More Risk to this Bull Market Than Meets the Eye

Jesse Pound and Maggie Fitzgerald of CNBC report the Dow falls after big jobs report miss, tech stock gains limit losses:

The Dow Jones Industrial Average retreated on Friday and the S&P 500 slipped from a record high after the August jobs report came in short of expectations, showing the impact of the delta-fueled Covid resurgence.

The Dow lost 74.73 points, or 0.21%, to 35,369.09, while the S&P 500 edged lower by 0.03% to 4,535.43 after holding a slight gain in afternoon trading. The broader market index was supported by tech stocks, which helped to lift the Nasdaq Composite by 0.21% to 15,363.52.

Nonfarm payrolls increased by 235,000 in August, the Labor Department said Friday. Economists surveyed by Down Jones were expecting 720,000 jobs. The report marks a significant slowdown from July’s revised number of 1.053 million and comes as the delta variant of Covid-19 has led to health restrictions being put back in place in some states and cities.

Federal Reserve Chairman Jerome Powell has emphasized the need for more strong jobs data before the central bank would start to unwind its massive bond-buying program, and the disappointing report could change expectations about when the Fed will start its tapering process.

“A surprisingly low jobs number this morning clouds the tapering outlook considerably as only 235k jobs were added in August, likely giving the Fed pause and pushing out their plans to announce their bond taper plans,” Chris Zaccarelli, chief investment officer for Independent Advisor Alliance, said in a note. “Many people believed that the Fed would announce their taper plans at this month’s FOMC meeting and that is no longer likely.”

The report raises questions about the long-term growth trajectory for the U.S. economy, but the impact of the Fed appeared to be offsetting that in Friday’s trading, said Yung-Yu Ma, the chief investment strategist at BMO Wealth Management.

“The early reaction was more difficult, but there’s at least some comfort now that the Fed pushing back tapering, and maybe increasing accommodation for longer in general, is at least giving the market some comfort,” Ma said.

The central bank will also be looking at how much Covid impacted hiring and activity during August. The virus variant has been a wild card for the economy, and its impact could be a factor that sways the Fed as it considers the first step away from the easing policies. Leisure and hospitality, which is the sector hit hardest by the pandemic in 2020, added zero jobs in August, according to the report.

Modest gains for major tech stocks including Apple and Nvidia supported the market indexes. Home builder stocks including Lennar and PulteGroup were under pressure, along with cruise stocks. American Express was the worst performing component in the Dow as financials stocks struggled.

Goldman Sachs chief economist Jan Hatzius said on “Squawk on the Street” that the impact of the delta variant could weaken in the months ahead, with cases and hospitalizations now declining in some states, and that the overall report was more of a “mixed picture” than the headline miss suggested.

“I think there is reason to believe the situation is improving somewhat and we’ll get better [jobs] numbers in coming months,” Hatzius said.

In a press conference on Friday, President Joe Biden touted the average monthly job gains since he took office and lower weekly jobless claims, and called for more vaccinations and for Congress to pass infrastructure and budget bills. Biden also said states should consider using federal relief money to extend enhanced unemployment benefits, which expire this week.

“Even with the progress we’ve made, we’re not where we need to be in our economic recovery,” Biden said.

The Nasdaq was the best performing index for the week, rising 1.5%. The S&P 500 gained roughly 0.6%, while the Dow shed about 87 points, or 0.2%. 

Alright, it was another busy week, so let me get to it.

First, the US jobs report, it was weak, missing expectations by a mile. As I keep telling my readers, it's impossible to guess US nonfarm payrolls and on any given month, the numbers can swing wildly (both ways), especially now that the delta variant is rampant.

CNBC's Thomas Franck looked closely at where the hiring took place in August:

The hiring blitz at bars, restaurants and hotels came to an abrupt halt in August as more Covid-19 cases and a scarcity of willing workers kept employers from adding to payrolls.

The broad leisure and hospitality sector, which includes restaurants and lodging, added a net of zero jobs last month. That’s a remarkable stop to a sector that had jumped by an average 350,000 per month over the prior six months.

