This week is set to begin earnings season for the third quarter of this year. It should be kicked off with earnings reports from large money center banks. If one were to look at the markets from a week ago, things were starting to look up again after a difficult end of August through the month of September. It was up a week ago Friday when a major pharma announced a possible pill that was to act a bit like Theraflu, but it was said to decrease hospital visits for COVID patients by somewhere in the area of 50%. On Monday of last week Mr. Market tried to take it all back but couldn't put in a worse number and the rest of the week showed some level of stability. Is it waiting for a great earnings report? Was it hoping for a great employment number last Friday? Or is it something that the media and the prognosticators haven't quite been able to put their finger on yet?
Before I go into the labor number from last Friday, I thought I would pose a little bit different idea of what could be going on this week. To begin with, it is the third Friday of the month this week and that means stock options expiration. This could be part of the reason for hesitancy this week, but I think it could be something that I haven't seen anyone talk about. This Friday, the 15th of October, is the final day for the extension of filing taxes for 2020. Although 2020 was clearly a strange year for anyone on the planet, for the stock market it was actually quite good. I have been talking to many CPA's and it seems that every one of them is getting hammered by last-minute filers. Could it be that they are all forced to sell to write big checks? Could it be that they are very concerned about the ultimate outcome of the increase in tax rates, both for individuals and corporations that are being bantered about by the current administration? Just a thought really, but when a stressful situation in the markets is coupled with a catalyst type of date, stranger things have happened!
But enough of that. Let me go into the employment number for last week. The reason why this is important is of course what it implies for the economy going forward, but also it is super important to understand the relationship between interest rates, currencies, economic expectations, and the markets. I know, I'm a little strange because I get into this stuff, but I do feel it is important in understanding what could be happening in the markets:
- The Number: Although the September non-farm payroll report showed a very disappointing soft gain of just 194,000 when the expectation was for 540,000 and there were whisper numbers as high as 780,000 (source: Bloomberg), we saw several silver linings in the jobs report. First, August was revised upward to 366,000 from the previously reported 235,000. Second, private-sector jobs were strong, and the public sector got weaker — namely concentrated in schools. Third, wages continued to rise, suggesting a tighter labor market than the official figures detailed. Wages were up 4.6% from a year ago.
- Interest Rates: This I found interesting and most telling. If the number was really bad, then it would be naturally assumed that the economy was decreasing its strength of growth and that quite possibly the economy was flatlining its growth even though we are just coming out of the recession. But no! Interest rates actually went up. Could it be that maybe, just maybe, the number didn't really reflect all that was going on under the hood, and interest rates are telling the truth?
- Unemployment and hiring: The really interesting number that I noticed was the unemployment number, which was reported at the same time as wages. The unemployment rate actually dropped from 5.2% to 4.8%. And wage rates were up 4.6% year over year. Could this mean that they are actually in a tight labor market and therefore there just weren't that many new jobs to be had in certain sectors of the economy? Could it be that this lock-up in supply chains that I discussed last week is hindering the rate of hiring due to a lack of sales due to a lack of salable inventory? So, I started looking at employment companies and I noticed that one of the staffing companies that focuses on higher educated and more technical labor actually broke to a new 52-week high Friday, October 8th!
- Oil Prices: West Texas Crude broke above $77 a barrel and on its way to $80 has broken above prices all the way back to 2014. Maybe it's a lack of production given our focus on environmental hazards and non-friendly drilling, or maybe it is consumption increases, but whatever the case, the price is what it is. At the same time, the agricultural commodity index broke above levels not seen since 2011. All of these spell the hated word: inflation. Back in 1974, the US suffered an 'energy crisis' as the soon-to-be OPEC nations embargoed oil shipments to the US. Cars were downsized, the speed limit was dropped to 55mph, and a number of different solutions to the situation emerged: gas lines, solar power, algae power, wind power — 50 years later we are dealing with oil-related issues once again.
