Economic Data Derails The Breakout

On Thursday, the market briefly peaked above 2100 giving the “bulls” a glimpse at all time highs. As I penned on Friday:

“The good news is that this sideways pattern of market action over the last year will come to an end and likely very soon.

The only question investors have to get right is whether that resolution will be a continuation of the bull market that began in 2009 OR will it be the beginning of a more protracted bear market decline.

“Step right up and place your bets.”

I have updated the analysis from last week which shows that while the market did bounce during the holiday-shortened trading week, it did so on very light volume. However, the more encouraging news is that on Thursday the market DID break above the downtrend that began last May.

However, since this is weekly analysis, that breakout MUST HOLD through the end of trading today (Friday).  A failure to do so would negate the breakout and keep the markets confined in the current downward trending pattern.” 

SP500-MarketUpdate-060315-3

Here is the interesting part.

While the short-term market dynamics are improving, it has been  primarily based on “hopes” the Fed will NOT raise rates in July.

With the Labor Department’s job report on Friday showing that non-farm payrolls grew by just 38,000 in May, much less than expected, this should not have been a real surprise. Nor should the backward revision to March’s data from 160,000 to 123,000.

The weakness in hiring trends has been clearly evident in the Federal Reserve’s own Labor Market Conditions Index, which is supposed to be driving their policy decisions, over the last several months. 

LMCI-060316

This decline in employment, combined with “global uncertainty” due to the potential exit from the Eurozone by Britain (Brexit), is being viewed as plenty of reason for the Federal Reserve to keep rate hikes on hold in July. 

One additional point on the employment report. Despite all of the talk about a “tight labor market,” such is hardly the case given such a small percentage of the working age population actually working.

Full-Time-Employment-JobClaims-060316

It is only “tight” because so many are no longer counted. When you have 1-in-5 families that have ZERO employed, that is hardly the case of a tight labor market.

Furthermore, the deviation in employment for long-term trends also clearly indicate the demographic and structural shift in employment. The deviation from the trend is clear evidence of that shift which will continue to weigh on the long-term economic dynamics in the future.

Employment-Situation-060316

Of course, it is NOT just the employment data keeping the Fed on hold.

As I addressed earlier this year, the “seasonal adjustment anomaly” due to the exceptionally warm winter was due to be reversed. As I stated:

First, the manufacturing reports are ‘seasonally adjusted.’ These seasonal adjustments are designed to smooth the data over time to account for DECLINES in manufacturing activity during seasonally cold times of they year when inclement weather normally shutters in manufacturing activity.

However, given that the economy just experienced one of the most unseasonably WARM winters in 122 years, activity ran ahead of normal seasonal tendencies. When combined with the normal seasonal adjustments manufacturing data saw extremely sharp, and abnormal increases.

This is clearly seen in the chart below (updated) which is a composite economic output indicator which is comprised of the Fed Regional Manufacturing Surveys, Chicago Fed National Activity Index, Chicago PMI, ISM surveys, NFIB Survey and the Leading Economic Indicators.”

EOCI-Index-060316-2

“Secondly, these bounces are simply normal restocking cycles as inventories are drawn down during protracted declines in activity. Furthermore, as with all economic data, nothing travels in a straight line either up or down.

However, in particular, the recent bounce in manufacturing data was a clear anomaly caused by the extremely warm winter weather. This could be seen in the recent slate of data points from the Fed Philadelphia Region as shown below:

  • February: -2.8
  • March: 12.4 (Anomaly)
  • April: -1.6
  • May: -1.8

The weakness in the manufacturing data will likely reassert itself as the seasonal cycle realigns with the seasonal adjustments.”

This realignment of the seasonal adjustments with reality is what we are witnessing now. As shown in the chart below, if we compare the Economic Output Cycle Index (EOCI) above to both GDP and the Leading Economic Indicator Index, we see a clearer picture of what is currently happening in the economy.

EOCI-Index-060316

Not surprisingly, the EOCI has bottomed coincident with Central Bank interventions which drag forward future consumption. Unfortunately, when you “drag forward” future consumption today, you leave a “void”in the future that must be filled.

That future “void” continues to expand each time activity is dragged forward until, inevitably, it can not be filled. This is currently being witnessed in the overall data trends which are being reflected in the deterioration in corporate earnings and revenues.

While the media continues to “protest too much,” the reality is that earnings and revenue are a direct reflection of real economic activity.

The only question for investors is whether the ongoing delay of rate hikes by the Federal Reserve, and continued accommodative policy, can continue to support asset prices long enough for the economic cycle to catch up.

Historically, such is a feat that has never been accomplished. 

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Disclosure: The information contained in this article should not be construed as financial or investment advice on any subject matter. Streettalk Advisors, LLC expressly disclaims all liability in ...

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