The Dirty Harry Jobs Report

| About: ProShares Inflation (RINF)

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For avid film critics, comparing one big screen hero of the action variety to another is serious arm chair sport. Recent favorites in the critic's corner: James Bond's suave but strong Daniel Craig vs. the no nonsense badass of the Bourne series' Matt Damon. The contrasting characters uncannily align with what was on offer to 1971 moviegoers. Sean Connery was turning James Bond into a legend, ordering his martinis, "Shaken, not stirred," before saving the world in Diamonds are Forever.

And then there was Clint Eastwood as Dirty Harry and the moment that secured his spot in the Badass Hall of Fame. Close your eyes, and recall that scene we've all seen: From his vista at a local San Francisco diner, Inspector "Dirty" Harry Callaghan observes a bank robbery in progress. He proceeds to calmly kill two of the robbers and wound a third, to whom he had this to say:

I know what you're thinking: 'Did he fire six shots or only five?' Well, to tell you the truth, in all this excitement, I've lost track myself. But being this is a .44 Magnum, the most powerful handgun in the world, and would blow your head clean off, you've got to ask yourself one question: 'Do I feel lucky?' Well, do you punk?

Investors no doubt went into Friday morning's August jobs report asking themselves the same question, whether they too felt lucky. It's a good question, all things considered.

The Bank Credit Analyst reckons that valuations on the stock market are near record levels as gauged by the median price-to-earnings ratio. And evidence is mounting that retail investors are flocking into stocks after a prolonged buyers strike. Vanguard, the crowned king of passive investing, raked in a record $25 billion in August alone, taking the total thus far this year to nearly $200 billion. The groundwork is laid to surpass 2015's record $236 billion in inflows.

In the minds of the slaves to momentum, the only thing standing in the way of fresh record highs in the stock market is a measly quarter-of-a-percent rate hike care of the Federal Reserve. And the only thing that assures that rate hike comes to pass is a jobs market that's also gaining momentum.

That message was certainly not in the August data released Friday morning. Forget the abysmal pace of job creation in May - that paltry 24,000 figure was an aberration. By the same token, discount the strength in June and July, where average gains of 273,000 also look deceptively high. Focus instead on the 12-month average of 204,000. That's the best yardstick against which to compare August's 151,000-gain, which fell short of consensus estimates of a 180,000 gain.

As for that wage inflation that will supposedly give the Fed license to hike in September despite other signs of a slowing economy, consider this nugget mined by the Wall Street Journal's Paul Vigna. The category that came in first place, with gains of 34,000 jobs, was 'food service and drinking places.' According to the Bureau of Labor Statistics, this falls under 'leisure and hospitality,' which paid an average of $12.92 an hour in August, making it the single-worst paying sector.

Vigna added this quip; "But hey, the hourly wage was up a hearty 3.8 percent from a year ago." What he did not add, but could have, was thank you legislated minimum wage increases.

So nothing disastrous, and nothing remarkable. The outcome, just what the market most wished for, was simply too wishy-washy to pull the Fed off the sidelines. We now reset the clocks and ask ourselves if we're feeling any luckier about September job growth.

Frustratingly, the data headed into the report provided anything but clarity to those trying to position their portfolios as markets head into their traditionally turbulent season. That's saying something with stocks stuck in a seemingly endless rut.

Like it or not, "mixed" is the best one could say of forward-looking job market indicators.

There was stabilization in both the ADP report and Help Wanted listings. But both have clearly peaked from their highs.

As for the Conference Board, its survey data indicated that jobs were both more plentiful in August, but at the same time, harder to get. Interestingly, the Conference Board only uses "hard to get" in forecasting nonfarm payrolls (NFP). Individuals have a natural tendency to paint a rosier picture when asked about job market conditions, but rarely stretch the truth when prospects darken.

The University of Michigan's final read on August consumer sentiment did little to settle the score on whether households were more sanguine on the future. Though the general outlook for the economy did improve a bit, the overall index missed forecasts, dragged down by young households reporting their budgets were being squeezed by smaller income gains and higher than anticipated expenses.

By far the biggest surprise arrived with the headline miss for the August Institute for Supply Management manufacturing report, which fell far short of estimates. What was underneath the hood, though, was even more telling. Yes, the factory sector is a small part of the economy, but manufacturing's tendency to lead the direction of economic growth stands firm. With that, the employment sub-index within the ISM was 48.3 in August and has been south of 50 for 9 out of the last 11 months; 50, you may recall, is the line in the sand that divides expansion from contraction.

The national weakness echoed some severe strains emanating from the Midwest, where the Chicago Purchasing Managers Index report revealed that backlogs had contracted to 41.7 at the same time the employment component held at 53.7. When forward-looking demand is in a decline of this magnitude, layoffs tend to follow; in other words, that 53.7 is looking mighty vulnerable. The national ISM, it should also be noted, saw backlogs decline by 2.8 points to 45.5, the lowest level in 7 months, which does little to presage strength as we head into the fall.

"Disequilibrium like this does not last," warned AIG's Head of Business Cycle Research, Jonathan Basile. "If the Chicago backlog starts printing consistently below 40, that's a slam dunk recession signal - and we're talking every postwar cycle."

Basile also worries about what the folks who hold the keys to the credit kingdom have been reporting. Though not a commonly considered labor market proxy, it would be best to not dismiss the National Association of Credit Managers Index. In August, it fell to a seven-year low for both manufacturing and services suggesting revenue pressures are building. We won't know for sure until third quarter earnings are released. But you'd best listen to credit managers - they get paid to know whether or not their employers are going to get paid.

As for the winning prize for calling the August miss, that distinction goes to Citigroup's Brent Donnelly, who shared this gem in the wake of the ISM weakness: Since 1997, the ISM headline index has missed estimates by more than two points 25 times, just 25 times in nearly 20 years. Out of those 25 times, NFP has missed its forecast 18 times - a 72 percent track record presaging a follow-on miss on NFPs. That's a pretty compelling history that panned out precisely according to script.

Taking in all of the data, the labor market expansion is exhibiting signs of exhaustion, as in acting very late-stage. A turning point would appear to be upon us. If the August slowdown does presage an inflection point, the Fed's determination to hike rates by year end will be severely tested in the coming months. It's as if the data are taunting the Fed to commit a policy error, which brings to mind an even more famous Dirty Harry line. Of course you know what's coming: "Go ahead, make my day."