This poses the question. How much of the weaker job gains were a function of the run rate, and how much were a weather snapback?
Perhaps the most important metric in the employment report is the growth in average hourly earnings. Economic bulls have been pointing to the recent growth in earnings despite the lower number of hours worked, which was supposedly due to poor weather. Recall that, post the February employment report in With Fed's Inflation Target, Be Very Careful What You Wish For
, I called these robust wage gains into question, citing Minyanville's Michael Sedacca.
An uptick in earnings could indicate the labor market is tightening and provide fuel for an increase in consumption and inflation, which, in theory, would put pressure on the Fed to potentially tighten policy faster than expected.
However there is reason for a less sanguine assessment of the wage story. Minyanville's Michael Sedacca
pinged me with a different interpretation of the jump in wage gains; he posited that the big drop in workweek hours was contributing to inflated growth. Sedacca pointed out that the weekly average hourly earnings were much more benign and in fact were showing a big deceleration in earnings to just 1%.
The March report proved Sedacca's suspicion to be correct. The month-over-month gain in average hourly earnings was 0%, and the year-over-year gain was 2.1%, with average weekly earnings only growing 1.9% year-over-year. These gains in wages are among the weakest growth rates in history. The data was weak and there is no sugarcoating it, though many did just that.
Because upon each release stocks were rallying and bonds were falling, the initial spin from the financial media was that while the reports were weaker than expected, they were still good. It was as if you just had to show up to succeed. Everyone gets a trophy. The economy is average, but it shows up and therefore it must be cheered.
Friday, after the initial gap higher in stock futures, the cash opening quickly faded; broad weakness in high-beta growth sectors led the decline. The markets finished off the lows, but the tech-heavy Nasdaq-100
(INDEXNASDAQ:NDX) declined 2.7% with the small-cap Russell 2000
(INDEXRUSSELL:RUT) down 2.3%, substantially underperforming the large-cap Dow Jones
(INDEXDJX:.DJI), which was only down 0.96%, indicating a clear bias towards cash-flow stability. This is exactly the same price action I cited last week that pointed to a deceleration in growth:
With the S&P 500 Index (INDEXSP:.INX) virtually unchanged for the first Q1 since 2008, bonds will have outperformed stocks... At the same time we have high-beta growth equities that have been leading the market rally beginning to underperform low-beta equities. Consistent with the rotation from high to low beta, you are seeing the smart money -- as measured by the Bloomberg Smart Money Flow Index -- clearly reducing exposure.
No one is predicting a recession or even a deceleration, but the markets are singing a different tune. I often tell my colleagues to watch what they do, not what they say. What they are doing is rotating out of high multiples, high beta, and growth.
Since peaking on March 6, the Nasdaq-100 is down 5.5% and is now negative for the year. On Friday, the index closed below the prior week's low after exceeding the prior week's highs, completing an "outside" week. This is a nasty technical development, and with momentum commanding the stock market rally, it is potentially a catalyst for a momentum shift.
Here's the problem. Because of the nature of the parabolic advance in high-beta stocks, there was very little in price consolidation on the way up. Many technicians will focus on such metrics as trend lines and moving averages, but I find these highly unreliable in the absence of horizontal consolidation. You should rely on levels where buyers absorbed distribution, and by this method of technical analysis you have two main spots in the Nasdaq-100 and Russell 2000 to watch for support.
For the NDX, the first stop is the February low just north of 3400, but below there you have to go down to the area between 2800 and 2600 before you find any significant price consolidation. For the RUT, you have 1100 at the February low and then down to 800 where price consolidated back in 2012. If the February lows are violated, the downside risk rises significantly. For the NDX, the downside risk below 3400 to 2800 is 17%. For the RUT, the downside risk is 27% in the area below 1100 to 800.
In August 2011 the market environment was very different. Market sentiment was focused on a renewed financial crisis sparked by European debt, and the positioning was from risk averse to outright short. Today the situation is just the opposite. Common sentiment says the economy is about to hit escape velocity with wage inflation leading the expansion, and the positioning is long beta and multiples.
The market needs to consolidate these two extremes, and that can happen with price and/or time. If the February lows hold, the consolidation may occur in time as we chop sideways. If they give way, the consolidation could occur in price as we retrace the rally in a deep test of the prior support. If we see a 20%-30% decline in stock prices, next time the weak economy won't be getting that trophy.