The financial markets had a roller coaster ride Friday after the surprisingly lower loss in payrolls reported by the non-farm payrolls report. Equity futures shot up almost 1.5%, well above their 2009 highs, while treasuries were sold hard. After an initial sell-off, possibly related to automatic trading linked to equity futures, the dollar rallied with the Dollar Index Futures (DX) finishing 1.68% higher above the key psychological 80 level.
The rise in dollar was a result of perceived strength of the US economy. However as soon as the dollar started rising, equities started to sell-off. The selling took the ES (S&P Futures) from a high of 957.50 down to a low of 933.25. After some more ups and downs, the equity markets finished almost flat with a slight negative bias. Unlike last week there were no fireworks into the close, with the market staying in a narrow range in the final hour, a rare occurrence. Interest rates moved up across the curve, with the biggest changes in the shorter duration (1 to 2 years) leading to a less steep yield curve from the historic highs reached earlier this week.
Commodities performed reasonably well given the backdrop of the rising dollar today. Traders are now pricing in inflation and economic growth and not just a weak dollar in their analysis. Oil hit the $70 mark in early trading before pulling back to close with a slight loss.
A Closer Look at Economic Data
The surprise drop in the number of jobs lost, had a few dark clouds hovering over it. The hours worked dropped to a level which would have corresponded to another 350K jobs lost. The unemployment rate (U3) rose to a record high of 9.4% as more workers, especially recent graduates from schools and colleges joined the workforce. A measure of true employment which accounts for all under-employed workers, U6, reached a high of 16.4%; this rate was at 9.4%, a year ago.
The retail sales data earlier this week was weak as expected. What also surprised on the negative side was the much sharper than expected drop in Consumer Credit of 15.7B compared to the consensus of -7B.
Corporate Earnings and the Bottoming Economy
There is no doubt that the free-fall in economic activity has been controlled and the economy has likely reached the bottom or close to a bottom. However, what the new normal will be like is not clear.
In spite of hectic activity in the distressed homes market, organic sales of non-distressed properties are very week. The rise in long term interest rates is likely to hinder this market even further. Home prices may not free-fall too much further, but the activity in the non-distressed sector is likely to remain depressed for a significant time to come. Home sales trigger a lot of consumer spending and that component of consumer spending is going to be missing from the economy, apart from depressed construction activity.
Consumer spending will continue to remain constrained due to higher unemployment, lower credit availability and a greater propensity to save. This is likely to limit the upside to the profitability of companies which are dependent on US consumers. Though earnings estimates are likely to go up as analysts' optimism catches up with green-shoots, the ability of companies to continue growing their earnings is going to be limited for quite some time to come.
Lack of Conviction Shows up in a Trigger Happy Market
The price action Friday showed how the equity markets lack conviction. The shock of the headline number of the NFP report sent the futures soaring, only for them to come down to earth as the rest of the report was digested. Such choppy volatile action is an indication of an uncertain market where participants lack conviction.
However, demand for equities will continue to be high purely from technical reasons. There are a lot of fund managers who are underinvested in equities and with the end of the quarter approaching in a few weeks, not many can afford to remain in cash as equity indices continue to outperform cash.
It is very likely that the market may continue to go higher but there risk of a major disappointment will grow as time passes, and the green shoots do not grow into strong trees. Art Cashin, the director of floor operations for UBS and a CNBC commentator said that another 1000 up move in the Dow will send him to the bomb-shelters.
I expect the dollar to strengthen further next week as the anti-dollar trade unwinds. Unless the correlation between the dollar and equity prices reduces, equities are likely to be under pressure. On a technical basis, the SPX price action Friday corresponded to Trader Vic’s 2B Rule, which would also suggest that a pullback is likely. How long the pullback will last before the bulls rush is a different question all together. Treasuries are likely to be under pressure as more supply comes to the market and the perception of an improving economy increases risk appetite.