The August employment report came in with a bang. While the consensus prediction for payroll employment was around +110,000 (I had figured around +50,000), the figure released by the Bureau of Labor Statistics was -4,000 -- the first month-to-month decline in four years. Ouch!! You can read about the report.
As I stated in class, this would clearly be one of those "other things are not equal" situations. On the one hand, a weak employment report further fuels the expectation that the Fed will lower rates at its next meeting on 9/18, possibly by 50 basis points (1/2 of a percentage point). That is a positive for the stock market (which is driven primarily by profit expectations and interest rates).
But, weak employment signals less spendable income in future months, which will cut into profits, a negative for stocks. Which effect would dominate? As the morning unfolded it became readily apparent that the negative aspects were more than offsetting the positive factors.
But how could this be? If the Fed will be lowering interest rates soon, and the unemployment remained unchanged, why so negative a reaction by the markets? That's where it is necessary to read the details of the report. First, let me state a rule for judging reports: NEVER PLACE TOO MUCH WEIGHT ON A SINGLE MONTH'S VALUE. Actually the markets didn't. As it turned out, the employment totals for the prior two months were revised sharply lower. This brings me to a second rule: ALWAYS LOOK AT REVISIONS TO PRIOR TIME PERIODS BEFORE JUDGING THE CURRENT VALUE. So, instead of having an average monthly employment gain of around 110,000 over the past three months, the average (with revisions) becomes only +44,000. In addition to this, a further examination of the unemployment rate is called for. While the unemployment rate remained unchanged at 4.6%, the labor force dropped sharply. Had the labor force participation rate (% of population in the labor force) remained the same as it was last month, August's unemployment would have surged to 5%. Now it should become more apparent why the negative reaction occurred.
It is important to keep in mind that the primary factor determining whether a recession is upcoming is whether housing weakness is "contained." The dominant view has been that as long as employment remains strong and the unemployment rate doesn't rise too much, persons should generally be able to afford their mortgages, limiting housing damage. Well, in August, employment fell and the unemployment rate should have risen (with the same participation rate as last month). So, it is not clear how much "containment" will exist going forward, raising the likelihood of a recession (my estimate this entire year has been 45%, well above the consensus until very recently). Add to this the fact that a very large number of mortgages will be "resetting" to higher interest rates in October, and you can see the basis for the stock market selloff. Here's an article highlighting whether a recession is likely.
While we haven't covered it yet, another big reaction to the weak employment report was a sharp drop in interest rates. The 10-year government bond, which is linked to mortgage rates, fell from 4.50% to 4.37%, a 13 basis point drop in one day!! Bonds are fixed (nominal) income assets, meaning they pay fixed amounts of income per year. "Bad news" about the economy, like this employment report, is good news to the bond market as it implies less of an inflation threat in the future (inflation lowers nominal income). And, we will see (later this coming week) that bond prices and interest rates move in opposite directions. So, on Friday we had a stock market sell off and a bond market rally!! Finally, not unrelated to all of this was a sharp rise in gold prices. See if you can figure out gold prices rose. (Hint: it is related to interest rate changes.)
All of this should demonstrate the point I made the first day of class: if you understand macroeconomics you tend to think in terms of sequences (sets) of variable changes, not just what is happening to a single variable. The ability to do this takes practice. Judging by the way this semester has started, you'll be getting lots of practice!
Showing posts with label mortgages. Show all posts
Showing posts with label mortgages. Show all posts
Saturday, September 8, 2007
Saturday, March 10, 2007
Employment Report Effects
The February employment report was released yesterday at 8:30 am. The stakes for the markets were high: too low a number and recession fears would re-emerge, which would hurt the stock market but help the bond market; too high, and the opposite would be a problem, with a reduced likelihood of the Fed easing in the near term.
The payroll employment number that emerged was +97,000, which was high enough to remove recession fears, but not so high that worries of overheating would emerge. This scenario has come to be called the Goldilocks Scenario. Read the following article about all of this. Also, read the chapter on the employment report in the Carnes and Slifer text (The Atlas of Economic Indicators).
The stock market began the day with a healthy rise but gave much of this back by the end of the trading day. This often happens when markets get what they were hoping for (this is a variant of the old saying: Buy on the rumor, sell on the news). So, SUPPORT AND RESISTANCE BOTH HELD.
The principle items that caused a reaction in the bond market were a higher-than-expected rise in average hourly wages and a decline in the unemployment rate to 4.5%. In addition to these, the prior months' employment numbers were adjusted upward (this has been occurring for a while now). So, it is very likely that today's somewhat tepid payroll employment increase will be revised higher with the release of next month's data. All of these factors heightened inflation fears, causing a bond market sell off. The 10-year bond rate rose to just under 4.6%, an increase of 8 basis points for the day. Clearly, the bond market wants the Fed to lower interest rates, and the employment report dashed those hopes (for now at least). I guess the bond market's view of the world should be referred to as "The Three Bears," given the stock market's view.
