What We Learned

As I was putting together my thoughts for last night’s post, I couldn’t help but note that my assertion that today’s BLS jobs data would be largely irrelevant may have struck many as strange.  Job creation, as we are repeatedly told, is the key to this economic recovery and, therefore, any data point that gives us a sense of this growth must, by definition, be an important, market-moving event.  Better-than-expected growth would translate to higher equity market prices, due to the resulting increase in consumption and, by extension, improved corporate earnings.  Less-than-expected growth would, as you might expect, translate to an equity price decline as the prospects for consumption and earnings growth would decline accordingly.  Pretty straight forward stuff you might say.  So why did I frame today’s jobs report in such a passé manner if the conclusions are so straight forward?

The reason for this has to with momentum and the effect it has on markets of all kinds.  In numerous past posts, I’ve alluded to the fact that market prices frequently do not reflect the true underlying fundamentals of their respective securities.  Examples of this abound.  The technology stock bubble at the end of the past century is one that immediately springs to mind.  During that time, valuations of the technology-related shares reached levels that had simply not been seen before en masse and had no basis in reality.  Because of the rampant growth associated with the widespread adoption of the internet, too many investors were willing to assume that those rates of growth could be expected to continue in near perpetuity.  However, anyone willing to take a step back and look at the bigger picture realizes that eventually the law of large numbers would cap, and subsequently decrease, the rate of growth.  Think about it terms of salary.  Is it harder for you to get a raise from $25,000/yr. to $50,000/yr. or from $100,000 to $200,000?  Putting aside all the constraints associated with a specific firm’s ability to pay the range of salaries, it is clear that coming up with an additional $25,000 is much easier than finding another $100,000.  The growth rate (100%) associated with each salary is the same, of course, but the likelihood of each increase occurring is VERY different.  Obviously the $25,000 raise will be much more likely than the $100,000 raise.  Unfortunately, though, this simple logic wasn’t applied during the tech bubble.  It wasn’t applied during the sub-prime-led financial meltdown.  It wasn’t applied during the railroad boom of the 1800s.  And it wasn’t applied during the Roaring ‘20s.  Could this be happening again?

To compare today’s market environment to the major bubble periods of the past is to greatly overstate our current conditions in my opinion.  However, I bring these comparisons to the forefront to spotlight how fundamentals, all too often, are meaningless in the ultimate direction of the market.  That’s why I viewed the absolute levels reported by the BLS today as largely irrelevant and looked to the reaction with much more interest.  While fundamental data points like employment levels, GDP growth, and manufacturing activity may be used as justification for a bullish or bearish bias, only supportive data will be considered while countervailing items are dismissed for a host of reasons.  And it is the manner in which markets react in the face of fundamental data that provides us with the best insight on where momentum currently lies.  Fundamentals, though, provide a sense of just how far momentum is moving market prices from reality.  Obviously, this creates a great deal of tension.  If fundamental data suggests things are overvalued, it would stand to reason that, as an investor, you would want to avoid buying in since prices are getting ahead of themselves.  But, on the other hand, knowing that momentum could, and frequently does, push prices significantly beyond that which fundamentals imply could suggest that there is still a fair bit of money to be made, thereby warranting entry.  So what does today’s reaction to the BLS numbers suggest is in the offing for the market since there is strong evidence that, fundamentally speaking, equity valuations are a bit rich?

With reported job gains of 192,000 in February and a corresponding drop in the unemployment rate from 9.0% to 8.9%, today’s report was largely consistent with expectations.  The decline in the unemployment rate was perhaps better than expected by most, but, again, this was consistent with a rate near 9% that most were expecting.  So with the data slanting slightly to the positive side of the ledger, it would have stood to reason that equity markets would have rallied through the session.  But as is too often the case, what seemed likely to happen ultimately did not come to fruition.  On the day, the S&P 500 fell 9.82 points (-0.74%) to 1,321.15.  To be sure, overly optimistic expectations that manifested themselves in the session leading up to today’s release contributed to the pullback, but, as I mentioned last night, concerns over the continued rise in crude oil prices and geopolitical unrest once again outweighed any positive sentiments that may have lingered.  This is evidence, to me, that the strength of the liquidity-induced rally since Q3 2010 is beginning to fade.  In periods prior (February most recently), an addition of 192,000 domestic jobs and a move in the unemployment rate below 9% would have been met with a HUGE spike in share values.  Clearly this was not the case today, hence my conclusion.  To be sure, the peripheral issues of commodity prices and geopolitics are contributing to the muted response, but the fact of the matter is that neither of these items were of concern to the market on Thursday as share prices rose sharply.  And with the commodity and global situations little changed since then, I find it hard to believe that the price action we saw today was driven by fundamental developments rather than a shift in investor sentiment.

Clearly, there are a lot of issues that are affecting the marketplace right now so it’s hard to keep up with all that’s going on.  With so many headlines coming out of Libya and the Middle East, weekend news could really sway direction on Monday.  But, again, today’s reaction appears to warrant caution over the near-term.  I’ll stick with gold, some cash, and perhaps even a little Treasury bond exposure (short-term position for the Treasuries) until the dust settles.  At the very least, these issues will have an effect on subsequent economic data points, which will likely be used to further the bearish narrative that is now materializing.

Until Monday…..