My recently proposed divergence theme is playing out so far, with short-term factors continuing to suggest more gains in the next couple of weeks, and longer-term factors still flashing caution lights about trouble down the road.
I can't tell you exactly what to make of the ADP June payroll report, and by the time many of you read this, the Labor Department (BLS) report will already be out. The two things that stand out are first, the headline number of 188,000, obviously, which if not quite robust was ahead of expectations and represented a decent increase over the month before. The other interesting aspect was that May was not revised upwards, but remained essentially flat at 134K after the original estimate of 135K.
Perhaps Labor's current methodology is yielding higher numbers based on the benchmark revisions to 2012, which were fairly substantial to the upside. The latest numbers have been more closely tracking last year's revised pattern, and it may be that ADP is refitting to be closer to the BLS report, as they periodically do. The ISM manufacturing report reported a below-50 employment reading that was due chiefly to respondents moving into the "same" number of employees category from "higher." This was fairly consistent with the ADP estimate of a tiny gain of 1,000 employees in manufacturing. The ADP gains were centered in services, essentially, with construction providing the production lift.
If you're wondering what it all means, I would suggest "wait for the July report." July will try to account for the layoffs that typically occur in the first half of the month as payrolls are trimmed post quarter-end. The substantial gain of 21,000 jobs in ADP construction was in keeping with the warmer weather, and July data should give a better picture of how strong the sector really is. Much of the rest of the gain in the ADP report suggests the leisure and hospitality sector again, and I would not be surprised to see it strongly represented again in the BLS report. Too bad the gains are likely to be mostly low-paying summer jobs.
Looking ahead, the main obsession for the market - until earnings season can provide a minor distraction - will remain central bank policy. Because the European economy is so deeply in the toilet, with many Portuguese openly talking of leaving the eurozone and Greece on the hot seat again, European Central Bank (ECB) President Mario Draghi went back to talking up easier monetary accommodation at the bank's latest press conference. As usual, Draghi doesn't have to do anything but flirt with the markets to send equity and bond prices soaring, without actually spending any money. That ought to make Federal Reserve chairman Ben Bernanke jealous, who has been spending about $1 trillion a year to get the same market effect.
One wonders. It's easy to conclude that yield-starved managers are happy to take what they can get in the eurozone's periphery bond market, where one can find ten-year sovereign bonds around five percent and up, with apparent ECB backing. The key word is of course "apparent," for despite the near-religious homage given the ECB's Outright Monetary Transaction (OMT) policy by major investment banks who cannot bear to contemplate a world not underwritten by central bank policy, it isn't at all certain that the OMT would work as advertised.
It's no tool to be used at the ECB's discretion, but in typical European fashion a potential outcome that might come after lots of negotiation - and so far as Germany is concerned, at least a kilogram of flesh. That last possibility is one that could end up seriously delaying and damaging the desired outcome, if not wrecking it altogether. It's curious that no one seems to want to test it - perhaps fearing a victory that would not be worth winning.
The path of divergence should continue through the first half of this month. The modest ISM survey results can be quickly forgotten if the jobs report can deliver on Friday. Other signs of the economic slowdown continue to deepen, but they simply don't matter as much to algo traders.
I wrote earlier in the year about the fact that the growth in goods imports turning negative has always heralded a recession in the past. It would appear that despite the uptick in May imports, we are headed for a second consecutive quarter of negative year-on-year comparisons. Some of that can be attributed to lower petroleum imports, but the numbers are still weak without petroleum. Many of my other key economic indicators are telling the same story of drifting towards contraction, or a zone dangerously susceptible to one. We aren't quite into the woods yet, but the constant talk of a second-half pickup followed by accelerating growth next year is sounding a lot like the same chimera that's been promised the last few years.
The way the picture is developing - excluding any more excitement out of the Middle East - the pattern taking shape is that the current rebound continues into earnings season and through the next-to-last week of July. Then we could run into headwinds. If earnings are as feeble as they promise to be and second quarter GDP is below 2% again - another odds-on favorite - then the traditional weakness that usually begins around the last week of July and lasts into mid-August would appear to be the most favored prospect. If the temperatures and/or tempers in Europe start to run hot in addition, that could add further downward pressure (and of course, there's always the Middle East).
Yet such outcomes could also lead the Fed to reverse course in September and shelve any plans for curtailing quantitative easing, leading to yet another blind-faith equity rally, one that might conceivably take us to new highs in October (unless the August dip had become too ugly). There's a lot of road to travel ahead, but it would not surprise this observer if this copycat year tries to keep to its familiar path. The algos would certainly appreciate it.