Whoa, Dude…..

Well apparently the potential issues associated with higher commodity prices (namely crude oil), geopolitical unrest, and the residential and commercial real estate markets were solved overnight as the major equity indices jumped about 1.75% during today’s session.  To be sure, news of a reduction in initial jobless claims to 368,000 during the last week of February along with solid productivity gains (2.6% during Q4 2010) helped to underpin today’s move, but, watching the pre-market futures this morning, it was clear that the market was simply in the mood to trade higher (S&P 500 futures were about 12 points above fair value prior to the open of trading).  This is further evidenced by the number of people who are pointing to the weakness in crude oil prices throughout the day as a reason for the run up.  Interestingly, those noting the decline in crude apparently gave no attention to the absolute value of the commodity as prices remained firmly above $100/barrel at $101.88, down about $0.35 on the day.  This is certainly not the scale of move that will alleviate the negative impacts on the economy and I am somewhat surprised that so many commentators would accept this notion so quickly.  I guess it’s just another reason why we all need to take media reports with a healthy grain of salt.

Perhaps even more interesting than the suddenness of today’s equity rally was the relatively sharp drop in gold bullion prices, down more than $20/troy oz. to $1,416.  Having just put in a new closing high, gold bulls, like myself, would like to have seen a greater amount of follow through buying.  Obviously that has not materialized so far.  Somewhat hawkish comments from ECB chairman Jean-Claude Trichet regarding the need for higher interest rates may have triggered some of today’s selling.  However, these comments were made in a longer-term context and did nothing to sway the ECB’s decision to keep its benchmark rate unchanged, so it’s quite possible that there was a bit of an overreaction in the bullion market.  Having seen prices jump from the $1,325 level just over a month ago, it is also quite possible that there was a fair bit of profit taking implicit in today’s trade, especially given the lack of follow through in upward price momentum seen yesterday and today.  Only time will tell if this marks a true reversal or a temporary setback.  I think it’s worth noting, though, that prices could not hold above the previous resistance level of $1,430, which is a fairly negative technical development.

Despite this rash of euphoria that swept through the marketplace today, I think equity investors are setting themselves up for a repeat of the first week of February.  At that time, positive private sector job creation was reported by ADP (just as was the case this week) and the markets moved up sharply in anticipation of an equally impressive jobs report from the Bureau of Labor Statistics.  And as is too often the case, the correlation between the two reports proved spurious and the BLS numbers fell far short of the levels implied by ADP’s report.  I see this scenario as quite likely to happen again this month.  That said, this doesn’t mean that the BLS numbers will be negative.  In fact, I fully expect them to be modestly positive, which would be consistent with the slow, but deliberate growth in employment that is likely taking place.  But with most market watchers looking for a number between 200,000 and 240,000, I think the risk is clearly on downside as I believe companies continue to add positions in a modest fashion (Q4 productivity growth further supports this notion) that is inconsistent with recent economic cycles.

To confuse the employment issue even more, I wouldn’t be surprised to see the unemployment rate move up even if the reported job numbers meet or exceed market expectations.  If the job market is, in fact, improving in a manner consistent with current expectations, I think it’s reasonable to assume that workers, previously classified as discouraged (meaning they are no longer looking for work and, therefore, not counted as part of work force), would once again begin actively pursuing positions.  This expansion of the labor pool would likely offset many of the job gains during the period, thereby increasing the unemployment rate.  With so much subjectivity implicit in the calculation of the unemployment rate, predicting its ultimate direction is difficult at best.  But if the past six months have shown us nothing else, it’s that the reported job gains/losses often provide little to no insight on the unemployment rate.  As such, the question becomes one of market focus.  Is the unemployment rate more important than the actual reported position gains/losses? 

Unfortunately, I think the answer is that the equity market will focus on whatever number fits the narrative that is currently en vogue.  This was never more evident than last month when the unemployment rate fell to 9.0% despite a modest addition of 36,000 jobs that was far below consensus estimates.  Subsequent to that release, market chatter regarding the implicit seasonality of the job creation numbers and the ‘flaws’ in BLS methodology abounded as justification for why the numbers were so different from consensus estimates.  In previous environments, these same pundits made the case that it was more important to focus on the change in the numbers from period to period rather than their absolute levels.  Obviously, this is simply an attempt to fit the data to one’s opinion.  As such, the market, once again, chose to focus upon the unemployment rate rather than the actual job numbers since it was more consistent with the prevailing narrative.  This is what makes trading around the BLS numbers so difficult as it’s more about identifying which theme the market will run with rather than the actual economic outcomes that are implied by the reported numbers.

By this point, I’m sure you’re wondering why I’ve gone on and on about the BLS jobs report and its various flaws and issues.  I bring these items to your attention because I believe that tomorrow will go a long way towards telling us what the underlying mood of the market truly is.  Having run nearly straight up since September, it’s obvious that the bulls have been in control for some time now.  But over the past couple of weeks, it has appeared that fear and doubt have begun to creep back into the marketplace.  Coupled with a widening perception that the equity market needs to take a step back after such a powerful move higher, the table is certainly set for some kind of retracement.  Today’s price action, though, certainly threw some cold water on the bear’s case.  As such, the manner in which the equity market reacts to tomorrow’s numbers will be among the best indicators of underlying investor sentiment and intermediate term direction available.  As most bull markets roll over amidst a wave of positive (though backward looking) news, failure to rally through a better than expected number tomorrow would harbinger negative things to come and prove consistent with growing negative sentiments.  However, reluctance to selloff in the face of another set of disappointing numbers would clearly show that the party is ripe to continue for a while longer.  To me, this is the real value of tomorrow’s report; the numbers are nearly irrelevant.

Finally this evening, I want to apologize again for not getting a post written last night.  As I mentioned via the FT Twitter feed (@FundTechBlog), I was pretty sick last night and simply unable to provide any meaningful commentary.  Thankfully, I appear to be over the hump (though not totally in the clear as yet) and the interruption limited to only one night.  Additionally, with the start date of my new position quickly approaching, I wanted to take this opportunity to say thanks to Peggy Sherman (a former colleague) for her support and guidance during the past year as I worked through several career-oriented issues.  Your willingness to listen and share your candid opinions on a range of issues was truly invaluable.  For this I am truly grateful, especially since this level of generosity is becoming less and less common in the workplace.  I can only hope that my new colleagues prove as generous and selfless as you.  They’ve got some mighty big shoes to fill.

Until tomorrow…..