When Up is Down

This morning brought a slew of market-moving economic numbers. Somehow they all managed to disappoint someone. We saw something similar yesterday when stocks like Zoom (ZM) and Target (TGT) closed sharply lower despite reporting better-than-expected earnings. It can be a very treacherous environment when good numbers are bad and bad numbers are also bad. What is an ordinary investor supposed to do, especially ahead of two days that will be dense with new economic reports?

The short answer – manage your risks carefully. The longer answer requires a closer look at the economic releases and the market’s reaction to each of them.

Image Source: Pixabay

Investors view the ADP Employment Change as an indicator of the more significant government payroll numbers that will be released on Friday, despite a spotty track record in that regard. The report came out at 8:15 (all times Eastern), showing an increase of 117,000 new jobs when 205,000 were expected. A positive revision boosted last month’s number by 21,000, but that was insufficient to offset the current shortfall. That threw cold water on ebullient pre-market futures, causing S&P Mini Futures (ES) to turn negative after rallying over 20 points in the pre-market before the release. But 10-year Treasury Notes, which were already declining, continued to slip. Equity markets viewed the shortfall as a negative, but bond markets failed to view it as a positive. That boded poorly for the subsequent releases.

At 9:45, we got Markit PMI numbers. The Services PMI was 59.8 versus a 58.9 expectation, which would have been unchanged from the prior month. Stocks bounced off their opening lows, but bonds continued to decline. That was to be expected because stock investors normally enjoy positive economic news while bond traders do not. Fifteen minutes later, the ISM Services Index came out at 55.3 versus a 58.7 expectation. This was a nine-month low and not good news for equity investors banking on an economic rebound. At the same time, the less-followed but still important ISM Prices Index leaped to 71.8 versus the prior month’s 64.2. That was the highest level since 2008. Both bond and stock investors fear a return of inflation – the former because it erodes the value of the interest and principal that they expect to receive, and the latter because sufficient inflation would cause the Federal Reserve to adopt a less accommodative stance. (More about the topic here) Neither appreciated that report, and both stock and bond prices sank. 

At least we found something that bond and stock investors can agree on. The problem we have now is that with stock traders keying off rising bond yields (lower bond prices), it creates a very tricky environment for equities. If bad economic news is bad for stocks, that’s one thing. That’s normal. Yet if good economic news is bad for stocks because the news is bad for bonds, that’s the market focusing on a second-order effect rather than a direct effect. That leaves investors with a very narrow path to success. This is not a permanently dire situation, since stock traders tend to change their focus frequently, but it may remain be an untenable situation until or unless that focus shifts.

Perhaps Ray Davies of the Kinks summed it up best, in the classic hit Lola – “It’s a mixed up, muddled up, shook up world”. That sounds like a potentially volatile environment where investors should manage their risks carefully – at least until the situation normalizes.