Weighing the Week Ahead: Mounting Worries

Market psychology and sentiment -- already terrible -- got even worse last week.

Those trading on a near-term time frame must always respect the tape.  For traders, the story is a bit confused.  The short term trend is terrible, but the trading range is holding.  For long-term investors it is more a question of fundamentals and data.

As usual in the weekly analysis, I will try to take both perspectives.

Background on "Weighing the Week Ahead"

There are many good services that do a complete list of every event for the upcoming week, so that is not my mission.  Instead, I try to single out what will be most important in the coming week.  If I am correct, my theme for the week is what  we will be watching on TV and reading in the mainstream media.  It is a focus on what I think is important for my trading and client portfolios.

Last Week's Data

The takeaway headline for the week was the employment situation report.  Bespoke Investment Group cites Friday's reaction as the worst market reaction on a payroll employment report day since 1998.  Please check out their report for a full table with a comparison of years. They also helpfully show the likely rebound from these bad days.

The MSM articles all attributed the Friday selling to a weak employment report.  There is more to the story.

The Good

There were some encouraging economic data points.  There was plenty of spin on other data, but I am sticking to the main themes.

• The ISM report came in at 59.7.  This corresponds to a real GDP increase of 6%.  The five-month results indicate real growth of 5.7%  All of the comments quoted in the press release are very bullish about pricing power and future growth.  As I indicated last week, I regard this as an important indicator.
• We held the bottom of the "trading range."  That does not sound like much, but it is important to traders who are looking for a breakout.

Stocks have been shuttling between the recent low near 1040 on the Standard & Poor's 500 and the zone of the April high above 1200. In doing so, the market has skirted the line between typical correction and something more worrisome.

• The jobs report showed an increase in hours worked.  Brian Wesbury at FT Advisors summarizes the significance of this as follows:

Average weekly hours in the private sector increased to 34.2 in May from 34.1 in April. That’s the equivalent of 315,000 jobs. In other words, had employers kept hours per worker unchanged, there was enough labor demand for private payrolls to increase 356,000 in May (the actual gain of 41,000 plus 315,000). That would have blown away the consensus expected gain of 180,000 for the private sector.

Wesbury's point is mentioned by some others as well.  Objective observers should note that the Bearish Blogging Network liked this indicator when it suited, but have recently fallen silent.  It is interesting how that works.

I am also skeptical about this "good news."  I wonder if any of my astute readers can figure out why.  Anyone who has followed my series on employment should be able to connect the dots.  If you can, you will be ahead of all of the analysts.

The Bad

There was plenty of bad news.

• The jobs report missed consensus expectations.  The market correctly dismissed temporary additions of census workers and looked through to the increase in permanent jobs, emphasizing the private sector. By this measure, job growth was very disappointing.
• There was no progress on the oil spill.  Since oil prices have fallen with other commodities (except gold) there has been little attention to the future threats.  James Hamilton highlights some excellent work warning of this risk.  This is a future look, but it is very important.
• Initial jobless claims remain elevated at 453,000.  This was down a bit from the prior week, but nowhere close to the level needed for solid net job growth.
• The ECRI growth index has declined again.  The ECRI has an index of Weekly Leading Indicators.  These share some great attributes:  They have predictive value, are reported promptly, and are not subject to revision (except for the money supply).  From this index, the ECRI comes up with an annualized Growth Index that smooths out monthly variations.  The official ECRI interpretation is that we do not face an imminent recession, but that growth will have a slower pace in mid-year.  The money supply and some (dollar denominated) commodity indicators are all that we really know.  Various pundits are putting their own twist on the ECRI indicators, even to the extent of predicting a recession.  It is amazing that people who do not even know the components of an index think that they can look at a chart and come up with a better interpretation than those doing the analysis.  Go figure.
• The S&P 500 tested and could not break through the 200-day moving average.

The Ugly

The S&P 500 was down 2.2% on the week, an extremely bad result.  It was even worse because Friday's extreme selling wiped out a potential winning week.  The volatility, negative headlines, and emphasis on the chance for a "double dip" recession presents a frightening scenario for the average investor.

The entire dynamic on the employment report was ugly.  Those listening on Wednesday to the President's Pittsburgh speech heard him express optimism about the Friday jobs report.  Many traders formed the opinion from this that we would have a great jobs number.  Some also took inference from similar remarks from VP Biden.  A number of firms increased their expectations, and the market rallied.

Wow!  How silly!  A continuing theme at "A Dash" is that most market observers do not understand government and to not draw the correct inferences.  The "analysis" of these speeches was a typical example.  The idea that the President would "leak" an important report had little basis in fact.  There are explicit public policies about the release of sensitive economic data.  The President's team does not get information on employment until Thursday afternoon.  Even if he managed an inkling from someone, why would he make a speech about it on Wednesday?

