Covenant Weekly Market Synopsis as of September 9, 2016

September 12, 2016

“Is this the big one?” The question was asked around trading desks, office water coolers, and at dinner tables on Friday evening as equity markets woke from their protracted slumber (the S&P 500 had not moved 1% in either direction for 44 consecutive days), got out of bed and tripped on the dog, cat or goat that was sleeping nearby. Most developed market equity indices fell more than 2% on Friday, emerging markets declined more than 3% and the long dormant VIX Index (a measure of market volatility) jumped nearly 40% to 17.5. What was particularly interesting about Friday’s selloff was that traditional ‘safe haven’ assets like US Treasuries were also being sold, causing yields to push higher.

As of this morning, the selling is continuing though not with as much vigor (at least not yet). And it is too early to tell if those putting new money to work right now will be rewarded – ‘buying the dips’ has been a wonderful strategy over the last couple of years with central bankers providing a liquidity backstop that has supported markets pushing asset valuations ever higher. However, last week’s selloff was precipitated by growing concern that central bankers might be tapping the brakes on their largess (the ECB did not expand their quantitative easing program and members of the FOMC made comments in support of raising rates this year). Several members of the FOMC are speaking today and, given the market backdrop, their comments will be closely scrutinized. 

For what it’s worth, thus far this selloff does not appear to be the “big one” as various financial market stress indicators, like swap spreads between banks, remain contained.  That being said most rational people acknowledge that risky assets (equities and bonds) are expensive based on fundamentals, finding value only in relative comparisons to low interest rate levels. In some respects, the markets have come to exhibit the great fool theory with asset prices rising based on the belief that someone (i.e. a fool) will pay a higher price in the future. Similar to musical chairs, everyone knows that there are not enough seats in the game, but all the players believe/hope there will be one for them when the music stops.  We’ll see if Friday was just another skip in the juke box record (like August ’15 and Jan/Feb ’16), or if the music is really stopping.  There have been so many false breakouts it’s difficult to call, especially when the whisper from a central banker can start the juke box again just like The Fonz in “Happy Days”.

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What wages giveth, hours taketh away:  Although the recent Nonfarm Payrolls (aka the “Jobs Number”) showed a reasonably healthy 151,000 jobs were added in August, the average hours worked data belies that strength. The workweek declined from 34.4 hours to 34.3 hours in August – no big deal right? Actually it is a big deal because when that 0.1 hour per week reduction is multiplied by millions of jobs it results in the equivalent of losing 230,000 jobs in August. On an hours-adjusted basis, the six-month moving average of jobs created is only 91,000, having peaked in August 2014 (see chart below).


Sources: Labor Department and Covenant Investment Research.

While the market had its mind primarily on the hourly wage, ignoring hours actually worked leads to an incomplete and inaccurate picture.  Furthermore, looking deeper into the details reveals that some of the highest paid occupations (manufacturing and construction) are seeing the bulk of the reduced hours. (Source: Foleynomics).


Beige Book Blues: The Fed’s “Summary of Commentary on Current Economic Conditions by Federal Reserve District” is commonly (and thankfully, because that is a mouthful) known as the “Beige Book”. The Beige Book is published eight times per year and contains anecdotal information (collected through interviews with key business contacts, economists, market experts, and other sources) on current economic conditions in each of the twelve Federal Reserve Bank districts. The contents of the report generally offer little guidance on the direction of the economy because the varied data sources and breadth of the survey generate a lot of conflicting signals. However, that was not the case in last week’s Beige Book release which First Tennessee Bank (FTN) characterized as “awful” and Bloomberg’s Richard Yamarone wrote, “Sitting on the sidelines would be the most prudent move given the lackluster details of this Fed report.” FTN summarized the report as follows: “According to the survey, consumer spending ranged from ‘modest gains’ to ‘slowed noticeably.’ Prices ranged from ‘unchanged’ to ‘modestly higher.’ The most telling result, however, was the perception of overall growth in the twelve districts, which was ‘unchanged,’ ‘flat’, and ‘little changed’ from the last period, when the economy grew just 1.1%.” Just another reason for the Fed not to raise rates in spite of their stated desire to do so.


Bottom Line: We don’t believe that the Fed needs to raise rates because the economy is overheating. That’s not to say they won’t raise rates this year, but their reason for doing so would have more to do with putting bullets in their gun for the next recession than the current economic conditions.


Economic Data Wrap-Up: The August ISM Nonmanufacturing Index whiffed, recording a six-year low of 51.4. Though still in expansion territory (i.e. above 50), the combination of a slowing services sector (which along with housing was one of the very few areas of growth in the economy) and a manufacturing sector in contraction (last week the August ISM Manufacturing Index was 49.4) raised more than a few eyebrows. The combined reading of these two indices is now at its lowest level since 2010. Then again, these index readings represent a point in time and given that the survey came during the middle of the Louisiana floods, the readings may be an anomaly that the September data will shed additional light upon. The July Job Opening Labor Turnover (JOLT) report was very strong across the board, consistent with the strong payroll growth in July (+275k). The report did however provide further evidence that the labor market is, or has already peaked, as Job Openings (while still at very high levels) are plateauing on a 12-month moving average basis.

Be well and Godspeed,