Mr GJ, Did you write this article? <G>
May 9, 2001
Nine Leading Indicators That Let Markets Ignore
Weak Jobs Story
The markets understand that payrolls lag and is willing to look ahead
Written by Tony Crescenzi , CEO BondTalk.com
When the latest monthly data on the employment situation were released this
past Friday, investors put their blinders on. The equity market rallied and bond
yields rose, despite the gloomy tone of the report.
The behavior of both the bond and stock markets following the release of the
report clearly suggest that investors are inclined to view the employment data as
a lagging indicator. Investors would rather focus on leading indicators instead.
If the markets continue to turn their back on the weak jobs situation, it would not
be the first time. Historically, in fact, the equity market has had a penchant for
ignoring employment data. During the last recession back in 1990-1991, for
example, although the unemployment rate rose sharply, so did the stock
market. The S&P 500, for example, which bottomed in the middle of the
recession in October 1990, gained 45% even as the unemployment rate soared
from 5.9% in October 1990 to 7.8% in June 1992. Similar market behavior
occurred in the previous recession in 1982.
The Writing Was On the Wall
The reason for this seemingly odd behavior relates to the simple fact that
investors recognize that the employment situation lags the rest of the economy
and is a coincident indicator at best. Since forward-looking markets are always
looking ahead, so employment statistics don’t resonate much on Wall
Street—by the time the unemployment rate starts rising, the markets have
already discounted that likelihood.
Who, after all, after seeing last Friday’s weak jobs report, had not heard about
the recent spate of corporate layoffs or the jump in unemployment claims?
Wasn’t the writing on the wall? The answers to both these questions are pretty
simple, of course, so it is easy to understand why the markets basically ignored
the data.
The markets generally see employment as a lagging indicator because it knows
that businesses tend to wait until there are sustained changes in the business
climate before they alter their payrolls. For example, the jobless rate did not
peak until 15 months after the end of the last recession.
Going forward, the market’s ability to overlook lagging but weak employment data
will only stay in play so long as the leading indicators on the economy point
north. Should these leading indicators turn south, it will be a whole new
ballgame. But for now, the markets are latching onto a number of key leading
indicators that suggest an economic rebound is around the corner. Here are a
few of them:
1) Housing activity: In March, total home sales (new and existing homes)
reached a record. The housing sector tends to provide benefits to the
economy for 18 months or more. Moreover, the multiplier effects from
the housing sector are bigger than perhaps any other economic sector.
The strength in housing is therefore an enormous plus for the economic
outlook.
2) Inventories: With inventories having posted their biggest drop in 10 years
last quarter, inventory levels are now at manageable levels. With the
bulk of the economy’s inventory adjustment essentially complete,
increases in production are around the corner.
3) Money supply: Led by the Fed’s sharp interest rate cuts, the money
supply is growing at an extremely rapid rate—even after taking into
account the recent shift from stocks to bonds (this lifts the money
supply, especially the Fed’s M2 and M3 gauges). Even considering the
shifts in capital, strong money supply growth has historically been
bullish for the economy.
4) Increased credit borrowing: The sharp gains in the money supply are
rooted in the expansion of bank credit and increased borrowing. Both
are bullish for the economy as individuals and corporations that borrow
money today will be spending money tomorrow. The proof: corporate
bond issuance is up roughly 40% from year ago levels; commercial and
industrial loans are up at a roughly 7% rate (despite sharply reduced
inventory investment); mortgage refinancing is running six times higher
than in 2000.
5) Yield curve: The yield curve has historically been one of the best leading
indicators on the economy, foretelling events 12 months in advance
compared to the 6 to 9 month lead the stock market provides. With the
yield curve having begun its steepening trend at the end of last summer,
an economic rebound is not likely far away.
6) Cyclical stocks: Cyclical stocks continue to significantly outperform the
broader market and are a sure sign of investor optimism in the economy.
7) Strong dollar: Despite the sharp slowing in the U.S. economy, foreign
investors have stayed invested in the U.S, thereby reducing the cost of
capital for U.S. companies. Foreign investors apparently believe that a
proactive Fed will help to maintain Corporate America’s deep competitive
advantages over the rest of the world. In Europe, for example, by
refusing to lower interest rates, the European Central Bank has missed
an enormous opportunity to help European companies gain ground on
the U.S. The ECB’s outdated focus on inflation will do little to reduce
Europe’s long-term growth gap with the U.S. Investors apparently
recognize this, judging by capital flows and the dollar’s strength.
8) Industrial commodity prices: Following a steady downtrend, industrial
materials prices have begun to tilt upward. The Journal of Commerce
index, for example, has jumped 3.7% since it bottomed at a 22-month
low on April 2nd. Presumably, investors active in the industrial
commodities are anticipating an economic rebound.
9) Tax cuts: There will be $100 billion of tax cuts released into the
economy this calendar year. Money should begin flowing in starting
sometime in July. Since Americans simply do not save, nearly every
extra penny of the tax cuts will likely be spent.
There are many other indicators, but these are some of the strongest indications
we have that tell us the economy is poised to rebound. Combined, these leading
indicators are a compelling reason to put the blinders on and stop looking in the
rearview mirror.
bondtalk.com |
