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Net-Farm Payrolls May Suffer Next Week

|Includes: iShares Core S&P 500 ETF (IVV), IWM, QQQ, SPY, VO, VTV

Summary

The Philadelphia Fed State Coincidences Index may be indicating extreme economic weakness ahead.

The Chicago Fed CFNAI-MA3 may also be indicating weakness ahead.

Non-farm payrolls tend to follow weakness in the State Coincidences and CFNAI-MA3 indices.

The market is up. The bulls are buying. However, what risks are they ignoring? Today, we will discuss 3 of these in detail. The risks stated below will show that selling is likely more prudent right now than buying. Consequently, if readers agree with the arguments, they should exit their positions and expect further stock market weakness.

The Philadelphia Fed State Coincidences Index

The State Coincidences Index has been trending down for some time. This index measures economic activity in every U.S. state and then combines the measures into a single number. This provides an excellent perspective on the state of the U.S. economy and tends to predict growth.

The DI3 is the 3 month diffusion index. Whereas, the DI1 is the 1 month reading. A DI3 below 65 is typically followed by a severe pullback in growth, if history is any guide.

According to the historical data, the DI3 hit 64 in July, 2007. It remained under 65 until March, 2010, when it hit 66. This indicator recognized economic weakness in mid-2007 and gave a good warning pointing to the Great Recession. The last time we visited 65 was in November, 2010.

 

DI1

DI3

Jan-16

74

76

Feb-16

68

76

Mar-16

70

78

Apr-16

62

72

May-16

60

70

Notice above how the DI1 readings in April and May are under 65. If the next reading is thereabouts, we should have a DI3 that is indicating significant weakness. Generally, it is best to sell upon predicting weakness.

The Chicago Fed CFNAI

The CFNAI is a weighted average of 85 national economic indicators in the U.S. and is published by the Chicago Fed. Particularly useful is the CFNAI-MA3, which is an average of the last 3 CFNAI figures. According to the Chicago Fed, an MA3 below -0.7 is considered recessionary. You can read about their analysis here.

The CFNAI-MA3 has been trending down for some time. This lines up with the State Coincidences index, despite different data being used to evaluate the status of our economy. Notice in the graphic below we have had a CFNAI of -0.51 for May. The next number will be crucial. If it continues to hover around this level or degrade, we will likely hit the dreaded -0.7 reading.

CFNAI-MA3 is trending down.

Non-Farm Payroll Employment Number

Non-farm payrolls will be reported next week. A subpar number is not being accounted for in the markets right now. Considering this, such a print will likely cause a sell-off in the markets.

As everyone knows, we had a 38K employee print last month and a revision down to 123K for the month prior. The next number will be crucially important, of course. If you examine the CFNAI-MA3 and State Coincidences numbers posted above, you will see that, together, the declines predicted the drop in non-farm payrolls.

The CFNAI-MA3 and the State Coincidences index have continued to degrade. Therefore, I anticipate the next non-farm payroll number will not be rosy. The 6/27 Markit Flash U.S. Service PMI report claims that job creation has expanded at the slowest pace in a year-and-a-half. This may be predicting a subpar non-farm payrolls number as well.

Conclusion

These 3 risks are significant, and they stack up. Furthermore, they are being ignored by the markets, as buying pressure lifts stocks today. Consequently, it would be wise to anticipate a sell-off when the next non-farm payrolls number is printed. I recommend the general market beware ignoring this important information. Because of the details above and many other risks not stated here, I have been building a position in puts since 5/10.

This article is relevant to the S&P 500 (NYSEARCA:SPY), Russell 2000 (NYSEARCA:IWM), and any other index-like product (NASDAQ:QQQ), (NYSEARCA:IVV), (NYSEARCA:VO), (NYSEARCA:VTV), etc.

Disclosure: I am/we are long PUTS ON THE RUSSELL 2000 AND DISH.