Upside Surprises
The 271,000 net new jobs was an upside surprise for Wall Street, whose average forecast was in the 180,000 range. In fact, 230,000 was the highest of those in the forecasting cabal. The official BLS data have, of late, been quite volatile, most likely because they use a controversial “concurrent” seasonal adjustment process which appears to actually cause that volatility. The average of the last four months is 196,000 (271,000, 137,000, 153,000, and 223,000). Private sector measures, like that of ADP, the payroll processing company, which has its own job creation series (always published a couple days before the BLS release) show much less volatility than the “official” BLS data. The last four months of ADP data averaged 181,000 (182,000, 190,000, 182,000 and 169,000). The markets may be better served by switching their focus to the ADP data. Doing so may avoid the market whipsaw and resulting volatility caused by the BLS’ built-in seasonal volatility issues. Since the BLS release, the markets have now priced in a December Fed tightening. History shows that there is always a negative market reaction around that first Fed rate hike, one that passes as the markets come to realize the reason for the rate hike is underlying economic strength. Market reaction this past week appears to be in anticipation of the December rate increase.
Finally! Average wages rose
The October employment report brought with it a 0.4 percent rise in average wages, also pushing the October year-over-year number to 2.5 percent from 2.3 percent in September. The “average” wage is probably the most lagging of all possible economic indicators, as it has a “normal” population distribution as its underlying assumption, and the demographics in the U.S. are anything but normally distributed. Private sector indicators, like surveys produced by ADP, show that in Q3, wages rose 3.5 percent, much faster than the “average” rate calculation, and those changing jobs saw a 6.5 percent hourly wage growth. Of interest is the fact that this first sign of a rising average wage rate was accompanied by a fall in the October unemployment rate to 5.0 percent. Then the Congressional Budget Office released its estimate of what economists call NAIRU (“Non-Accelerating Inflation Rate of Unemployment,” the lowest unemployment rate that is consistent with stable prices), and that NAIRU estimate was also 5.0 percent. The implication here is that any further drop in the unemployment rate will be accompanied by higher rates of inflation.
The “wall of worry”
Yet despite a strong U.S. service economy, there is always that “wall of worry” that the stock market must climb. Current worries include:
- China’s slowing growth: There is no doubt that economic growth in the world’s second-largest economy is slowing as they switch from a centrally planned, debt-ridden, infrastructure-driven economy to one propelled by market-driven consumer demand. As I have written for the past six months, China’s slowing industrial economy has, and will continue to have, an impact on the U.S. But that impact will remain small.
- The strengthening dollar: The much-anticipated federal funds rate hike will strengthen the dollar even further and continue to slow the U.S.’ industrial base. In addition, further dollar strength will cause more headaches for U.S. multinational corporations as they “translate” their foreign revenue streams to U.S. dollars (when the dollar strengthens, foreign currencies translate into fewer dollars).
- The impact of higher interest rates: The last market worry is when, and to what extent, higher interest rates will slow down the economy. We haven’t had a rate hike for 9-plus years (June 2006), and, as indicated earlier, the first impulse of the equity markets is to move lower. But that urge nearly always dissipates after a short period of time.
Conclusions
The economy is strong in its service sector (the largest part) and only fair in its industrial base. Employment is strong and the average wage rate, a lagging indicator, has finally begun to increase. The beginning of the Fed’s rate “normalization” process will likely occur in December, and markets appear to be reacting in anticipation.
If history is any guide, however, a bull market in equities has never been ended by the first Fed rate hike. Historically, the S&P 500 doesn’t peak until the federal funds rate rises 350 basis points (3.5 percentage points) on average (median is 220 basis points). There doesn’t appear to be any significant economic slowdown or recession in the forecast horizon, implying no extended bear market in equities.
Robert Barone (Ph.D., Economics, Georgetown University), an adviser representative of Concert Wealth Management, Inc., is a Principal of Universal Value Advisors (UVA), Reno, NV, a business entity. Advisory services are offered through Concert Wealth Management, Inc., a Registered Investment Advisor. Dr. Barone is available to discuss client investment needs. All accounts welcomed. Call him at (775) 284-7778.
Statistics and other information have been compiled from various sources that Universal Value Advisors believes to be accurate and credible but makes no guarantee to their complete accuracy. A more detailed description of Concert Wealth Management, Inc., its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.