Whatever the case may be, we have tighter labor markets, increased oil prices — which is an implied tax on the consumer due to higher cost of gasoline vs. more money to spend on goods and services, and wage rates going up. All point to the economy on the mend. When coupled with fewer infections being reported and death rates declining, we could be getting ready to come out of the backside of the pandemic. Only time will tell. The past two weeks have been the year 2021 sort of compressed in a nutshell. For the last few weeks, I have been addressing the small-cap index (Russell 2000) as it has most clearly shown that it has been locked into a very tight tug-o-war for the last 8 months. The large-cap S&P 500 has come back and tested its breakout points from months ago. All in all, we are still in an advancing market. Maybe not at the level of ascent experienced last year, but a breather was due. Large technology companies have actually come down to what appears to be quite attractive levels:
What I found particularly interesting was the quote from Jeff Saut of Saut Strategy on Monday morning. Jeff said, "Last Friday was session 2 in the current 'selling stampede.' Recall that such stampedes, both on the upside and downside, tend to last 17 to 25 sessions. I have seen some go longer than that, but it is rare. It just seems to the rhythm of the thing in that it takes that long to get everyone bullish enough to throw in the towel and buy, or in the current case, bearish enough to sell just in time to make a bottom."
Bloomberg actually reported the cheapness of the tech sector relative to the S&P 500. The NYSE FANG+ group is trading at a spread relative to the S&P 500 that is the lowest since December 2018. This seems to align with data from J P Morgan Positioning Intelligence which shows that Mega Cap tech net exposure has fallen back to the lowest levels since the start of 2018, while software has seen net selling since July. This can be seen below in the Smart Money vs. Dumb Money Index!
This brings me to one of my favorite things to see. That is the headlines. I mean I find it incredibly interesting that after the market has been in a selling stampede for 5 weeks, all of the sudden the press is going to tell us how bad it is. So here were a few of my favorites:
- "As the Labor Shortage Persists, Fed Runs Risk Of Runaway Inflation" - Barron's, October 11th. States that September's employment report is an inflation signal more than it is a labor market signal.
- "How Bad Are Things in China? Goldman Sachs just Slashed Its Growth Forecast to Zero" - Dow Jones Institutional News Feed, September 28th. Due to Evergrande and another real estate company's crack afterward, Goldman has become the latest bank to cut China's growth forecasts. They also mention energy prices as being a culprit for zero growth for the third quarter.
- "Big Box Retailers Chartering Their Own Ships" - Bloomberg, October 11th. The shipping disruption continues with big box retailers chartering ships to help alleviate possible supply shocks and the lack of goods to sell for the holiday season.
- "Bottlenecks Threaten Economy" - Wall Street Journal, October 9th. Pictures of massive stacks of containers waiting to be unloaded. This even as the director of the Port of Los Angeles considers 24-hour per day offloading.
- "Economic and Earnings Concerns Begin to Weigh on Stocks" - New York Times, October 8th. "After having few cares about the markets all year, investors are getting nervous as the Fed Signals that tougher policies are on the way." Could this be a random year without a year-end rally? Only time will tell.
In the end, it appears that these points have already roiled the markets, and the markets tend to be a discounting mechanism, not a mechanism that reacts to issues as they are presented. Could these items already be priced in? Some could be, but we still don't really know what is going to happen with the debt ceiling, rising tax rates, and the ultimate top in the price of oil. So, again, usually by the time these topics are trending on Twitter and making the front page of Yahoo! Finance, the moves are mostly done, which is one reason the news always seems to be the most negative at bottoms and the positive at tops. While my approach isn't perfect, it assumes that the market knows more than we do and if anything is going to be major enough to take stocks down significantly, it's going to show up in the price charts and indicators I follow. And no, I don't consider the current 5-8% decline in the indexes as significant, even it feels that way after several months of truly frustrating action in prices. What we have seen over the last few weeks remains well within the realm of 'normal' digestions, yet at the low last Monday, things were stretched to a point that is normally seen at near-term extremes. I can't say that the tough times are over, but I can say that the earnings reports and forecasts we are about to see could give us an indication of what we could expect. And I will finish with the seasonality chart. Here you can see what typically occurs at this point in the year.