Sentiment Readies for a Tumultuous Fall
By Chris Maxey and Ryan Davis
May 7, 2012
Stocks Sell Off Ahead of EUro Elections
Markets posted the worst performance of 2012 last week, as the S&P 500 and Dow Jones Industrial Average declined 2.3% and 1.3%, respectively. A poor government jobs report and concern surrounding European elections weighed on investor psyches during the week, despite moderately positive news in the consumer and manufacturing sectors.
Over the weekend, Francois Hollande overtook incumbent Nicholas Sarkozy in the French presidential run-off, as expected. Mr. Hollande is the first socialist president elected since Francois Mitterrand in 1981, capitalizing on a populace displeased with aggressive austerity and fiscal reforms. If parliamentary elections also result in a socialist majority (as anticipated), Mr. Hollande will have little impeding an agenda that includes rolling back tough fiscal reforms and raising taxes on the wealthy. The president-elect has also vowed to renegotiate the Eurozone’s budget pact agreed to late last year.
Similar turmoil unfolded in Greece, where the long dominant political parties were decimated in parliamentary elections. A fractured government will now take over the legislature, likely undermining conditions of Greece’s bailout agreements with the IMF and EU. A wide scale default and Greece’s eventual expulsion from the Eurozone appear more likely now than at any point over the past three years.
Incredibly, President Sarkozy is the 11th successive Eurozone leader to be ousted since the European debt crisis began in 2009, as reported by Reuters. With several other elections scheduled in the next few months, there is almost certainly more leadership changes in store for the region. This regime
change threatens to undo much of the progress made since the initial drama surrounding Greece and other peripheral countries unfolded.
Back in the US, last week began with several encouraging economic reports before deteriorating by week’s end.
On Monday morning, the Bureau of Economic Analysis reported personal income and outlays data for March. Following an outsized 0.9% expansion in February, consumer spending increased 0.3% in March. This was roughly in line with expectations after factoring in a modest upward revision to February. Encouragingly, the personal savings rate also ticked up to 3.8% from 3.7%; the series has been in a downtrend since mid-2010.
Incomes slightly outperformed expectations after growing 0.4%. This was the fourth straight month of at least 0.3% growth, adding some stability to the consumer sector in the face of generally weak labor conditions. Continued traction in incomes is key to a sustainable recovery in spending, which thus far has been financed primarily through savings and debt.
The Institute of Supply Management (ISM) released both its manufacturing and non-manufacturing reports last week. The diffusion indices survey purchasing and supply executives nationwide in an attempt to capture national trends in economic activity.
The ISM manufacturing report, released on Tuesday, defied consensus calls for weakness by rising 1.4 points to 54.8. This was the 33th straight month of expansion for the manufacturing sector.
Interestingly, acceleration in the manufacturing PMI occurred despite deterioration in two important Fed regional reports, the Empire State and Philadelphia surveys. Strength in the index was broad-based, with the important new orders, production, and employment components experiencing healthy gains. Each of those respective indices is currently at 57 or higher, indicative of strong expansion.
ISM’s services, or non-manufacturing, report was not as positive after unexpectedly declining by 2.5 points to 53.5. In sharp contrast to the manufacturing report, readings on new orders, production, and employment each slowed in April, although they remain in expansionary territory.
The biggest takeaway from April’s ISM reports is that the manufacturing and service sectors of the US economy remain squarely in growth mode. While there have been some month-to-month fluctuations, these important indicators on the health of the US economy have been positive for the better part of three years. With new orders showing continued strength, there is likely enough positive momentum to keep this trend alive for the foreseeable future.
Job Growth Underwhelms in April
On Wednesday, ADP’s national private employment report disappointed expectations with an 119,000 gain. This compared to consensus estimates of an 183,000 jump, setting the stage for a less-than-stellar April employment report.
Friday’s jobs report was indeed a disappointment, after nonfarm payrolls were estimated to have grown 115,000. This fell well short of expectations for a 165,000 gain, and followed a subpar March report of 154,000. Between December and February, the US economy averaged 252,000 new jobs per month.
Underlying data was mixed, with several sectors actually posting net contraction in jobs, including construction and transportation & warehousing. The biggest job gains occurred in professional & business services, retail trade, and health care. Within the leisure & hospitality sector, food & drinking places added another 20,000 jobs in April, following a 35,000 gain in March.
