Jobless Claims and Economic Turning Points

Mon, Jun 12, 2017 - 12:22pm

The strong positive bubble readings in tech identified by the FCO supercomputer resolved last week in a steep correction. Given the price action in various sectors, the consensus among market technicians is that last week's move was a "risk-on rotation" as investors trimmed high-priced FANG and growth stocks to purchase undervalued names in energy, financials, and other areas, which have been underperforming.

Though general valuation levels for the US stock market argue for below-average returns over the next decade, as Ed Easterling recently explained on our program, confidence in the growth outlook will continue to provide support for stock prices until market participants switch from risk-on internal rotations to risk-off external rotations into cash and bonds.

This final turning point will likely take place once earnings growth peaks, coinciding with a protracted economic slowdown in the world's largest economy, which is why we decided to get an update from economic "superforecaster" Jim O'Sullivan at High Frequency Economics on our program last week.

We label O'Sullivan as a superforecaster not to inflate his importance but in honor of his track record and, most importantly, his signal-focused methodology, which appears to closely align with the traits Philip Tetlock identified in his book on how to become a superforecaster.

Here's a clip from our recent interview where Jim comments on the underlying trend for employment in the US:

Jobless Claims Key Going Forward

With last month’s employment report coming in weaker than expected, some are concerned the US economy is at a turning point. O’Sullivan doesn’t see it this way, however.

“(Last month’s) employment report … was largely noise,” he said. “The payroll number came in at a 138,000 rise on the month, which is not a terribly weak number anyway. Over the long haul, it’s actually more than enough to meet labor force growth.”

We need to remember that monthly numbers are volatile and seasonal adjustments present challenges, particularly in May, he stated. Jobless claims remain basically near the lows since 1973. There’s no sign of a turn in those numbers, O’Sullivan stated, which is one important measure he watches for determining a trend change in the overall economy.

Source: Bloomberg

“If you were to ask me to highlight just one indicator, in particular, to judge whether there’s been a major change in the trend, absolutely it’s going to be jobless claims,” he said.

What’s the Fed Going to Do?

We’re likely to see the Fed continue to hike, and eventually begin to normalize its balance sheet. We’ll almost certainly see a quarter-point rate hike in June, with another in September, and subsequent quarter-point hikes each quarter thereafter, O’Sullivan noted.

At the December meeting, he expects that rather than implementing the conventional quarter-point rate hike, the Fed will use that meeting to begin the balance sheet normalization process.

“The goal at this point is obviously not to cause a recession,” he said. “Most recessions in recent decades have been preceded by Fed tightening cycles, although not every Fed tightening cycle has resulted in one.”

He’s not concerned about balance sheet normalization, either, as he expects the Fed to pause rate hikes when it begins reducing its balance sheet in December. The exact amount the Fed’s balance sheet needs to come down isn’t clear, he stated, but he thinks it will be higher than the levels we saw before the crisis.

“In the scheme of things, it’s not going to make or break US markets in any major way,” he said.

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