Sunday, April 08, 2007

Bonds continue to do the Fed's work for it as they price in some inflation worries.

- Stocks rise early, rise late, close higher yet again.
- Bonds continue to do the Fed's work for it as they price in some inflation worries.
- Jobs report and revisions shows continued growth.
- Riding the low volume ripple up toward the February highs and earnings.

Sellers nowhere to be found as market melts higher, caps upside week.

For a schedule light of economic data, there certainly was a plethora of information to wade through in the pre-market. Jobless claims rose to 321K, almost smack on target (320K) and though up, at a level indicating a sustainable jobs market. Indeed, the jobs report jumped to a record level. The Bank of England left interest rates steady. China raised bank reserve requirements (for the sixth time since June 2006). Norfolk Southern railroads announced rail rates were lower and carload volumes were lower as well. Talk about a mixed bag. How would the market sort it out?

From the look of it, it ignored it all. They sized up the news and opened flat to lower. Once again, however, they started a slow, steady rise. Indeed, the price action resembled that seen in a strong bullish run higher: steady moves up, tests back to the 15 minute moving average, then another steady move higher. We anticipated some selling attempts to stall the move out heading into the long weekend and ahead of the Friday jobs report, but sellers didn't want any of that. Sure there were a couple of tries to take it lower, one right before lunch and then again in the last hour, but the market shook it off.

Ever since the two sharper down sessions two weeks back the sellers have left the building. Upside volume has not really surged (though it was fairly solid on NASDAQ Tuesday), but with the sellers AWOL, stocks could drift higher toward the prior highs. Enough so that NASDAQ and DJ30 put together a string of 6 straight upside sessions.

Technically the action showed decent price gains once more with leadership from technology (mainly large cap), some energy, metals, chemicals - - much of the same crowd crowding the leader board of late. Tuesday renewed the follow through and breakout off the early March double bottom, and Thursday and Friday kept the move alive. There was no volume as expected, and breadth remained modest. No surprises there. It was the lack of interested sellers versus a run of new buyers that is keeping this slow rise toward the February highs on track.

Some volume would be nice after the holiday to take on the prior high. If it does not get it, the ability to take out that high and continue on is low, likely leading to a test of the prior low, and that means another decline. For now we ride the move higher for what it will give us, then size up the next move when the indices start approaching those highs and exhibit signs of balking such as slowing moves and narrowing ranges, stocks leading higher starting to distribute, sharp intraday reversals. Those are classic signs when an old high is approached and a stock or index is preparing to give back some of the run.


Bond yields rising again, helping the Fed in a tough spot.

We have written about the lingering inflation that is dogging the economy thanks to interest rates held too low for too long and an initial stimulus package that only fanned demand during the economic slowdown when demand had held up quite well. Of course, the levels of inflation as measured by the Fed and its PCE and CPI are debatable; is 2% the limit the economy can withstand? Highly doubtful. It is a level the Fed has chosen, however, so that the Fed can foist upon us the policies and thus the control as it is directed by the powers that be such as administrations and the ultra rich.

That heightened inflation reading, however, is something we have to deal with because the Fed is using it as its monetary policy guide. Thus the rate hikes started by Greenspan and continued for a time by Bernanke. An interesting thing happened along the way to fixing inflation, however. The bond yield curve inverted during Greenspan's tenure. A flat curve (short term bond yields roughly equal to long term) historically suggests slowing to flat economic growth. An inverted curve (short term yields above long term yields) historically suggests recession.

There was a twist, however, due to an unquantifiable bid in US treasuries due to the 'recycling' of US dollars back to the US as part of our large trade imbalance. One of the chief sources of dollars for treasuries is OPEC as those 'petro-dollars' are turned back to the US in exchange for US treasuries which are, basically, IOU's to pay at some point. This large amount of dollars due to the price hike in oil buy treasuries, and as bonds are purchased and 'rally,' bond rates are pushed lower. The rub as Shakespeare put it, is no one, not even Greenspan, knows how much of an impact there is on treasuries.

