Markets Playing Whack-A-Mole

Seasonally the weakest part of the year, especially during mid-term elections, put on show after a weak start on more “better than expected” news, especially from the much analyzed employment report. Adjusting for the reduction in census workers, the economy showed modest job growth – more than expected – giving investors reasons to cheer and economy that may be coming out of its summer torpor. Looking a bit deeper into the various reports last week some inconsistency in the reports. For example, in the supply management reports, employment was showed as declining in the service sector (60% of the economy), while rising modestly in manufacturing. Job gains in the service sector continued to be from the government, not necessarily helpful for a sustained recovery. The unemployment rose as more workers were spurred to look for a non-existent job, yet the financial markets were excited about the still below ~150k in new jobs to keep the unemployment rate unchanged. Even accounting for the census workers, the job growth this year has been just above 90k/mo, still more than 50% below necessary job growth. Not a pretty picture.

By the end of the week, the markets had increased by over 5% in just four trading days, although on diminished volume (again). However, by Friday the market internals: net advancing volume and number of stocks gaining were the strongest since the March ’09 bottom. Unlike 18 months ago, volume is contracting instead of expanding and rallies have been short-circuited by selling as the markets approach recent highs (around 1150 on SP500). The summer peaks (hit twice) of 1125 are more the more immediate target, that if cleared then the next two likely targets would be 1150 and 1200. The good news is investors are actually getting more bearish as the markets rise, as Investor’s Intelligence bullish percentage is at its lowest level since (drum roll) March ’09. It is too early to put all the eggs in the rally basket, however the nearly year trading range could be the rest the market needed from the March ’09 bottom and is ready to begin the second leg higher. 

Bonds have been bouncing violently over the past two weeks, from 2.7 to 2.5% on the 10-year bond as bond investors seem to be getting increasingly nervous about still lower rates ahead. Combined with the strong equity markets: bonds were sold and stocks were bought last week, plain and simple. What is interesting is the bond model remains in positive territory, indicating lower yields ahead. There are a couple of trigger points that would turn the model negative after a 25-week run of positive readings. The 30-year bond’s yield would have to rise roughly 6 basis points, a 5% decline in utility stocks and a roughly 3% correction in corporate bond prices. While those may not occur next week, a persistently higher equity market could force investors to rethink their “comfortable” bond holdings and force the above to occur.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.