It the middle of March I postulated that the rally was getting long in the tooth and that investors should buy cheap protection for their portfolios as I thought the first quarter rally would peter out much like previous rallies did in 2011 and 2012. My main concerns were centered around job growth, Europe and consumer spending. It certainly appears that the second quarter is going to have more volatility than investors grew accustomed to in the five months since the post-election pull back given the action of the first three trading days of the new quarter.
We will revisit my core areas of concern later in the article. I want to first discuss some indicators that have gotten more worrisome since my previous article. It is hard to know where to start. Commodities posted a negative first quarter and copper prices continue to fall, not something you would expect if worldwide growth was indeed rebounding. In addition, the last month of the rally was led by defensive sectors like healthcare, consumer staples and utilities. Both technology and the energy sectors underperformed significantly. Again, not something one would expect to see in a sustainable rally. Meanwhile, since the start of the second quarter both the financial sector and the transportation space have broken down. These are not signs of health in the markets.
One of the main factors in today's decline is the ADP jobs reports that showed only 158,000 jobs created in March. This would be the worst monthly performance since October and puts even more focus on the government jobs report on Friday. Anything significantly less than the 203,000 jobs created that we have averaged over the last three months could be taken negatively by the market. I am especially focused on the makeup of the jobs report. The February jobs report showed private sector job growth of 246,000. However, over 350,000 part-time positions were included in the report. This means full time jobs actually dropped by more 100,000 for the month. I believe the primary factor behind this result is the logical consequence of businesses moving to more of a part time work force to avoid the fines/mandates of the Affordable Care Act. Investors should play close attention to this trend to measure the true strength of job growth. Finally, the jobs component of the non-manufacturing ISM report released today showed a decline from 57.2 last month to a print of 53.3.
Europe continues to weaken. The continent is set to report the sixth straight quarter of economic contraction when it reports first quarter GDP figures soon. Unemployment continues to increase with some 19mm out of work across the continent with a record unemployment rate of 12% throughout the Eurozone. Unemployment in Spain and Greece is over 25% and still climbing. The debacle in Cyprus continues to resonate and Slovenia is now rumored to be the next potential country that will need a bailout. The slow drip of negative news in Europe is unlikely to abate any time in the near future and our market is vulnerable to any more surprises.
Finally, I remain concerned about consumer spending. The first quarter of the year did show remarkable strength in this metric. However, yearend bonuses and income tax refunds should be mostly spent by now. High gas prices for this time of the year are still in effect and consumers are becoming more aware of the bite from the expiration of the payroll tax holiday (over $100B annually taken out of the economy). Wage growth remains anemic. The simple fact is that the Fed's actions have done a solid job in lifting asset inflation (stocks and real estate) but the policies have yet to enable significant job or economic growth.
Given this pessimistic outlook, I continue to hold the cheap protection I bought in March. I also hold a significant amount of cash in my portfolio. I believe we will give back half of the first quarter rally over the next two months and look forward to lower entry points to deploy this cash as I don't believe we should have a major correction, but I am looking for a 5% to 7% pullback before we can resume the recent climb. Happy Hunting.