A closer look within the sector shows a loss of 42,000 jobs in food services and drinking places offset by a gain of 36,000 jobs in arts, entertainment and recreation.


The headline numbers from the August jobs report showed the U.S. economy added just 235,000 jobs last month, well short of the 720,000 expected. The unemployment rate fell from 5.4% to 5.2%. CNBC studied the net changes by industry for August jobs based on data contained in the government’s employment report.

The Labor Department noted the flat employment in leisure and hospitality coincided with a drop in consumer confidence, which fell in part due to concerns about rising Covid cases last month due to the delta variant.

Leisure and hospitality added 2.1 million jobs from February through July — half of all U.S. jobs added over that period. The Bureau of Labor Statistics said leisure and hospitality employment is 10% below where it was in February 2020.

The “headline number is obviously disappointing – much lower than expectations – and markets will react. But the interesting question is why the number is so low,” Commonwealth Financial Network chief investment officer Brad McMillian wrote.

“Looking at the unemployment and underemployment numbers, which dropped, as well as the labor force participation rate, it looks to have come from workers electing not to enter the workforce,” he added. “This ties the shortfall to the pandemic, again, rather than to general economic weakness.”

Retail trade, which has lost jobs over several years, shed 28,500 positions in August. Food and beverage stores, as well as building material and garden supply stores, saw net job losses of 23,200 and 13,000, respectively.

Building and garden shops likely saw payrolls decline ahead of the cooler months and a deceleration in Covid-era at-home projects.

On the upside, manufacturers had a decent month with 37,000 new jobs amid strong hiring at transportation equipment makers. Factories that produce cars and car parts saw some of the sector’s strongest numbers, up 24,100.

Transportation and warehousing came out best in August with a gain of 53,200 net payrolls. The Labor Department said warehouses and other storage facilities added 20,200 jobs while air transportation advanced by 11,400.

While economists will analyze the latest jobs report in detail, Mitch Bollinger, VP product Research at Markov Processes International (MPI) posted this on Linkedin:

With employment data coming out today, I think it is helpful to step back a bit and put our current employment situation in long term historical context. To do this I show the employment to population ratio which does away with all of the adjustments for the number of job seekers, the number of people on permanent disability, etc.

See that the current employment to population ratio is right in line with what it was at the depths of the GFC which I would suggest this is not good. We can run some back of the envelope calculation and see that today's employment to population ration of 58.5% is fully 6.2% lower than its peak in 2000 of 64.7%. We currently have a working age population of 205M so this equates to 12.7M jobs we are short compared to we would be if the employment to population ratio were what it was in 2000.

This gives you good perspective on how weak the US economy remains from an employment perspective and suggests the Fed will not taper this year. 

But not everyone is convinced the Fed will pause its tapering in spite of clear evidence the economy is slowing.

In his latest comment which came out on Thursday, Yes And No Taper To Labor (and inflation), Jeffrey Snider of Alhambra Investments writes another doozy (h/t: Mathieu St-Jean):

It doesn’t really make much sense, does it? If you stop and think about it for more than a quick second, this notion of a labor shortage doesn’t get past the smell test. The economy overall is, we hear, booming. Really booming. And it’s booming in a way that has the labor market healing far faster than thought not long ago (setting aside, for now, how we’ve heard this a few times before). So fast, even the cautious Jay Powell is rethinking his models into tapering his QE.

Yet, American workers already sidelined by two huge recessions (we still hadn’t recovered from the prior one) just are not streaming back into the workforce like they would if any of the above were true.

The only way to attempt to reconcile this booming economy with that damning labor force contradiction is by way of some presumed labor shortage. Companies are, according to this view, falling all over themselves to find workers, but are unable to procure their labor because of the overly zealous government handouts rendering employers’ preferred wages uncompetitive.