So the "wildcard" for now is the mortgage market. How far will weakness in the sub-prime market reach higher tiers? It has already impacted the "Alt A" market, and with the tightening of lending standards, it will very likely creep somewhat into the market for prime mortgages. The different perceptions of the future state of the economy held by the stock and bond market centers largely on the answer to this question. For now, at least, it appears safe to say that "all's quiet on the carry trade front." Stay tuned.
An interesting article for you to read is by Jeremy Siegel. He attributes part of the recent volatility in stock markets to "trend following" by technicians. These traders (myself included) often place automated "stop loss" orders below the trend so they can insulate themselves from potentially large losses. Here's how a stop loss order works. You choose a price level at or below which you want to get out of a stock (or index like an ETF). Hopefully your choice is based on where support is. You should place the "stop" a bit below support, so that if a false breakdown occurs you don't get "stopped out," after which the stock begins to rise again. You then place an order stating this with your brokerage account. To automate this, specify the time frame for your order as "Good Till Cancelled," or GTC. Normally, this will remain in effect for several months. If, instead, you specify market day, you are only covered for that trading day, after which the order no longer exists. Specifying GTC thus automates this process so you don't have to remain in front of your computer all the time.
So when trendlines are finally broken in sustained uptrends, many of these stop orders kick in, potentially causing large sell offs, and magnified price declines. Hence the volatility aspects. I doubt that stop loss orders played the major role in the large Tuesday sell off, but they were certainly part of it.
A recommendation when you buy stocks: USE STOP LOSSES, but leave room below support in case a false breakdown occurs. Remember, capital preservation should be a primary factor for you.
The payroll employment number that emerged was +97,000, which was high enough to remove recession fears, but not so high that worries of overheating would emerge. This scenario has come to be called the Goldilocks Scenario. Read the following article about all of this. Also, read the chapter on the employment report in the Carnes and Slifer text (The Atlas of Economic Indicators).
The stock market began the day with a healthy rise but gave much of this back by the end of the trading day. This often happens when markets get what they were hoping for (this is a variant of the old saying: Buy on the rumor, sell on the news). So, SUPPORT AND RESISTANCE BOTH HELD.
The principle items that caused a reaction in the bond market were a higher-than-expected rise in average hourly wages and a decline in the unemployment rate to 4.5%. In addition to these, the prior months' employment numbers were adjusted upward (this has been occurring for a while now). So, it is very likely that today's somewhat tepid payroll employment increase will be revised higher with the release of next month's data. All of these factors heightened inflation fears, causing a bond market sell off. The 10-year bond rate rose to just under 4.6%, an increase of 8 basis points for the day. Clearly, the bond market wants the Fed to lower interest rates, and the employment report dashed those hopes (for now at least). I guess the bond market's view of the world should be referred to as "The Three Bears," given the stock market's view.
So the "wildcard" for now is the mortgage market. How far will weakness in the sub-prime market reach higher tiers? It has already impacted the "Alt A" market, and with the tightening of lending standards, it will very likely creep somewhat into the market for prime mortgages. The different perceptions of the future state of the economy held by the stock and bond market centers largely on the answer to this question. For now, at least, it appears safe to say that "all's quiet on the carry trade front." Stay tuned.
An interesting article for you to read is by Jeremy Siegel. He attributes part of the recent volatility in stock markets to "trend following" by technicians. These traders (myself included) often place automated "stop loss" orders below the trend so they can insulate themselves from potentially large losses. Here's how a stop loss order works. You choose a price level at or below which you want to get out of a stock (or index like an ETF). Hopefully your choice is based on where support is. You should place the "stop" a bit below support, so that if a false breakdown occurs you don't get "stopped out," after which the stock begins to rise again. You then place an order stating this with your brokerage account. To automate this, specify the time frame for your order as "Good Till Cancelled," or GTC. Normally, this will remain in effect for several months. If, instead, you specify market day, you are only covered for that trading day, after which the order no longer exists. Specifying GTC thus automates this process so you don't have to remain in front of your computer all the time.
So when trendlines are finally broken in sustained uptrends, many of these stop orders kick in, potentially causing large sell offs, and magnified price declines. Hence the volatility aspects. I doubt that stop loss orders played the major role in the large Tuesday sell off, but they were certainly part of it.
A recommendation when you buy stocks: USE STOP LOSSES, but leave room below support in case a false breakdown occurs. Remember, capital preservation should be a primary factor for you.
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