Friday, October 3: Employment and Vote

This morning, the US Bureau of Labor Statistics released its September employment report. True to expectations, payroll employment fell by 159,000 relative to August. There were some revisions to earlier months, but these were very small (actually positive). The unemployment rate remained unchanged at 6.1% (I had expected this to rise), and average hourly earnings rose by 0.2%. Read this article about the report.

What reaction did markets have to such a disappointing report? The opposite of that expected. Stock market futures improved substantially. And, with this "bad news," interest rates rose, as did the US dollar. Perhaps the only expected result was the movement out of industrials, which are cyclically sensitive. What happened?

"Other things" were not even close to being equal. The weak employment report was perceived as increasing the likelihood of the passage of the rescue plan later today. Furthermore, credit crisis effects weren't even reflected in this report, so employment reports in future months should be even more disappointing. Thus, markets are also building in the presumption of Fed rate cuts, possibly today if the legislation fails to pass.

What about industrials? These are pro-cyclical, so with a slowing economy, you should expect these to decline. But, industrial companies also tend to rely substantially on externally generated funds. So, in light of the current and ongoing financial difficulties, even if the rescue legislation passes, there are questions about how far down industrials might fall in coming months. Where did the money exiting industrials go (rotate) to? Large banks, who have the money, even if they don't necessarily want to lend it. Graph XLI on Stockcharts.com and observe its behavior over the last few days and contrast that with today.

Let me reiterate that I continue to believe the Fed must lower interest rates. Remember, the Fed has a target of 2%, but the fed funds rate is a market rate that isn't always at its target. So, go back to the graph we did in class with real money demand falling due to a slowing economy and the Fed having a target of 2%. Were they to have kept the fed funds rate at 2%, the money supply would have been falling. But, all the injections of liquidity over the past few weeks have made the actual fed funds rate much lower than the 2% target. So, if the Fed decides to keep its existing 2% target and enforce it, they would have to undertake major withdrawals of liquidity, which would further exacerbate the current national recession (I continue to believe the US has been in a recession since January) and global weakness.

Finally, even if the rescue legislation plan passes (and I expect it will), DO NOT expect equity markets to go straight up from here. There is still a national recession, Europe and Asia are weakening, and global weakness will continue moving forward. And, last Monday when it was presumed the legislation would pass the first time around, the market was down about 3% even before the vote. There is an old saying in the stock market: Buy on the rumor, sell on the news. So, "the news" will be passage of the legislation. And, lots of money is waiting to sell any rally. So, don't be surprised if the market is down, maybe by several hundred points, for the day. And, if the legislation is passed, the anti-shorting ban will have a time table for expiration of a few days. What will happen when this is removed?

As I write this post (10am on Friday), the Dow Jones is up 136, NASDAQ is up 44, and the S&P 500 is 23 points higher. The 10-year bond is up 3 bp to 3.67%.