Market Commentary

In my view June’s unemployment data was disappointing.
July 06, 2010

In my view June’s unemployment data was disappointing.  Even though the unemployment rate did decline as I had expected to 9.5%, the reason for this drop was one of weakness.  Or was it?

Several times I have noted a small group of economists/academics who believe the unemployment rate is about 100 to 150 basis points lower than reported.  This group hypothesizes 40% of people on the lower socio economic rung of the proverbial ladder are collecting benefits but are also working part time in an underground economy, not reporting their wages. 

The rationale for this belief is simple.  Consumer spending is not consistent with a 9.8% unemployment rate and the sharpest drop in consumer credit in history.  Where is the source of funds supporting these purchases?  The data is missing something.

As inferred above the accepted reason for the decline in the unemployment rate was a function of workers leaving the workforce, not greater hiring.  Individuals no longer seeking employment, a criterion required for unemployment insurance.

The next three months’ will be critical in determining whether or not the hypothesis of the above mentioned economists/academics is accurate.

For what it is worth department, private sector payrolls rose by 83,000 versus the consensus view of 110,000.  Average weekly hours declined 0.1 hours instead of remaining flat and average hourly earnings fell by 0.1% as opposed to rising by 0.1%.

I believe I must write the hurdle was extremely low but many, including me thought the data could be the proverbial “Hail Mary” that could end the current slump in equity prices.

Earning season commences next Monday with the release of Alcoa’s second quarter results.  The market is suggesting that estimates for profits [and economic growth] may be too optimistic given the 16%-18% decline in prices during the last 60 days. 

Currently the S & P is trading at 12.6x project profits, the lowest level since March 2009.  Bloomberg stated the S & P has traded at an average multiple of 16.4x since 1954.  The economy is projected to grow by 3.2% in 2010, the greatest growth rate since 2004, also as per Bloomberg. Treasury yields are at or approaching generational lows.

In my view a dichotomy has evolved.  Either the markets (both treasuries and equities) is correct or analysts.  Rarely do I go against the treasury market; especially as this the market exerts the greatest influence on equity prices. However today is an exception.

I reiterate my long held view the massive amount of excess cash on both corporate balance sheets and excess bank reserves have gravitated into treasuries thus driving yields lower.  Behavior 101 dictates we fear more of the unknown than known.  All have shallow scars from the horrid events of fall 2008/winter 2009, events that have forever altered Wall Street and the psychics of investors for at least a generation.  And then there is Washington where even those left of center are questioning today’s progressive agenda and the potential damage that could occur. 

All must remember markets are people and people move markets, hence the decline in treasury yields and stock prices, a decline in equity prices perhaps magnified by the impact of algorithmic trading, a strategy that is now 82% of volume.  As inferred this type of trading is based upon mathematical assumptions not fundamentals.  Math is math and most and it is my understanding there is little difference from one firm’s model to that of another.

However it is my belief once something is generally accepted the inverse occurs.  It is against this backdrop why I believe the odds are over 75% equities should rally from vastly oversold levels.  The pessimism is so deep, values are so compelling.

Unfortunately only history will suggest whether or not I am correct in this belief.

Commenting briefly about Friday’s markets, stocks were down in excess of 1% in light holiday trading as the result of the unemployment data but rallied the final 45 minutes posting a nominal gain but  to close about 50 points lower on an abrupt wave of selling that occurred in the last five minutes.  I ask what impact did quantitative trading have upon the averages?  Treasuries were quiet.

What will happen this week?  The economic calendar is light for the exception of today ISM non manufacturing index.  This relatively new but high profile statistic is expected to post a 55.0 reading.

Last night the foreign markets were up.  London was up 2.12%, Paris up 2.79% and Frankfurt up 2.04%.  Japan was up 0.77% and Hang Sang up 1.22%.

The Dow should open moderately higher.  As per Bloomberg analysts are rising earnings estimates for US companies at the fastest rate since at least 2004.  The 10-year is up 3/32 to yield 2.96%.