After "The" Employment Report

As you know from class, the September employment change was essentially in line with expectations. Payroll employment for the prior two months (July and August) was also revised significantly higher. Most notably, the original employment change for August, a 4,000 decline, was erased. The revised August employment number is an increase of 89,000. Along with this, the unemployment rate rose slightly to 4.7%, and average hourly earnings rose by a greater-than-expected 0.4%.

Hopefully, you took the time to perform the practice exercise in advance of this report. The markets viewed this as a strong employment report. The perceived (key word!) likelihood of a recession dropped noticeably as the result of today's data.

- The stock market liked the report a great deal. It was not too high as to preclude further Fed rate cuts, but not so low that it might have indicated we were in the early stages of a recession. Read a story about this.
- The bond market didn't like this at all -- both significant employment gains and the "hotter" than expected wage gain raised the inflation flag. Here is a story about this. Examine the yield curve to see how the bond market ultimately reacted. Clearly, the yield curve got steeper, indicating the expectation of stronger upcoming growth and inflation.
- The oddity today was the foreign exchange market. Normally, we would assume that the greater perceived economic growth and higher interest rates would both strengthen the US Dollar. However, by day's end, the dollar had weakened further. Read about this. It might have been profit taking by currency traders and the overall perception that the direction for the US dollar is still down. Where is the bounce (support)?

Following what I did in yesterday's posting, I revisited the Market Carpet at StockCharts.com. This time, I looked at the most recent 10 days (not the entire time since the Fed rate cut). The "carpet" below is what pertains (click to enlarge):
Now look at the sectors that have performed the best over the period of this carpet, the last 10 days. All (no exceptions) are cyclically sensitive sectors (look at the bottom right). The leader is Financials. This sector had taken a beating after the financial worries in August. But, with recent data showing that the commercial paper market is improving and possibly stabilizing, there was some "make-up" momentum. Generally, however, it is desirable to see both the Financial and Consumer Discretionary sectors outperforming other sectors.
So, over the past 10 days, the equity market has signaled expectations for an improving level of economic activity. None of these sectors would have performed so well had there been substantial recession concerns. For extra credit (due at the beginning of class on Wednesday), replicate this market carpet (look at yesterday's post for how to do this) but for the 14 days since the last rate cut. Print out the carpet and bring it to class.

Finally, look at the sectors that underperformed: Utilities; Health Care; and Consumer Staples. All of these are defensive sectors, that outperform when recession worries accelerate, but underperform when recession fears abate, as has been the case recently.

Sector Performance Before "The" Employment Report

Tomorrow we get the September employment report. This will be a market mover, but not in the traditional way. The stock market wants the Fed to keep cutting. So, if the employment gain is very good, the Fed will be less likely to cut at its next meeting, causing a market sell off. The same is true for a very bad report. Yes, the Fed would likely cut again, but this would signal the possibility that we might already be in the early stages of a recession, so the souring of profit expectations would overpower the effects of lower expected interest rates. Remember:

Stock prices = f(expected profit, interest rates)

So, when both factors change, the effect of one may well offset the other. That is the nature of forecasting! The ultimate change in stock prices will ultimately be determined by the changes in each factor and how sensitive stock prices are to those factors when their changes are that large (or small). This is a non-linearity -- the impact of each factor depends on its own level and how the other changes.

The next thing to look at is which sectors have performed well since the Fed rate cut in September. To do this, go to StockCharts.com. On the left side, click on Market Carpet. Under the heading Available Carpets, select S&P Sectors Carpet. You should see the image below (click to enlarge):

Step #1: Stretch the number of days bar on the bottom right (indicated in red typing on image). Move this to 13 days. NOTE: you can change both start and end date by dragging on either or both ends of this.

Step #2: When step #1 is completed (the days are correct), click on the button on the top left (indicated by the red typing in image). This will give a more aggregate overview, listing the sectors that have done best and worst over the time period you chose.


The result should be the next image (click to enlarge): NOTE THE PERCENT CHANGES IN EACH SECTOR (Highlighted in a reddish tint on bottom right).

There is a mixed picture since the Fed cut rates. The leading sectors are Materials, Technology, and Financials -- this signifies that the rate cuts have up to now apparently stimulated sectors related to growth. But Health Care, a defensive sector has done fairly well, while Consumer Discretionary, which we would have expected to be among the best performers is one of the slower performers (it was the only declining sector).

Note that on the left side of this Java Applet the sectors and their percent changes are noted over this period (which was summarized on the bottom left). If you double click on one of the gray headings you get a breakdown of that sector and the bottom right list shifts to the best and worst performers in that group.

Try double clicking on Consumer Discretionary. Let's see who has been holding this back, making its growth less than expected. Look at the bottom 5. What has been slowing this sector down to less than expected? How does this information alter you view (if at all) about growth prospects.

Tomorrow "the" report on employment is released at 8:30. I encourage you to see how the above results change. In general, when a major release occurs, read about it in the Carnes and Slifer text (Atlas of Economic Indicators), and check out the sector patterns to discern any rotations. What do these rotations indicate about growth expectations?

Finally, it is important to keep in mind that all of this note has pertained to the stock market only. To see how the bond market is viewing the world, look at the yield curve and how it has changed (go to Bloomberg.com for this or go to the Links for this blog under my picture). Has it steepened or flattened (or possible inverted)? Finally, check out the dollar's exchange rate with other countries and its index ($USD). What does the world think about how this report has altered growth prospects here? You can also check out www.dailyfx.com for exchange rate information.

This weekend I will post a follow-up note after the employment report has been released.