Various indicators I track suggest that we may get a decent pullback in the markets in Q1 2013. While the indicators I look at suggest a correction, they do not shed any light on the catalyst that would precipitate such an event. As I show below, stalling employment growth will most likely be the key.
Two important leading indicators of employment suggest that monthly payroll gains slow to a crawl in Q1 and, if that happens, markets will have reason to worry.
Job Growth Set to Stall Ahead
Currently, there are some positives as the economy recovers from the malaise earlier this summer as leading economic indicators continue to climb along with coincident indicators. For example, the Philadelphia Fed’s State Coincident Indexes for November came out this week which showed 45 of the 50 states showing economic expansions.
Source: Philadelphia Fed
The one-month diffusion index for the Philly Fed State Coincident Index came in at 80%, well above the 0% threshold that often marks recessionary onsets, and shows a robust economic expansion with no immediate danger of slipping into a recession.
While short leading and coincident economic data is still encouraging, various employment leading indicators suggest the U.S. economy may hit a rough patch in Q1 as employment growth looks set to stall. U.S. Job Openings as well as the Conference Board’s Employment Trends Index (shown advanced in the figure below) suggest payroll growth stalls beginning in December through June of next year. The three-month moving average of monthly payroll gains has been 139K as of November, and a decline down to zero growth would certainly raise some eyebrows and elevate market tensions that the fiscal cliff drama is finally taking a toll on the economy.
Market Correction Likely in Q1 2013
It may be a stalled recovery in employment that sets the spark to cause the bulls to run for the hills in early 2013. The tendency for early to late-stage cyclicals relative performance to lead the S&P 500’s performance suggests we rally in early 2013 (possibly due to a partial repeal of the fiscal cliff fiasco) followed by yet another spring correction like we’ve seen now for three years in a row.
Whatever the reason for a market correction beginning in Q1, the above indicators suggest that we continue to repeat the annual volatility we’ve seen for three years running now as the Wash-Rinse-Repeat Cycle continues. Economic data has been surprising to the upside since September but it looks like incoming data, like employment, will begin to disappoint and lead to yet another market correction.