It sounds plausible enough in a vacuum of ceteris paribus, especially since pockets of such anecdotal complications are easily spotted throughout the US. However, if business was as incredibly robust as all this, then an extra $300 per month wouldn’t really be much of an impediment to buzzing businesses more concerned about keeping the good times rolling in.

If things are this good, what’s stopping them from paying the market-clearing wage?

The logical, rational answer is: maybe things aren’t “this” good after all. Or, at best, maybe the situation is alright even relatively good (better than last year isn’t a high bar, though) right now, but perhaps companies are a bit more concerned about whether it will or even could last much longer.

In either of those scenarios, in the aggregate firms would continue to operate more cautiously, content to over-manage their costs in exactly the same way as they had been, frustratingly, since 2009. Practically everyone’s biggest cost is, of course, payrolls.

It is not a labor shortage when businesses say they want more workers but won’t or can’t offer nearly enough for those prospective employees to come off the sidelines. Not a labor shortage but an economy shortage.

And maybe the best single example of this is the ISM’s PMI estimates. Being September 1, that means the ISM reports today its estimate for August 2021 manufacturing. The headline index bucked the recent trend, mildly, by rising 0.4 pts to 59.9 from July’s 59.5. These are 2018-type numbers, so already nothing really extraordinary.

They do stand in sharp contrast to one particular subset mixed up in the overall calculation: the ISM M’s employment subindex. This part has been “unusually” weak since peaking all the way back in March (again, March and April show up everywhere around the world). But even in March, and going back to last year’s recession, this substantial difference between the headline index and its employment component stands out.

No more so than this latest update for the month of August when the ISM reports a few more manufacturing employers said they cut workers than replied they had added them; the subindex dropped from nearly four points, from 52.9 in July to just 49.0 in August. It was the second month below fifty out of the last three.

In other words, according to the ISM (and we’ll see on Friday if the same holds for their Services PMI in August as it already has up to last month) it sort of looks like manufacturing is doing well except that these businesses aren’t really hiring as if that was the case; an excellent example of this labor “conundrum.”

COVID? Cold/warm weather? Xi Jinping’s crackdown cybergoons? What was it about March/April (or February around the 24th and 25th?)

Before thinking about the shrinking possibility the labor market’s apparent problems might really stem from some shortage, payroll processing provider ADP today also released its payroll number for the same month of August 2021.

In years past, +374,000 (private) would’ve been decent even excellent; in 2021, it counts as a pretty sizable disappointment and for the second straight month. This is about half the monthly rate set by, and expected for, the taper-rationalizing Establishment Survey.

And it is uncomfortably too close to slowdown pattern showing up in the ISM’s; along with the same apex falling right after March/April. Even ADP’s resident Economist couldn’t deny this “unexpected” detour:

Our data, which represents all workers on a company’s payroll, has highlighted a downshift in the labor market recovery. We have seen a decline in new hires, following significant job growth from the first half of the year.

Lazy Americans too comfortable at home eating off Uncle Sam’s leftover nickels? Or, US businesses which have realized once those nickels fade into history the economy probably, even very likely doesn’t look anything the same as the “red hot” frenzy of ISM’s and retail sales (or PCE) from earlier this year when the government’s expensive helicopters flew freely.

The former a labor shortage quite like the imaginary one from 2018 which didn’t sway much back then, either. The latter, all-too-consistent with data, evidence, actual markets, etc., all but the mainstream economic narrative in that same way, too. Even the Establishment Survey and the Unemployment Rate find themselves in isolation once more, as there are any number of alternative employment data – a few shown here – which are looking at ostensibly the same thing, the labor market, and coming up with a grossly different picture of it.

Even if there had been a worker shortage, much of this data indicates the growing possibility of its past tense.

The most probable, and logical, interpretation is an economy materially (and predictably) slowing down more likely never having had the jobs situation tighten as much as had been said. If the FOMC holds to type, they will taper anyway on the advice of their true “love” while in the end, yet again, it won’t make one bit of difference.

Yes, taper; no tantrum. No labor shortage; yes, another summer slowdown.