With continued gains in certain retail and leisure sectors, there is concern that a large portion of the job gains experienced during the recovery has come in low wage industries. This may have the effect of depressing wage gains and protracting a true labor recovery.
Government continued to shed payrolls in April, cutting 15,000 jobs. The majority of those losses were concentrated in local governments, reflective of ongoing budget struggles faced by local municipalities. Local governments have slashed more than 130,000 jobs in the past 12 months.
The unemployment rate edged down in April, falling from 8.2% to 8.1%. Unfortunately, much like March, the jobless rate fell because of a reduction in the labor force rather than any significant improvement in employment. In fact, the household survey indicated 169,000 fewer people were employed in April relative to March, while approximately 342,000 people left the labor force.
The broader U-6 measure, referred to as “underemployment,” was unchanged in April. The alternative measure takes into account part time workers who would prefer to be full-time, as well as workers who are marginally attached to the labor force (not actively looking for work). Many consider this a truer indication of labor market health, making its decline from 15.9% to 14.5% in the past 12 months encouraging.
April’s employment report left much to be desired, despite a net positive 53,000 revision to January and February data. It appears to validate critics’ concerns that unseasonably warm winter temperatures had pulled forward typical hiring patterns. A recent Wall Street Journal article has also suggested that the abnormal hiring patterns experienced during the financial crisis have created problems for the government’s seasonal adjustment process. In their estimation, April’s payroll gains would have amounted to 184,000 under the “pre-crisis” adjustment factors.
With so many questions cropping up about the BLS data series, it is difficult to assess the results of month-to-month employment reports. However, when taken in context of other employment indicators, it certainly appears that hiring has slowed after a period of growth. This is a troubling development for an economy so dependent on that sector’s recovery.
Sentiment Readies For A Tumultuous Fall
Market sentiment has oscillated quite rapidly in recent months on the heels of dramatic market intervention by the European Central Bank and shifting views of global economic stability. Sentiment is likely to remain unstable in the months ahead as investors grapple with any number of events, from elections in Europe and the US to the end of recent monetary easing efforts domestically.
While markets have rallied substantially over the past six months, retail investors are maintaining a somewhat neutral view on their allocations. As of April, retail investors reported a 60% allocation to stocks with 16% to fixed income and the remaining 24% in cash. This is largely in line with long-term allocation averages.
Source: Pragmatic Capitalism
Retail investors are not overly bullish on the outlook for stocks, either. Approximately 35% of retail investors are bullish on the six-month outlook for stocks, four percentage points below the long-term average.
Source: Pragmatic Capitalism
Institutional investors are in disagreement with the neutral-to-somewhat bullish stance of retail investors. The State Street Investor Confidence Index, which measures sentiment among global institutional investors, fell to 87.7 in April, holding near levels last seen at the end of 2008.
Sentiment is likely to become a major force in the markets towards the latter half of the year. Not only will participants begin to price in the election effect, but a number of other 2013 events will make their way into market prices. The issue may be especially acute for U.S. investors.
First up will be the end of Operation Twist. In the last several years, stock returns have been highly correlated to monetary operations from the Federal Reserve and the European Central Bank. A sell-off in equity markets resulted from the end of large-scale quantitative easing programs in the US and Europe.
In addition, by some estimates, the expiration of payroll tax cuts, coupled with a reversion of current income and dividend tax rates will present a 3% to 4% headwind to current GDP growth rates in 2013.
Source: J.P. Morgan
The final challenge in what will be an otherwise busy fall is the debt ceiling, which once again looks set to be reached before year-end. It is problematic in the sense that Republicans and Democrats will both posture to look good during the election cycle, raising the possibility that the debt ceiling hike will not occur in a timely fashion, similar to what we experienced last summer.
Investors are largely embracing neutrality at the moment when it comes to their portfolios. Tremendous amounts of uncertainty permeate the domestic and global economies, suggesting that neutrality is well warranted.
the week ahead
This week is fairly light on economic data, with information on the trade balance and producer prices being the most notable reports. The National Federation of Independent Businesses also releases their monthly Small Business Optimism index.
Earnings season continues with results due from Walt Disney, Macy’s, Toyota Motor, Cisco Systems, Sony, ArcelorMittal, Hitachi, Suzuki Motor, Nissan Motor, Panasonic, and Telefonica, among others.
Central banks meeting this week include Poland, Indonesia, Norway, Peru, Malaysia, and the Bank of England. The BoE is not expected to change rates from a current level of 50 bps.
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