By Joseph Hogue, CFA
Last week presented a big head fake for investors. I was about five seconds away from penning an article assuring readers that it was ok to get back in the market even if they had missed the beginning of the rebound. Unfortunately, Friday’s unemployment number showed that investors may still have an opportunity to find their market bottom.
There were zero net nonfarm payroll gains last month. A country of over 300 million people with gross domestic production of almost $15 trillion failed to create a single job; granted, a bit of an exaggeration, but the number struck me as rather dramatic. A few sectors reported losses including retail trade, manufacturing, construction, information services, and public administration. The Verizon (VZ) strike accounted for 48,000 lost in information services, so the resumption of work at the company will help next month’s release.
Perhaps worse than the headline numbers is the loss in average hourly earnings and average weekly hours. This is the third payroll report that has severely disappointed the market. I remember three months ago when the dismal July report was supposed to be a one time event before the second half rebound. At some point, expectations become so low that even a moderate gain will drive the market higher, but calling that point is for smarter minds than my own. Until the Christmas hiring spree, I would look to protect my portfolio around the release of each month’s report. Watch the S&P500 Volatility (VIX) the week before each release for entry points to hedge your portfolio against another bad employment report.
As bad as the jobs number was, I watched the consumer confidence data come through with particular pain. The reading of 44.5, a dramatic fall from 59.2 in July, was the lowest since April 2009. Particularly depressing was the ‘jobs hard to get’ versus ‘jobs plentiful’ spread which was the widest since November. Only 4.7% of respondents reported jobs as plentiful while 49.1% reported jobs as hard to get making it the highest reading in more than two decades. For investors hoping for a rebound in confidence in next month’s reading, the drop in the jobs report and average hourly earnings will not help to reassure consumers.
One bright spot last week was the release of personal spending which increased .8% in July and continues at about a 2.7% annual pace. Real consumer spending had trouble keeping up with inflation, but the decrease in gas prices in July and August bode well for spending going forward. The only other piece of economic data that didn’t disappoint was the Chicago PMI report. Though the indicator dropped from July’s reading of 58.8, it remained above the all-important measure of 50 as a sign of growth. The decline in the Dallas Fed manufacturing index and the Philly Fed index showed that growth may not be even throughout the country.
The Institute for Supply Management non-manufacturing index will be released on Tuesday. July’s reading was 52.7 but the August number will have to deal with the debt ceiling debate and the S&P downgrade. Investors will certainly have something to cheer if the number can stay above 50. If the number does come in below that associated with growth, it will be another nail in the market’s coffin. I would look to a sub-50 reading and the accompanying selloff as a signal to a possible entry point into the market.
Despite the barrage of negative data, economic activity in the non-manufacturing sector has grown for twenty consecutive months. I would be willing to put some of my cash to work if the ISM number comes in below 50 and initial claims can break the 400k level for consecutive weeks.
Eurozone GDP is also to be released on Tuesday. This was released, partially, a few weeks ago but will now include component data as well. The release itself, consensus view of .2%, will probably not move the market much, but it will certainly bring back fears of Eurozone peripherals. An article last week looked at possible ways to position for a recession in Europe, something PIMCO’s Mohamed El-Erian puts at 50% probability. As bad as the economy is here in the states, I would look for relative strength in U.S. financials and the dollar compared to European assets.
The European Central Bank will hold its policy meeting on Thursday. Though the consensus is for no change in rate, I am going with the opinion of El-Erian and betting on a rate cut. The economic data has been weak and inflation seems to be sufficiently contained to warrant some accommodation. If this happens, look for weakness in the Euro relative to the dollar. The Greek Prime Minister is calling for a decline of 5% in GDP this year and rumors are that the budget talks are breaking down.
A position in the PowerShares DB US Dollar Index Bullish (UUP), which uses futures contracts to replicate the performance of the dollar against a basket of other currencies, including the Euro, could be a way to play relative dollar strength against the euro. Another potential positive for the UUP came in the form of the Japanese election of Prime Minister Noda. PM Noda and his cabinet lineup are very much a team for the status quo, which has not worked for Japan in the last twenty years.
With the continued economic weakness on both sides of the Atlantic, any renewed accommodation from the U.S. Fed would also weaken the dollar so I would hedge the trade with some exposure to gold. Though I would not necessarily pile into the commodity itself, there is potential in a pair trade with a long position in the Market Vectors Gold Miners ETF (GDX), a trade I supported with data in a previous article.
The U.S. trade balance is set to be released on Thursday. As the recovery in Japan relieves the pent-up demand for auto and auto parts, the trade deficit in the United States will most likely widen. The deficit reading last month continued its climb to $53.1 billion. Industrial supplies were the weak spot, though capital goods also contributed to the increase in the deficit. Though the consensus is for a narrower deficit, even a higher deficit may not act much to move the market. I would look to the initial jobless claims and the ECB rate decision to be the deciding factors of market movement as we close up the week.
Initial jobless claims is a weekly favorite given the state of unemployment and the economy. I am not expecting anything dramatic from the week compared to last week's 409k reading. With sentiment throughout the business community and no real catalyst, claims should stay elevated. Look for consecutive readings below 400k as hopeful signs of labor market strength and a good entry point to the market.
Earnings have taken a back seat to economic data in the past few weeks, but a few companies will see releases this week.
FuelCell Energy (FCEL) releases earnings on Tuesday. The developer and producer of fuel cells for the clean-energy industry is set to release after market close with a consensus of a loss of $.09 per share. The company has beaten estimates for four consecutive quarters and losses per share are roughly half of what they were in the prior 12 months. Despite this, the stock has traded flat over the last year and is down over 80% in the last three years. Investors looking for a rebound may have to stick with the stock for a while. For exposure in the alternate energy space, I would look to a more diversified play in one of the exchange traded funds.
Homebuilder Hovnanian (HOV) releases third quarter results after market close on Wednesday with a consensus loss of $.49 per share. As with the rest of the homebuilders, Hovnanian has performed abysmally in the last twelve months with a loss of more than 60% to trade at $1.53 on Friday. Short interest in the company is above 30% so any surprise earnings could force a squeeze and drive prices up considerably. Investors looking for speculative bets might look at an options bull spread in the shares.
Call options expiring on September 17th for the strike prices of $1.00 and $1.5 are trading at midpoints of $.52 and $.15, respectively, for a net payment of thirty-seven cents. As long as the shares do not fall further on earnings, the bet returns 35% before taxes. For longer term players looking for a rebound in the housing market, I would again defer to more diversified ETFs.
Analog and mixed-signal circuit producer National Semiconductor Corporation (NSM) releases first quarter earnings after market close on Thursday. Consensus estimates are for $.26 per share which would be a loss of 28% year over year. The shares surged 72% on April 5th and now trade at over 20 times, well over the industry average of 13.3 times earnings. Standard & Poor’s has a 12-month price target of $25 which is barely above the current price of $24.89 and would continue its relatively flat trading range over the last six months.
Meat processor Smithfield Foods (SFD) reports first quarter earnings before market open on Thursday with consensus estimates of $.67 per share. The stock is up over 25.7% in the past twelve months yet still trades at an attractive 7.1 times earnings. Though first quarter earnings are estimated to increase 45.7% over the same quarter last year, earnings for the next four quarters are seen to be relatively flat. With forecasted earnings over the next four quarters at $2.45 the P/E rises to a still attractive 8.5 times earnings compared to the sector average of 18.1 times. The company recently completed a cost cutting program in which it closed six plants. Key risks include volatility in hog prices and feed commodities.
Additional disclosure: The opinions expressed by the author are his own and do not necessarily reflect those of Efficient Alpha.