The BLS Report Bombs

04/10/2017 2:48 am EST

Focus: OPTIONS

Don Kaufman

Co-Founder, TheoTrade

Weak earnings growth and weak jobs growth will hurt the stock market because the Fed has taken away some of the alcohol in the punch bowl took a big hit April, asserts Don Kaufman, founder of TheoTrade.

While there were some similarities between both the ADP and BLS jobs reports, there was a wide variance between the headline numbers. It’s important for me to point out the connection because at face value, it looks like the reports are measuring two different economies. That face value assessment is mostly accurate as the ADP report was a blockbuster positive report and the BLS was a big miss as it showed the labor market weakened in March.

There might be revisions in the coming months which boost the BLS report and cut down the ADP report. The size of revisions and the inconsistency in the reports make it difficult to analyze the data. It would be easy for me to say that you shouldn’t trade off the labor data because the labor market is a late cycle indicator, but I think it is a critical factor in any assessment of the market. Labor market strength and strong consumer and small business confidence are the lynch pins of the bullish narrative since the GDP and productivity growth have been so weak. Therefore, a weak labor market can catalyze a bear market.  

This thesis that I have come up with that weak earnings growth and weak jobs growth will hurt the stock market because the Fed has taken away some of the alcohol in the punch bowl took a big hit April 7. Even with the US action in Syria pushing overnight futures lower and this weak BLS report which I will delve into in this article, stocks managed to rally off the lows of the morning to close flat. As you can see in the chart below, the ten-year bond rallied after the announcement, as yields fell below the four month range they had been in. However, along with the “risk on” trade causing stocks to increase, the ten-year bond sold off after the initial kneejerk reaction.

As the chart shows, after New York Fed President Bill Dudley spoke, the bond market sold off further. Stocks also rallied on this news. There were two main points made by Dudley. The first was that the US should pull back some of the Dodd-Frank regulations. This point doesn’t matter much because the Trump administration is already attempting to do that. It shows how Fed members can alter their tone to fit with the political momentum of the day.

chart 1

The next point was about the Fed’s balance sheet. As I mentioned in my article describing the Fed’s Minutes, the Fed needs to clarify its perspective. The market doesn’t like jumbled language. The market doesn’t like tightening at all, but at the least it likes the guidance to be clear. Dudley clarified the Fed’s statement in a way that leaned dovishly which is exactly what I was looking for. The two dovish points were that the slowing of the bond purchases would be gradual and that the interest rate hikes would be paused during the unwind. That second point is new dovish language. The Fed’s new guidance looks to be a six-month delay in rate hikes after the unwind starts, meaning we should expect one to two rate hikes in 2018.

That was a description of the latest wrinkle in monetary policy. Getting back to the jobs report, the headline number showed 98,000 jobs created which was a big miss from the 180,000 expected. Making things worse, the prior two months were revised lower by a combined 38,000 jobs. The reasons I initially expected a weak report ended up bearing fruit as the winter storm and weakness in retail hiring were the main reasons why it missed expectations. I then altered my expectations higher because of the strong ADP report. Usually they are reasonably close, but sometimes they aren’t.

The chart below breaks down the job gains and losses by industry. The retail industry shed about 30,000 jobs. Amazon (AMZN) is becoming a job killer as it takes market share away from traditional retailers. Part of this trend is being caused by low interest rates. Amazon stock is getting an expensive valuation because the market loves growth even if high profit margins don’t come with it. You can either make the case that the stock market bubble is helping to support the innovation firms like Amazon and Tesla (TSLA) provide or you can claim capital is being inefficiently distributed to bad ideas. The explanation for why momentum stocks doing well is an example of a bad idea is based on their low and sometimes negative profit margins. The other aspect of the decline in retail is simply because of the change in consumer spending habits.

chart 2

In my article describing the non-manufacturing ISM report, I mentioned that some construction projects slowed. We saw this play out in the BLS report because of the bad weather. I didn’t realize the statement made in the ISM report about weak growth may have been related to the weather as no reason was given. The weather is likely partially responsible for why the ISM report missed expectations.  

The one positive aspect of this report was that the unemployment rate fell from 4.7% to 4.5%. This is weird because the labor participation rate was steady and the headline number was weak. I don’t focus on the unemployment rate since the rate isn’t accurate anyway. If it was accurate, there would be much more wage growth than has been experienced.
Heading into the report, I expected wage growth to beat expectations because of the tightening labor market and the great ADP report. Even though the BLS report wasn’t in tune with the ADP report, wage growth was able to meet the expectations for 2.7% year over year growth and 0.2% month over month growth.

Conclusion

Before the winter storm arrived, I mentioned that it would cause the March data to be in flux as I was able to mix amateur meteorology skills with economic analysis. Besides Dudley’s statement, the other reason why the market rallied off the lows was because the bulls wrote off the bad report because of the bad weather. The bulls probably would have written off the bad report anyway because it isn’t consistent with the trend of growth in the labor market. That may be a fair assessment, but at some point soon bad labor reports will be the norm. 

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