In my opinion, Snider nails it here and people will do well to listen to him because he's been calling the slowdown and the direction of yields right. 

By the way, long bond yields backed up a smidgen today following the jobs report but they remain near historic lows with the 10-year Treasury yield at 1.32%:

Not surprisingly, the market is sniffing out an economic slowdown and that's why "defensive" big tech companies have been rallying lately whereas financials, industrials and energy stocks (cyclical sectors tied to the economy) have been lagging:

You also saw the same reaction today with growth and hyper growth stocks rallying whereas anything related to the recovery/ re-opening trade got slammed hard:

Rising Covid-19 cases among the unvaccinated is also influencing markets and the CDC has advised unvaccinated Americans against traveling over the holiday weekend, worried the festivities could kick off another surge in cases. 

So, if the economy keeps slowing and yields stay low or even unexpectedly start declining, you'd expect large cap growth stocks to continue doing well going into year-end. 

But if inflation proves stickier than originally thought and yields start rising or the Fed starts tightening, this will impact growth and hyper-growth stocks.

In his latest weekly market comment, Francois Trahan of Trahan Macro Research points this out: 

Institutional investors should take the time to read Francois's latest comment, he goes over 10 macro checklists as to why a correction could be looming ahead. 

Nonetheless, after a  weak jobs report, some strategists say investor focus may stay on strong profit growth rather than other potential negatives:

Stocks were mixed in the past week ahead of the long Labor Day weekend, with the Nasdaq outperforming, the S&P 500

Hogan said investors expect the trading activity to pick up as a result, but it typically remains slow in the holiday shortened-week. Investors may assess their summer performance and move to lock in gains or add hedges.

“If you look back at the last five post-Labor Day weeks that have happened with the market near all-time highs, the post Labor Day week is the worst for September,” Hogan said.

Friday’s disappointing August jobs report — with just 235,000 jobs added — was a dampener for sentiment, but stocks were mixed.

“My outlook for the last several weeks is sideways to moderately higher, and that seems where they’re headed. There isn’t a lot of bearish data accumulating. At worst we go sideways,” said Randy Frederick, Charles Schwab managing director of trading and derivatives.

Frederick said even with worries about the weaker jobs and Covid,-19 investors may continue to focus on profits. Economists blamed the spread of the Covid delta variant for the weaker than expected jobs report.

Strategists say other issues for stocks in September could include the efforts in Congress to pass infrastructure legislation and possible new taxes.

Ignoring jobs report

Frederick said he expects the market to look beyond the August employment report, which was about 500,000 lower than expected.  

“I don’t think there’s spillover much into next week for the most part,” he added. “The markets are down a little bit, but I think they’ve taken it in stride better than might be expected.”

“You’ve got this Labor Day effect. People are back from vacation” in the coming week, National Securities chief market strategist Art Hogan said.

Weekly jobless claims data Thursday could be even more important than usual because of the big miss in August’s employment report. Jobs data is important because that is one area where Federal Reserve Chairman Jerome Powell said he would like to see more improvement before the central bank can decide to slow its bond purchases.

The market has been fixated on the Fed’s move to end its $120 billion a month bond-buying program because it is viewed as a precursor to interest rate hikes. However, Powell has stressed the two are not linked.

“If feels like [the jobs report] pushes the announcement of a taper to the November meeting, rather than the September meeting, and for the most part that was consensus,” Hogan said.

Hogan said the market will also be watching any inflation-related data, so that makes Fridays’ producer price index important after it surged last month. The consumer price index, released the following week, will be even more important for the market.

NatWest Markets head of macro strategy John Briggs said the markets will be watching for any Fed-related headlines after the disappointing employment report.

“Next week, you have [New York Fed President John] Williams speaking. His take will be important. He’s viewed as being close to Powell,” Briggs said. Williams is set to speak Wednesday at a briefing on the economy.

What’s next for stocks

Besides the Fed, the next big event for stocks will be the third-quarter earnings season, which gets underway in early October. Before that, investors will be watching for any company comments on results.

