Friday’s employment report confirmed the extent of the economic recovery from the Great Recession of 2008-2009.
We’ve already seen the two main driving forces of the economy, autos and housing, leading the way. U.S. auto sales bottomed in 2009 with only 10.4 million units sold, and have seen impressive growth since to the current annualized pace of 15 million units, almost back to pre-recession levels. Home sales and prices bottomed last year and have been recovering at a surprising pace since.
As I’ve argued for several years with those complaining about the jobs picture, employment is a lagging indicator, and would not pick up until those two main driving forces of the economy were recovering in a meaningful way. And now we can see from the jobs reports of recent months that the recovery is finally impacting jobs.
Friday’s report that 236,000 new jobs were created in February was well ahead of the consensus forecast for 160,000 new jobs. And the unemployment rate fell from 7.9% to 7.7%. Even more important, those new jobs were largely the result of growth in the private sector, in construction, manufacturing, retail, and healthcare, gains that were substantial enough to offset the continuing cut-backs in government payrolls.
But investors should not get carried away with the thought that the report indicates the economy and stock market now have clear sailing ahead.
Here’s what investors need to realize.
Historically the stock market tends to act three to six months ahead of the economy in both directions. That pattern has not gone away. The 2007-2009 bear market bottomed in March, 2009 when the current bull market began. The 2008-2009 recession ended three months later in June, 2009.
The stock market has been factoring in the economic recovery since, and has already recovered to its pre-crisis levels, the Dow and S&P 500 now back to their peaks of 2007.
Meanwhile, the economy is merely catching up to what the stock market has been predicting for it.
But as the economy catches up to the market’s expectation, the market will continue to focus on what lies ahead, and at this point it may not be a continuation of what it has anticipated for the last four years.
Through those years the economy has been fueled by extreme easy money policies, record low interest rates, and massive government fiscal and monetary stimulus.
The government already began reversing the fiscal stimulus last year with cutbacks in federal payrolls, and is significantly stepping up that reversal this year, with the 2% payroll tax increase in January, and now the upcoming automatic ‘sequester’ cuts in government spending, or some negotiated form of the automatic cuts.
Meanwhile, the Federal Reserve has promised to keep its easy money policies and QE programs, including record low interest rates, going well into 2014 – unless the economy improves faster than expected or inflation heats up.
And already we’re hearing hints that the Fed may also begin to remove the QE punchbowl sooner than currently expected.
The president of the Richmond Federal Reserve Bank said on Tuesday that the Fed’s exit strategy is a major concern and “I just fear that small mistakes could get translated into large consequences.” And the president of the Philadelphia Federal Reserve Bank said Wednesday, even before Friday’s impressive employment report, that the Fed should begin scaling back its QE program now.
Markets don’t wait for governments to act, especially on interest rate changes. Already we’ve seen interest rates, mortgage rates, and yields on bonds beginning to rise. In fact bond yields have risen enough that 20-year bonds have seen their value drop 12% since last August, in a fairly serious correction. (Bond prices move opposite to their yields).
It’s not just bonds but also the stock market that loves low or declining interest rates but hates rising rates. So if, as bonds apparently already are, the stock market begins to anticipate higher interest rates, that could be yet another potential catalyst for my expectation that the market will run into trouble again this summer.
Yes, in addition to correctly anticipating the long-term economic recovery, the stock market has also done a good job of anticipating the short-term setbacks within the recovery by rolling over into corrections just before the economy stumbled in each of the last three summers.
So rejoice in the improving employment situation, but don’t fall for the thought that it means clear sailing now for the stock market. It may soon mean just the opposite if it encourages Congress to be more aggressive in cutting government spending, the Fed to begin reversing its easy money policies, or a more pronounced rise in interest rates.
I and my subscribers remain on a buy signal for the market from last fall, but if anything the strong employment report enhances my expectation that the stock market will again run into problems as April and May approach and the market’s ‘favorable season’ ends, by encouraging an earlier removal of the easy money policies that have driven the recovery.
