Shove This Jay-Oh-Bee

Equity markets around the globe ripped higher in response to Friday’s US non-farm payroll report. If you watch equity markets to gauge the true state of the global economy, it’s like listening to Gomer Pyle to understand physics. 

If you want to understand physics, listen to Stephen Hawking. If you want to understand the true state of the economy and the current level of stability in financial markets, listen to the smart markets, fixed income and currencies. 

People love the monthly US jobs reports. Rick Santelli yells about how the jobs numbers are never good enough and Steve Liseman gets so lathered up he looks like Pee Wee Herman after an afternoon at the movies. The monthly labor reports are important and sometimes carry a lot of monetary policy significance. The problem comes when investors and pundits over-emphasize one report to the exclusion of all the other relevant information. 

One jobs report in June has absolutely zero impact on whether the Fed will hike rates or not. Investors tend to run from one headline number to the next headline number with the belief that the last economic report was the “most critical of all-time.” It’s easy to fall into the trap of being the cat chasing a laser pointer. It’s really fun if you’re the guy holding the laser pointer, it’s no fun and downright unprofitable to be the cat. 

The non-farm payroll headline number “smashed” expectations. First, expectations are forecasts and forecasts as we know are as accurate as Uncle Benny playing darts after 5 Irish Car bombs. So “smashing” numbers that are always wrong anyway isn’t really an accomplishment. Second, the headline number doesn’t mean squat, the devil really is in the details. 

Where the Devil Lives

First off, April and May’s reports were both revised and it turns out that the US economy actually lost 6K jobs in May rather than gaining job positions. This is the first time the US economy has lost jobs during the month of May, since 2009. 

The headline number also can’t tell you about the quality of jobs being added. We are only adding minimum wage jobs, which is making it difficult for the US to get a decent lift on wage growth. Wage growth is how people buy cars, computers and services that help our economy growth. More jobs are absolutely good. But we need an increase in jobs and an increase in wages before we’ll see a substantial lift in the US economy. 

We also lost construction jobs for the first time since 2010. This is the kind of information that gets overlooked but can sometimes be the canary in the coal mine. I have no idea if it’s a canary or not, but anything labor-related that is occurring for the first time in 6 years, certainly has my attention.

I can hear you now. “Calm down, Landon, it’s all good. Both the Atlanta Fed and the New York Fed’s forecast for Q2 GDP is registering at 2.4% and 2.1% respectively. That’s an acceleration from Q1 growth of 1.1%. The S&P is simply pricing in the fact that US growth is accelerating.” 

If you think Uncle Benny’s dart game is all over the place, you should check out the Fed’s track record for forecasting GDP. I prefer current economic data over forecasts that have no possible chance of being accurate.

Just 24 hours before the NFP report came out, ADP released the private payroll data which showed the weakest annual growth rate in over 3 years. 

We also found out last week that factory orders have declined for the 19th month in a row. This has never happened in 60 years! If you think something that hasn’t happened for 6 years has my attention, something that hasn’t happened 60 years has my full and undivided attention. 

And the latest service sector reports are pointing to a Q2 GDP growth rate of just 1%. 

You don’t need a math tutor to realize that 1.0% is lower than 1.1%. Which means that US growth, which was already as malnourished as a Paris runway model, is getting even weaker. But it's not just economic reports, the markets are telling us the same thing about US growth, only in real-time.

The Bedeviled Markets

On Friday, Gomer Pyle believed that all is fixed with this one labor report. Equity markets all over the globed pushed higher: US 1.5%, Eurozone 3%, Latin America 4% and Emerging Markets were up over 2%. 

The trouble for equity bulls is that Stephen Hawking didn’t agree.

The most sensitive market to the US monthly labor reports is the US Dollar. It never fails, if the payrolls are good then the USD has buyers and if the report sucks, then the USD gets sold. There is no in between. 

On Friday, while Gomer was giddy, the USD attempted to climb above the critical level at $96.50 but couldn’t hold it and managed to gain just 4 basis points on the day. 4 basis points!  This shows you how insignificant this jobs report is in the grand scheme of things. The most sensitive market didn’t give two thoughts about it. Friday might as well have been a holiday from the Greenback’s perspective.

US yields are also very sensitive to the monthly labor reports, because yields go up as growth expectations improve and they decline when the expectations for growth are subdued. The entire yield complex responded to the report, from 2 years out to 30, by declining on the day. 

Huh? If this report was the answer to all of the US growth cares, then why didn’t US yields move significantly higher? This a market that has been trampled this year and is WAY overdue for a bear market bounce. But this “great” jobs report couldn’t even push US yields positive on the day beyond lunch time. Not to mention that both the 10-year and 20-year yields closed the day and the week back below the previous all-time lows set in 2012. 

So if the economic data continues to paint an unfavorable picture and the smart markets are confirming this picture in real-time then how is it that the S&P is within earshot of a brand spanking new all-time high? 

Shazaam! It’s corporate buybacks.

During Q2, the only net buyer of US equities was the US corporations themselves. Hedge funds, retail investors and institutional investors were all net sellers for the second consecutive quarter. Not to mention that sovereign wealth funds have been net sellers for well over a year. 

Sovereign funds from crude countries from Qatar to the United Arab Emeriates and Russia have all been unloading US equities since oil started to fall apart in 2014. In the last 12 months alone, China has dumped 40% of their US equity holdings. Almost half! 

Just a couple of weeks ago, post Brexit, all of the big US banks announced more plans for buybacks. Morgan Stanley, Goldman, Bank of America, JP Morgan, all announced buybacks from $5B to $11B.

Announcements are great, the problem is how much staying power do these guys really have?

Q2 Earnings season begins next week and 90% of the S&P 500 will report between July 22 and August 5. There are two things to keep in mind about earnings season. First off, there are no corporate buybacks during this time period. So the only recent buyer of US equities is going to be sidelined for another month. 

Secondly, corporate earnings have slowed for 4 consecutive quarters and Q2 could be the fifth. It’s not all the energy sector’s fault either. Only half of the S&P sectors are expected to post positive earnings, the other half, including financials are expected to be in all out contraction.

So how much longer can corporations who can’t generate positive earnings keep buying back loads of stock? I guess we’ll find out but I wouldn’t want to bet my 401k on that outcome.

Remember, the event that set the Financial Crisis in motion was the July 2007 Bear Sterns liquidation of 2 funds investing primarily in the subprime sector. The USD peaked a year before and US yields began to decline the month before. The S&P 500 reached a brand new-all time high 3 months after the fact in October 2007. It went on to lose 57% over the following 18 months. Fixed income and currency markets can sense when the storm is coming. Equities tend to stand in the rain and debate whether they should go back inside for an umbrella.