Clearly there are imminent events that ought to create volatility in the stock market this month, beginning with the October jobs report on Friday. The current consensus stands at a gain of about 120,000 jobs, with a tick back up in the unemployment rate to 7.9%. While I freely admit the danger of making projections about a report with significant seasonal adjustments and revisions, I nevertheless suspect that based upon recent weekly claims and historical data, it will come in above that number.
The four weeks ending October 6, 2012, showed a 10.9% decrease in weekly claims from the year-earlier period. That was the week apparently missing data from California, but averaging the October 6th week and the October 12th week produces a decrease of about 10%, in line with the previous year. October 2011's initial jobs estimate was +150,000 with an unchanged unemployment rate; the actual increase, with the year-year drop in claims also around 10%, was 895,000 (not adjusted). That makes it reasonable to suppose that this year's number might come in around the same level of 150K. Other services have modeled a gain of 140K-150K using Labor Department (BLS) seasonal adjustment factors.
Against that, Trim Tabs has a prediction of 140,000 jobs. While that may seem to support my thinking, the downside is that the service has been well ahead of BLS figures in recent months. Trim Tabs says that the BLS is behind in real-time data; if they are correct, then September might see an upward revision too. I lean slightly towards the Trim Tabs view for the same reason - weekly claims indicate a somewhat higher number for new jobs. The initial unadjusted estimate for September, based upon the payroll survey (not the household number), was an increase of 604,000 jobs, which would partly explain the recent high sentiment levels in the consumer sector.
Thursday morning brings the delayed Conference Board consumer confidence report and the ADP payrolls report, but in my experience they are not strong indicators of the initial employment release. If you want to argue that it's because the initial number is too much of a guess, you have my sympathies, but the market will still react to it.
One good reason that the stock market may react strongly is that prices are in a somewhat oversold posture, yet trading just above support levels. In a situation like this, a strong positive report will usually generate a good upside move - stocks were oversold. However, they are only modestly oversold, which doesn't protect against a big downside move in the event of a weak (sub-100K) number. Additional selling would kick in if the S&P 500 index trades below the key support levels of 1400-1405.
Those levels are key right now because first, 1405 represents the close before the Day of the Draghi, when ECB president Mario Draghi announced the potential for "unlimited" sovereign bond buying from EU member countries. Any move below that will trigger stop-loss selling. The 1400 level is a psychological barrier as a round number. Below that is the 200-day exponential moving average at about 1375, and many traders would prefer to exit positions on a break of 1400 and re-enter at the first test of the moving average.
Any challenge to the moving average is more likely to come next week, when the next big test for the market comes with the presidential election on Tuesday. The ordinary playbook for a Democrat-to-Republican switch is to buy the election and sell the inauguration, another variant on buying the rumor (of heaven) and selling the news (new presidents do not get magic wands). A notable feature of the current election is the recent appearance of investment pros making a contrarian case for a sell-off in the event of a Romney victory. There are of course many predictions of gain and loss for every outcome, as always, but the widespread assumption of market gains in the event of a Romney victory is a warning sign worth considering: The market tendency is to thwart the maximum number of people.
The Intrade prediction market, which has a good record, still has Obama as a pronounced favorite (however close the margin might be), though the jobs report could alter the betting in either direction. It seems less likely to me that the market would sell off in the event of an Obama win, not because it approves of him more - it surely doesn't - but because Obama is a known quantity. Markets are unhappy with uncertainty and a Democratic sweep - which would rattle the Street - isn't at all likely. Approval of Obama isn't the issue, it's the potential surprise factor that matters. For example, if the jobs report comes in above consensus, I would expect the Intrade odds to move up in favor of the President. However much the Street might prefer Romney, an Obama re-election could not then come as a trading surprise.
There is a good possibility of a trading surprise, and it isn't from either candidate winning on Tuesday. It's from a deadlocked electorate and a repeat of Gore-Bush. That shouldn't come as a shock, as the media has certainly given serious consideration to the possibility of another split decision between the popular vote and the electoral college. In view of the impending fiscal cliff, though, probably the last thing the markets would like is an election in doubt that could freeze any chance of a budget agreement before January.
It's not a clear picture. That may be why the State Street Investor Confidence Index reported a sharp drop to 80.6, down from 87.3. While the decline was led by investors abandoning Europe, there was also a decrease in North America equity positioning to an even lower 79.0 (100 = neutral weight). The fact that institutions feel like it's a good time to sit one out certainly doesn't mean that the markets can't go higher; it could indeed be considered a contrarian buy signal.
Yet given the lack of risk appetite and the calendar - the first half of November is known for featuring sharp declines - the drop in equity allocation does support a case for moving discretionary money to the sidelines, especially if the market provides an exit-rally opportunity from a positive jobs report Friday. I do expect that some sort of extend-and-pretend loan package will be reached for Greece later this month, but that outcome already seems to be widely anticipated.
Earnings season has generally been a disappointment, but an intriguing divergence in views came this week from Dow Chemical (DOW) and MasterCard (MA). Dow CEO Andrew Liveris, whose company announced fresh layoffs and lowered guidance, has been warning that the global situation is worse than people think. MasterCard CEO Ajaypal Banga, on the other hand, was cheerily optimistic about North America on the conference call after the company announced results Wednesday morning.
In a reflection of that divide, new orders went negative in the latest Dallas Fed manufacturing survey released Monday and in the Chicago PMI survey on Wednesday. The latest Chinese PMI readings were about flat: 50.2 or 49.5, depending on which you prefer. It doesn't really matter, as both are close enough to unchanged that no change is probably the right conclusion. Last week's European PMI readings were abysmal.
Manufacturing is slowing around the globe. It's slowing fastest in Europe, probably followed by China, then the U.S. Yes, China seems to have higher GDP (there are increasing rumors that it is at stall speed), but the rate of decline in its growth has easily exceeded the rate of softening in the U.S. David Einhorn has been impressed enough to go short on iron ore.
Consumer spending and employment, by contrast, exemplify the Dow-MasterCard split. They have been doing relatively well of late, certainly compared to manufacturing. Although real disposable personal income fell in September, expenditures held up reasonably well. The downside of that is that employment and consumer confidence are lagging indicators, while manufacturing is a leading indicator.
Last week I wrote that GDP was likely to come in close to the second quarter number, but changed my mind after seeing the durable goods data on Thursday. The big bump, driven heavily by aircraft and defense spending, bailed out the quarter. The reversal in federal spending was the biggest swing factor in the report and without it, GDP would have been close to 1.3% again.
I don't expect a similar repetition in the fourth quarter, nor does it seem plausible that business investment will pick up before the budget is resolved, regardless of next Tuesday's outcome. The 2.0% personal consumption rate seems safe enough, albeit with Sandy-related volatility, but the rest looks likely to be flat.
This isn't a prediction of recession or disaster, but a trend worth watching. If some eventual version of the budget does nip US GDP in the first quarter, as many economists are starting to conclude, it might be the nudge that eases us into a mild recession and the global economy into what is at best a growth recession.
After a long expansion, that shouldn't come as a surprise, nor would it signal the end of all things. But with the market likely to get more anxious as the cliff draws near, it does suggest another reason for stepping back from risk until the market is more deeply oversold, or perhaps Thanksgiving if you want to play the end-of-year trade.
In conclusion, although this is an essay about the market outlook and the economy, I would like to extend my heartfelt sympathies to all in Sandy's wake. All of us know people there.