Frederick said the strength of earnings has been propelling stocks and could keep doing so. ″The market was so overvalued for awhile until earnings caught up, but earnings were spectacular and now the valuations aren’t as high as they were a few months ago, so we can do this,” he said.

Earnings are expected to increase by 29.8% for the third quarter after the second quarter’s stunning 95.6% increase, according to Refinitiv.

“There’s a vacuum of earnings related news,” Frederick said, noting the market could be influenced by geopolitical events in the meantime.

But even if the market loses steam, he doesn’t expect a major sell-off because for now, dip buyers continue to come in whenever the market has a setback.

The S&P 500 ended the week up 0.6% at 4,535, versus a 1.5% move higher by the Nasdaq to 15,363, a new high. The Dow was flattish, off 0.2%, at 35,369.

The closely watched 10-year Treasury yield was at 1.32% late Friday, just above where it was a week ago.

Still, it's probably wise to also look at valuations here as they are signalling trouble ahead. 

We Americans invest more of our 401(k) plans in stocks than in any other asset class. In total we hold 39% of the money in stock funds, and another 26% in “target-date funds” that, depending on your age, allocate smaller or larger amounts to the stock market as well. Most of that is in the U.S. stock market and most of it in the large-company stocks in the S&P500. So arguably nothing matters as much for the retirement prospects of tens of millions of workers than the current level of the S&P 500, and its likely future returns.

Before anyone gets complacent, and dismisses talk of a stock market bubble, take a look at this killer chart, which comes courtesy of money managers GMO in Boston.

It shows that today fully one quarter of U.S. stocks are selling for more than 10 times annual sales — a generally ridiculous level of overvaluation. It’s not just that this is the highest percentage of stocks selling for silly prices since the infamous tech bubble 20 years ago. It’s that historically we have never seen anything like it other than during those two episodes: 1999-2001 and today.

This doesn’t mean that the entire U.S. stock market is in a bubble. It means that there is undeniable euphoria when it comes to the sexy ‘growth’ area of the market.
Ben Inker, the head of investing at GMO and the author of the report, reminds us of just what “10 times sales” really means.

He quotes Scott McNealey, the CEO of Sun Microsystems, and his famous comments about it nearly 20 years ago, after the last tech bubble burst.

“Two years ago we were selling at 10 times revenues,” McNealey said in 2002. He talked through the impossible financial feats Sun would have had to perform to justify that stock price. “Do you realize how ridiculous those basic assumptions are?,” he asked investors. “What were you thinking?”

It was a good question. It still is.

GMO shows that, going back to 1980, stocks purchased at more than 10 times annual sales have overall been terrible investments, earning half the annual return of the overall S&P 500.

The late, great investment manager Peter Bennett used to say that a knowledge of financial history was even more important than a knowledge of financial theory. One reason: Stock market fashions go in cycles, they always have, and during each period investors insist the current fashion is permanent. (If they didn’t they wouldn’t buy the shares, after all).

Stocks generally fall into two categories, ‘growth’ and ‘value.’ (I sometimes think of them as ‘future’ stocks and ‘present’ stocks). So-called growth stocks are generally more expensive in relation to current sales, earnings and so forth because investors are betting on big things in the future. As with anything, you can pay too much. Everything has a price.

Right now we’re in a growth stock mania. The valuation gap between growth stocks and ‘value’ stocks is at near record levels, GMO data show. We’re not quite at the 1999-2000 levels, but we’re close.

Growth stocks have beaten value stocks by a wide margin over the past 15 years. But GMO analysis, echoing that of hedge-fund manager Cliff Asness, finds that this outperformance is entirely due to changes in valuation. Growth stocks have simply become much more expensive. To extrapolate that into the future is to engage in double counting, or circular reasoning.

Incidentally I should give a shout-out here to GMO co-founder Jeremy Grantham, who is too often dismissed as a “perma-bear.” In 2007, when ‘value’ stocks were booming and ‘growth’ was still in the doghouse from the dot-com bust, I met Grantham at an industry dinner. He told me then, presciently, that growth stocks that looked cheap. A terrific call.