What is more interesting is how the yield curve has responded to the Fed's actions as the economic expansion aged. As the Fed remained hell bent on stamping out inflation and talked tough about doing so, the yield curve inverted and remained inverted. As Bernanke took over and talked to Congress early on in his tenure, he got a bit too lax with respect to inflation, indicating it was possible the Fed could up and pause. The curve flattened and even reverted for a brief point; then the Fed came out with fire and brimstone, basically saying Bernanke spoke too loosely and was not being literal. The curve inverted again. Then when the Fed paused the curve reverted again. Once more, tough talk ensued and the inversion returned. After that first rebound following the 'pause' comment we opined that the market was telling us that if the Fed would lay off the curve would revert. That suggested that the market viewed the Fed's action as overreaching, i.e. likely to lead to a recession in the future.

Now with the last statement where the Fed dropped the 'further tightening' language the curve has reverted and is holding it (4.62% versus 4.68% Thursday). That suggests that despite the inflation, the market views the Fed backing off as helping preserve the expansion. Rates rise when there is economic expansion. The Thursday close put the 10 year back at the February highs. Thus the yield curve has reverted and higher rates show demand for money down the road. Higher rates are also doing the Fed's job for it if you view monetary policy only through the prism of rate hikes. Bernanke has shown us it is much more what with his rather sage management of money supply that Greenspan kept at a high growth rate thus fueling the inflation he was hiking rates to combat. Nonetheless, if it is rates you are worried about with respect to the Fed, the 'natural' rise in rates of late means the Fed is very much out of the rate hike game for now.

Jobs rebound, unemployment fades to cycle low, wages continue modest rise.

Jobs blew past expectations, coming in at 180K versus 135K expected. January and February were revised 16K higher each, bringing the 3-month average up to 152K. The unemployment rate, the so-called household survey, fell to 4.4%, matching the cycle low hit in October. Wages rose 0.3%, in line with expectations and roughly matching the range shown the past quarter. Wages grew at a 4.0% rate year/year. At this stage of the cycle they are showing the gains typically associated with an expansion. In other words, despite what many like to say, wage growth is following the typical path: it lags the overall economic recovery, gaining strength well after the recovery is underway and employment heads toward capacity.

That brings up two important points regarding the employment data. First, it is lagging. As noted, wages start to log their best gains well after the expansion is underway. Thus while it is nice to see strong employment, it does not answer the question of where the economy stands with respect to the future. It is similar to beating a weak team at the first of the season; it is nice, it is expected, but it does not tell you much about the strength of your team. Thus the economy could be slowing even as the jobs report strengthens. Indeed that is what we are seeing, but as we have said many times, this is not a serious economic slowdown, just a mid-cycle economic slowing.

Second, the payroll numbers are not as accurate as the household survey depending upon what type of recession and recovery you have. We all remember Greenspan opining to Congress that the payroll report was the most accurate, and thus the moniker 'jobless recovery' attached to this expansion. As history has shown, Greenspan was wrong on many occasions, and this is just another one in the list. The household survey or unemployment reading, however, showed consistently strong jobs growth. When people were asked if they had a job, more and more were saying 'yes,' much more so than the payroll figures reflected.

What happened was big business stopped investing and spent three years cutting its workforce sharply. With no jobs coming from the 'traditional' means, those ex-employees had to find means to make money. Thus the explosion in Subchapter S and limited liability corporations as thousands and thousands of new businesses were born. The government data did not reflect this because it was looking in the wrong places. Not until two years after the surge was this known by the government because it takes that long for the feds to acquire and analyze the data from tax returns and other filings.

Thus this recovery was much stronger than first thought. In addition, the wages are much better than thought as well. Again, the government figures focus on the non-farm payrolls for their wage data, but with big companies, the 'traditional' hirers for many workers, laying off workers and increasing productivity, wages did not grow. The government cannot accurately measure self-employed workers wage growth, however, so it has no real idea whether wages are growing for all of the new businesses spawned by the tech boom to bust plunge. It has thus grossly misjudged the strength of the US worker/entrepreneur.

The empirical evidence shows it did just that. The housing boom attests to the incomes and optimistic views of US citizens. Spending and consumption boomed. Business investment boomed as those hundreds of thousands of new businesses bought capital equipment, aided by the much more generous expensing options contained in the Bush tax cuts. If wages are low and the outlook for jobs and income are poor, consumers don't spend. The data rebut that emphatically.

In sum, the jobs data is closely watched and is great political fodder. It does not tell you about the current economic strength, however, nor does it even accurately measure jobs in the modern economy. Futures were up on Friday after the jobs report. Whether they can hold over to Monday remains to be seen, but it is rather false optimism; things were good enough to hire more workers, but as we know, CEO confidence also lags the economic cycle, missing the tops and the bottoms.

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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