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Stephen Percoco, CFA
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Steve Percoco founded Lark Research as an independent provider of investment research in 1991. He has been the publisher of the Income Builder newsletter since 2001. He is a generalist, but focuses on several key sectors, including housing (and the homebuilders), real estate, utilities... More
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Risk and Reward
  • Parsing The Jobs Report And Friday's Bounce: What, If Anything, Is Mr. Market Trying To Tell Us? 0 comments
    Dec 10, 2013 11:32 AM | about stocks: SPY

    On Friday, the Bureau of Labor Statistics reported that nonfarm payroll employment increased by 203,000 positions, while the unemployment rate dropped from 7.3% to 7.0%. Both of these statistics were better than expected. The establishment payroll gain was slightly above the high end of the range of economists' estimates. The decline in the jobless rate was more of a surprise, driven by the return of furloughed Federal workers and temporary hiring for the holiday season, but also due to broad-based gains.

    The stock market cheered the news. The major averages posted gains of 1.1%-1.2%. Bond prices were little changed. The yield on the 3-year Treasury note rose 3 basis points to 0.64%, but the 10-year yield was flat at 2.88% and the 30-year yield fell 2 basis points to 3.90%.

    The strong gains in stocks was a surprise and left many market watchers (including this one) scratching their heads. The stronger economic data highlighted in Friday's job report and a big upward revision in third quarter GDP growth clearly set the stage for an earlier start to the tapering of Federal Reserve's quantitative easing program than most economists had been expecting.

    Some strategists now assess the chance of a December start at 50-50. Given the belief, as articulated in the last FOMC statement, that the economy was performing quite well, especially considering the drag caused by the sequester, the latest data points should help to convince the Committee that the economic rebound is sustainable. This should clear the way for a start to the taper. On the other hand, it is still possible that the FOMC could continue to exercise extreme caution and await more proof of the economy's strength before letting the taper begin.

    The conventional view had been that the start of the taper means higher interest rates. The business media has conditioned us to believe that more Fed QE is good for stock prices and less is not. Some analysts (including this one) have tried to make the case that higher interest rates on the heels of Fed tapering are not necessarily bad for stocks. Yet, it does seem that every hint of an early start to the taper has coincided with a sell-off in stocks, while every indication of a delay has sparked a rally. On Friday, however, good economic news was, uncharacteristically, good news for stocks. So what gives?

    If, in fact, investors have been operating under the belief that QE is good for stocks, then expectations of a start to the taper should usher in a period of turbulence. The market should face downside pressure until it becomes evident that the economy can still perform well, even with rising interest rates. This would cause a reversal in sentiment - a change from "more QE is good for stocks" to "less QE is good because the economy is beginning to stand on its own." After the shift, investor optimism could (and should) rise steadily along with expectations of the sustainability economic recovery. The market would suffer a correction and then the rally would resume. If this is the most plausible scenario, then Friday's rally was a fluke.

    Yet, Mr. Market often behaves in unpredictable ways. Sometimes, his behavior seems irrational. Other times, what seems like irrational behavior is later seen as prescient. Like God, Mr. Market often works in ways that are not fathomable to common folk, like you and me.

    Nevertheless, I am not buying Friday's rally. I don't think that market sentiment can change on a dime. It cannot (or should not) be that easy. I still expect a correction in the near future. I am therefore waiting to put the bulk of my cash back to work, knowing full well that Mr. Market might leave me behind. So be it.

    Stocks: SPY
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