VERSACE: One month does not mean a trend

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ANALYSIS/OPINION:

Over the past several weeks, the stock market has wound its way higher as evidenced by the 8.5 percent climb in the Standard & Poor’s 500 index since early June. Even though the stock market has moved higher, the fundamental economic data that many use to gauge the health the U.S. economy and the global economy, as well as corporate earnings, has slowed. The fuel behind the rise in the stock market has been hopium-filled prospects for additional stimulus here in the U.S. as well as similar efforts in China and the eurozone.

Adding wood to the hopium fire came this week in the form of August purchasing mangers’ surveys in the eurozone and China. New orders dwindled in the eurozone, suggesting the outlook for the 17-nation economy remains poor. In China, the August data showed a stagnation of growth as manufacturing output declined and the services sector continued to slow.

While we have yet to hear from China in terms of further easing, on Thursday the European Central Bank announced its “Monetary Outright Transactions” program, or MOT. That program includes a new and potentially unlimited bond-buying program to lower struggling eurozone countries’ borrowing costs and draw a line under the debt crisis. This contributed to Thursday’s relief rally in the stock market.

But in tandem with the announcement of the bank’s monetary program, the bank also cut its growth forecast and raised its inflation expectations. Three months ago, the central bank forecasted growth between -0.5 percent and -0.3 percent for this year and 0 to 2.0 percent in 2013. Based on continued weakness, it now sees gross domestic product for this year to a fall between 0.6 percent and 0.2 percent, with expectations for 2013 ranging between -0.5 percent to 1.4 percent. In terms of the bank’s revised inflation expectations, prices are seen ticking up even more so this year and next year than it had expected just a few months ago, which likely reflects higher food and energy costs.

Based on that revised forecast, it seems the European Central Bank did not so much choose to enact its monetary program, but rather it had to.

Several weeks ago, the notion of another round of easing from the Federal Reserve was close to a foregone conclusion in some minds. Yet in recent weeks, favorable data from the housing, automotive and aerospace industries have pointed to some strength in the economy. Add to this the stronger than expected July Employment Report from the Bureau of Labor Statistics and the private sector job surge reported by ADP’s August Employment Report and the need to ease may not be as dire as was thought just a month or two ago.

Just because we have gotten some favorable data does not mean we are out of the woods just yet. In recent months, data in the form of the Institute for Supply Management manufacturing index revealed a contracting manufacturing economy colored by eroding orders. Falling orders reduce the outlook for manufacturing activity in the coming months, and weak orders since June are now starting to flow through in the August production data. As one would expect, the continued weakness in orders means slower business activity ahead, and that means the need for more workers will also slow if not contract. In other words, slower job growth ahead.

As the saying goes, one month does not make a trend, and to be fair there has been some discrepancy between the number of jobs created as reported by ADP and those by the Bureau of Labor Statistics. With the Fed eyeing unemployment in the country as a barometer on which to act, Friday’s August Employment Report will be closely watched, prodded and dissected.

The reality is if the ureau of Labor Statistics’ read on August job creation is in sync with ADP’s results and therefore better than expected, the odds are against the Fed easing further next week at its policy meeting. If the jobs figure disappoints, it is bound to once again raise questions about the effectiveness of President Obama’s economic initiatives. If the August jobs figure is as expected that means we will have 42 consecutive months with the unemployment rate above 8 percent.

Chris Versace is editor of the PowerTrend Brief and PowerTrend Profits newsletters. Visit them at ChrisVersace.com or follow him on twitter @chrisjversace. At the time of publication, Mr. Versace had no positions in companies mentioned; however, positions can change.

About the Author
Chris Versace

Chris Versace

Chris Versace, the “Thematic Investor,” is the director of research at Think 20/20, an independent equity research and corporate access firm located in the Washington, D.C. area. Before Think 20/20, Mr. Versace was the portfolio manager of Agile Capital Management (ACM), a thematically driven alternative investment fund. The groundwork for ACM was laid during Mr. Versace’s tenure as senior vice president of equity ...

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