More and more, it appears the bounce is played out. Not just “the” bounce, but all of the bounces – the one that had stocks threatening to double from the March 2009 lows; the bounce in bond yields; the bounce in economic growth.
Markets and economic variables experience tides of ebb and flow, with smaller ripples around those tides. This isn’t a revelation, of course: R.N. Elliott founded an entire school of technical analysis on this observation. (I tend to be skeptical of strict Elliott Wave counts myself, since Wave practitioners tend to assert great insight into market wiggles so fine that surely the noise outweighs the signal, but I do occasionally refer to Wave principles in big moves.) The economic tides are harder to discern than some of the market’s patterns , but I believe that is mainly because economic variables are imperfect measures of the underlying activity that is subject to society’s grand vicissitudes.
But it is good to keep in mind, whether you are riding with the tide or fighting it, that tides will change; moreover, even if you have the tide right the waves may temporarily be against you. Economists are not very good at identifying these shifts, again partly because the data they are tracking are noisy, but there is a larger behavioral issue at work too. When I was just starting my career, the firm’s chief economist told me that she always would forecast a zigzag because then she could point to the half that was right. Either “we expected this weakness,” or “the strength in today’s number suggests that our longer-term view may be coming to fruition earlier than we had expected.” Needless to say, with that approach she tended to be big-picture bullish on the economy, since it really didn’t make much difference and it was more cheerful to zigzag that way than the other way.
I mention this because as I said we seem to be undergoing another zig that in my opinion was overdue but more importantly was completely missed by most observers. Despite the fact that the ADP report last week set off flares, calling attention to the fact that private payroll growth seemed very weak compared to what economists were forecasting (see my Thursday comment – I was not sufficiently confident, however, to do more than make my observation parenthetically), the whole Street was shocked by a Payrolls figure that was “only” 431k , with hefty downward revisions and virtually all of the growth provided by Census hires.
One of the reasons that people professed to be surprised is that President Obama, early last week, had expressed confidence that the employment data were going to be very strong. The market took administrative note of this utterance, and assumed that “Obama must know something.”
As many other events during the first 17 months of this administration must have made clear by now, “Obama must know something” is usually a bad bet.
But easy snide remarks aside, this is a silly reason to expect a good Employment report. The Employment Report isn’t even assembled until the night before the release; some of the data comes from outside of the BLS, and so the final numbers aren’t available – even to the President – before then. The average man on the street probably doesn’t know this; the average Wall Street economist has no excuse not to know it.
So then why did he say what he said? Simple: like everyone else, Obama knew the headline number would be the biggest in a while, and he thought that (as in the past) he could put one over on Americans who would be too dumb to know that Census jobs are temporary and should be ignored. He also probably trusted the media to back his play on that one, and to hype the “big number” as good news. Seriously, how many Americans would have looked critically at a 431,000 Payrolls number, combined with a decline in the Unemployment Rate to 9.7%, if everyone had stuck to the White House’s line? It is a measure of the lack of health of the Administration – shocking, this early in Obama’s term – that no one bought it. It, too, is looking played out.
A potential implication of the weak Payrolls growth is that the pilot light of overwhelming government spending failed to ignite the broader organic economic growth that is crucial if we are ever to pay for that overwhelming spending. But, indeed, it appears that we should score one here for economic philosophers: since it was clear from the vast size of the fiscal stimulus that some belt-tightening would eventually be required, economic actors behaving according to rational expectations would decrease rather than increase their spending compared to what it otherwise would have been. We all knew that taxes would eventually rise to pay for this massive deficit, and the immediate result of that realization is to cause us as consumers to rein in spending and accelerate plans to save. It should not be surprising that fiscal policy failed to cause lasting growth – if government could run huge deficits and pay for them later with no friction, then we would never have been in this circumstance to begin with. Fiscal policy can move demand forward, or push it back, or (with carefully considered policies) reallocate income and wealth to different sectors. But unless (1) government spending is systematically more productive than private spending (and evidence is rather the opposite), or unless (2) debt never needs to be repaid (within limits, there is some traction to that thought, but we are wayyyyyyy beyond those limits), a bigger role for government implies a lower standard of living in the long run.
And the stimulus is played out. There is no more money to spend, and in fact the piper is already demanding payment. Past stimuli have precipitated longer bounces, partly because they were tax- rather than spending-based and so the money went into the hands of the more-efficient private sector and partly because they were smaller so that the rational expectations of economic actors didn’t require a duck-and-cover response.
We will be arguing about these effects for a long time, but the salient point at the moment is that the tide is still going out, and the wave of stimulus is receding, and although we are swimming as hard as we can we have not yet reached the shore. In fact, we seem to be getting swept back out to sea. On Friday, fears suddenly developed about Hungary when senior Hungarian officials reportedly said that country has “a slim chance of avoiding the Greek situation,” but will not implement austerity measures. They’re actually in a better situation than Greece; Hungary doesn’t use the Euro and its bonds are denominated in its own currency, so it can always meet its obligations with the printing press. Surprisingly, the Hungarian Forint is only down a little bit compared to the Euro even though this option would imply the chance for a sharp devaluation in the future.
Meanwhile, the EU’s big “shock and awe” package is looking increasingly played out as well. The Financial Times notes that the most important near-term part of that package, the supportive purchase of sovereign debt markets, would be more-aptly characterized as “shock and yawn” as the ECB has bought a fairly small amount of such paper (and declining each week).
As these economic trends sputter, the financial markets trends continue to roll over as well. The S&P lost another 1.4% today, following Friday’s 3.4% shudder, and is back below the “flash crash” lows. That marks the lowest close of the year, and only 1% or so separates the current print from intraday lows last month. Below there be dragons.
The 10y Note contract gained 3.5/32nds, with the 10y yield falling to 3.19%. Here, too, a slim margin separates these markets from the abyss. We are plainly near levels where the market’s give and take has become mostly “take.” Some people will surely say that the stock market is oversold, since the alternative is disheartening.
Checking the tide charts, it does not seem likely that they will turn on Tuesday. There is no important economic data due, and the Fed’s auction of $36bln 3y notes just sucks up more money from other asset classes. I suspect the stock market will make a run at the 2010 lows, and right now that’s probably a wave worth riding.