Should he have shown more awareness of the likely market perception?  Probably.  But it is about time for us all to understand something.  The financial market react to much to some very visible TV figures who offer their advice on a daily basis.  In fact, this President is not speaking to please Jim Cramer or Rick Santelli or any other pundit.  He is not parsing every speech with a view to the market reaction.  He is speaking to a different audience.

You and I can like this or not, but it is the reality.  I strongly advise people to accept the facts and try to profit.  Be politically agnostic.  It does not matter very much what the loud pundits believe the policies should be.  In this case, it was pretty obvious what was happening and a good trade was available for anyone who was paying attention.  I pointed the way on Wednesday when I specifically recommended shorting the Friday number.  (Interestingly, my webmaster tells me this was one of my least popular articles.)

Our Own Forecast

Our own indicators turned bearish right after our May 9th report and then flipped neutral when volatility increased.  This continues to be our vote in the weekly Ticker Sense Blogger Sentiment Poll.   As you can see from the data, and as I reported last week, the call could easily be a bearish tilt.  It is only the general volatility that suggests a neutral posture.  Here is what we see:

• Only five of our 55 ETF's have a positive rating.  Four of these are inverse ETFs or gold.  This is about as weak as it gets.
• The single ETF in our buy range has a rating of only 8.
• Only one sector is outside of our "penalty box," showing an extremely high level of uncertainty and risk.
• Our Index Package now has a very strong negative rating.

[For more on the penalty box see this article.  For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly email list.  You can also write personally to me with questions or comments, and I'll do my best to answer.]

For short-term accounts we were mostly neutral last week. We did start a small position in one ETF, so we now have a small long lean for trading.

The Week Ahead

The dramatic emphasis on the jobs report as indicating a "double dip" is a wild overstatement.  Here is why.

• The expectations for the report were exaggerated because of the Obama and Biden speeches.  This is classic trader oversimplification.  There are well-documented procedures for releasing data.  Traders lack experience in large organizations.  As a result, they treat everything as if it were a small business with the owner knowing everything and bossing everyone around.  It is absolutely clueless!  I predicted that private jobs would be weak on Wednesday, and explained the speeches on Thursday.  I also suggested that traders should play the market short on Friday morning. 
• The group that I regard as serious researchers on payroll employment growth did not expect dramatic growth.  My own estimates were almost exactly what we saw.  The consumer confidence and jobless claims data are not good enough to support dramatic job gains.  Some of the big sell-side firms goosed their numbers after the speech, but they never reveal their methods.  I ignore them, and so should you.
• The wild critics on the jobs report are reaching to new extremes.  The New York Post articles on faking census jobs represent a new low in reporting on employment data.  The jobs reports are based on a survey -- a point in time -- not on a count of hires for the census or anything else.  Even the most cursory study of methods would reveal this fact.  It is poor journalism.  The BLS did a nice job in responding to this on their webchat, confirming what I had previously explained to an interested questioner on Seeking Alpha.

So what about Europe....and others?

I really liked the take from Colin Barr, one of our featured sources:

The latest round of questions about the euro sent debt-default insurance prices soaring across the Continent. Even in stronger economies such as Germany and France, the price of credit default swaps on sovereign bonds soared 15% or more.

and also....

"Consumers in a number of Eurozone countries are now facing earlier and/or more aggressive fiscal tightening as a consequence of the region's debt crisis," said economist Howard Archer of IHS Global Insight. "Consumers are also concerned that the debt crisis could derail Eurozone recovery."

Investment Implications

The media emphasis on the jobs report was overdone.  Much of Friday's trading was a reaction to the Euro breaking 1.20.  For whatever reason, stocks have traded inversely with dollar strength.  The popular media sources went with the easy story of the jobs report, but the real story was the dollar strength.

I have little interest in economic data for the coming week -- a very unusual posture for me.  The Fed Beige Book should have few surprises, and nothing else hits the highlights.

I expect short-term action to focus on the trading range, the dollar strength, and the media emphasis on "headline risk."  There are plenty of small countries.  Even if they represent little risk to the US, you can count on plenty of attention.  You can count on people finding more cockroaches.

Eventually, there will be a different viewpoint, more familiar to long-term investors, but we might need some fresh news.

This summary from Michael Santoli's weekly column (one of my favorite reads) in Barron's really captures the key elements.

Ed Yardeni of Yardeni Research last week offered this: "There is plenty of good news. It just happens to be old news. We know that earnings are great. We know that the Fed[eral Reserve] will keep the federal-funds rate near zero for an extended period....The problem is that the new good news will take time to unfold, because it must show that lots of potentially bad scenarios aren't occurring as widely feared."