I am sending out today’s letter early as I want to be ready for this morning’s employment report. Many markets are sitting at important inflection points and this report might determine the direction for the next big move.
Although I do not play the game of trying to guess economic report numbers, gun to my head, I am leaning towards this release disappointing. Wednesday’s ADP report was terrible. But more importantly, we haven’t seen any effects from January’s brutal global economic swoon. My suspicion is the US is far less immune than most economists suspect - it simply takes a little while for it to translate down into weaker employment numbers. Part of me also wonders if yesterday’s strange relentless bond bid was smarter money getting positioned for a weak report.
Instead of betting in front of the number, I wanted to write about potential market reaction. Contrary to popular opinion, stock market bulls should not be hoping for a strong employment report. This paradoxical phenomenon is often the case, but even more so in the current environment.
A strong report will increase the chances the Federal Reserve resumes their foolish overly hawkish path. The possibility of the January deflationary vicious self reinforcing feedback loop of a stronger US dollar / lower commodity prices returning will increase.
Bespoke Investments has this terrific chart that shows the S&P 500 average response on stronger and weaker than expectation employment days. I was only able to track down one from 1998 to 2014, but it doesn’t matter - the pattern is fairly stable.
Strong employment days are often met with an initial move higher. But on average, the high is put in around 10am. From there it usually drifts lower, closing down on the day.
If we get a stronger than expected employment report, I expect this scenario to play out. The current environment of an overly aggressive Fed itching to pull the trigger ahead of the market makes the stock market extremely susceptible to this pattern. In fact, my only worry is that we sell off earlier than usual. But either way, the lows will be made in the afternoon, not the morning.
If the opposite happens and the employment report disappoints consensus, I will lean long. The stock market wants the Fed on the sideline, and although a bad employment release will be short term bad news for the economy, it will be positive for risk assets.
Bespoke confirms this trend has played out during the past fifteen plus years:
I would always err on assuming this pattern repeats, but for today, I think it is especially relevant. Most importantly, the stock market will not like a strong employment report.
Remember - having a position right in front of a big number isn’t trading, it’s gambling. And remember, gambling never works.
For the past month, I have been arguing sentiment is quite negative. It’s strange because during the recent rally, few investors jumped on the bandwagon.
This has been one of the most hated rallies in the history of Wall Street. I know this intuitively, and all you need to do is look at the recent hedge fund guru Sohn Conference where all the supposedly “smart money” experts were uniformly bearish. But I have had trouble demonstrating it. Until now. A Bloomberg reporter created this terrific chart that shows the past three rallies, with the accompanying ETF flows. During 2014 when strategists were “so bullish it hurts”, investors piled $35 billion into ETFs. Then in the aftermath of the summer swoon of 2015, $9 billion of ETFs were created. But in this last rally, only $3 billion has been made!
Maybe you could argue there is no more money left to be put into the market. That’s a legitimate point. But I think we can now safely agree, few investors have bought into this latest rally.
Thanks for reading and have a great week end,