The stock market is not the economy. I’ve offered this reminder for years, and I’m sure the phrase has been used by others. The stock market is nothing more and nothing less than the collective optimism or pessimism of traders/investors executing at any particular point in time. The market’s performance after last Friday’s horrific jobs report is proof positive of that theory. While stocks did close down on Friday, the decline was mere peanuts given the nature of the jobs report.
Coming into last week traders were dreaming of new highs for the year. The indexes were just a few points shy of those goals at the close Thursday. In fact, a new 2011 high for the NASDAQ would also be an almost eleven-year high for that index. That still leaves it short 2,000 points of the year 2000’s high , but that’s not even in the discussion. When the jobs numbers came out, the markets did drop sharply with the Dow down about 150 points. But by the end of the day the index was down only 63 points. This token decline after the worst economic data we’ve had in a full year, tells us that rampant optimism on Wall Street still rules.
You’ve probably already read quite a bit about the number, but I want to highlight the worst of the worst. The paltry 18k gain would have been even worse had the Bureau of Labor Statistics (BLS) not added almost 150k phantom jobs through the birth/death adjustment of businesses. This is an economic modeling assumption, not based on actual data. There are approximately 14 million workers unemployed, with half of those unemployed for more than twenty-six weeks. There are another 7-8 million workers that simply aren’t counted any longer due to classifications by the BLS. The true Unemployment Rate is 16.2% or possibly even higher. Temporary workers declined for the third straight month. This category typically signals trend changes. If so, the trend is not your friend.
Wages and hours worked fell. Wage growth is now roughly 1% below the inflation rate on a year-over-year basis. The hours worked decline is not a good omen for businesses adding workers. I think you get the drift.—a poor job market accompanied by low wages.
While Wall Street mavens and pundits expressed surprise and disbelief at the number, the fact is that this weak report is in line with what we’ve been seeing in other numbers over the past two months. Almost every indicator, other than one recent manufacturing report, has been signaling slowdown. The day before the Unemployment Report the ADP payroll service predicted jobs would increase by more than 150k. Traders rejoiced at this projection. Yet, at the same time, a highly respected survey of small businesses said that small businesses added fewer jobs in June than in any month in more than a year and businesses were planning for weak hiring the rest of this year. But Wall Street’s traders completely ignored that report. It clashed with the pretty picture they were painting.
The U.S. is supposedly two years into the recovery, but we’re still short 7 million of the jobs lost during the recession. Wages are going nowhere, consumer confidence is shaky at best, and the housing market has at least one more year in purgatory. I don’t believe the economy is ready to fall off a cliff without a shove from Europe or some strange action in Washington. But the very long process of unwinding the credit bubble has years to go and leaves us vulnerable to shocks.
Does this mean that stocks are ready to tumble? Not necessarily. With this much optimism in the market, warranted or not, traders are not going to give up easily. Additionally, there are some developments that might help a bit in the next few months. As mentioned last week, I’m hopeful that commodity prices continue to decline and allow consumers to spend more in discretionary categories. There is also some validity that the Japanese tsunami did more economic damage than thought to the supply line, and a rebound is likely as the supply line is restored. Business inventories are low, and any renewed confidence should cause an increase in production to build inventories. Finally, corporate earnings are still good. Most are good because of cuts to operating costs, but some businesses have found ways to expand business.
The paragraph just above lays out reasons for hope, but the paragraph just above that one lays out how things are. The markets are trading on hope, not reality. Perhaps we should be thankful for blind optimism.
This coming week you’ll hear virtually nothing about the awful jobs report. This is the beginning of earnings season. In case you’re not familiar with the “season,” this is when most companies release quarterly earnings. It’s also one of four times a year when companies, stock analysts, and traders all come together to play a game. The game is that companies and stock analysts tell us that earnings for a company will be X, knowing full well that earnings will be X-plus. Traders know this too, but they pretend shock and delight at the prospects of companies beating expectations. The only real surprise comes in those rare releases that only match or fall short of expectations. It’s a dumb game, and most everyone knows the game is rigged. But everyone seems willing to play along, especially when optimism is so extraordinarily high.
Just remember my basic premise. The stock market is a reflection of collective optimism or pessimism. We’re currently in the stage of optimism to the extreme. The market has been telling us that even through the very modest selloff in May and early June. There is no way to predict when optimism will give way to pessimism. Fortunately, periods of optimism last far longer than pessimism. But I’m throwing up the caution flag. Not the red flag, just the yellow one. The basic drivers of the economy are still broken; at best they are merely functioning with short term patches. Given the overwhelming consciousness of optimism, I worry what things will look like when that morphs into pessimism.
Wall Street loves to claim that the stock market is the Great Anticipator of future events. That’s a lie. If it were true, the Dow would not have been at 14,000 just prior to the credit meltdown. It also wasn’t true at the Dow’s 6,500 just before the recovery began. The stock market isn’t the Great Anticipator. The stock market is the Great Mood Ring.
dwightjohnston.com
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