It’s worth remembering at this point that the stock market is a giant, ongoing experiment in crowd psychology. Fashions and fads come and go. Human beings, after all, are merely the third branch of the chimpanzee family, and chimps are pack animals. To gamble that growth stocks will continue to outperform is, as Ben Inker argues, to gamble on multiple implausible mathematical assumptions. But it’s also to argue that human beings have stopped being subject to fashion and pack behavior on the stock market — a very long odds bet, I’d have thought.

We never know when the pendulum will swing back the other way. The past, of course, is no guarantee of future performance. But as a long-term investor here I’d rather own “value” stock funds than “growth” funds in my retirement accounts. I prefer the odds.

Great food for thought, remember, valuations do matter n terms of prospective returns, especially over the long run.

Lastly, if you're still not convinced there's a market mania going on, as Jim Keohane recently warned, take the time to read this tidbit from Martin Roberge of Canaccord Genuity from his latest weekly market wrap-up ("September 1999 Vibes?"):

Our focus this week is on the US technology sector and the possibility of another bubble brewing. With this week’s advance, the return of the S&P Technology sector has more than doubled (+125%) from its March 2020 low. As our Chart of the Week shows, looking at historical returns from 2-year lows, the performance of tech stocks in this cycle has now eclipsed the 2011 cycle. The next episode on the list is the 1999-2000 bubble. Can it really happen once again? Why not? After all, the seeds are similar, with central banks overstimulating after a global growth shock (i.e., Asian financial crisis in 1998 and global pandemic in 2020). Moreover, the US technology sector today (27x P/E) is cheaper than it was before the mania began in October 1999 (33x P/E) (second panel). Last but not least, today, the Fed is conducting a monetary experiment that could fuel such a bubble. Indeed, in contrast to Fed Chair Greenspan, who hiked rates six times to contain a jump in inflation from 1.9% to 2.8%, Fed Chair Powell continues adding punch to the bowl despite inflation surging from 1.3% to 4.2% (third panel). Yes, the latter will come down but our inflation models project a floor of ~2.5-3.0%, which means that real rates will stay hugely negative for another year, encouraging risk-taking behavior. Should other central banks follow the footsteps of South Korea and Chile in preemptively raising rates to guard against inflation and the build-up in financial imbalances, the Fed would become isolated quite quickly.

Will the Fed follow other central banks and start to raise rates? We shall see but as far as bubbles go, this will be the Mother of All Bubbles because all the major central banks unleashed unprecedented liquidity into the global financial system.

Also worth remembering Keynes' famous dictum on markets and bubbles: "Markets can stay irrational longer than you can stay solvent."

Below, as the S&P 500, Nasdaq hit record highs — three market experts look at what’s next:

The tech-heavy Nasdaq and broader S&P 500 are setting records after records.

Three experts joined CNBC to discuss where markets are headed next.

Mike Wilson, chief U.S. equity strategist at Morgan Stanley, says expectations may have been too lofty and a market cooldown could be healthy.

“We’ve seen consumer confidence … suggesting the consumer is fading a bit — not a recession but the consumer is tired — and that’s been our thesis all along. Is there’s going to be a payback here on demand? Overnight, our economics team actually lowered their GDP forecasts from 6.5% to 2.9% for the third quarter. They’ve kept their fourth-quarter number the same, but look, there’s risk to that probably if delta doesn’t fade or my view is that delta is a bit of a trap. People are saying, ‘Oh, the slowdown is due to delta.’ The slowdown is not due to delta exclusively. What it is due to is the fact that we overshot on the upside, we had monster stimulus and now we’re going to have some payback and that’s OK.”

Jeremy Siegel, professor of finance at the Wharton School, says the momentum trade is in full swing.

“I think we’re still in a bull market. I think long-term returns are not going to be as robust as they’ve been certainly over the last 10 years and maybe not even over the last 200 years, but still far ahead of inflation and way, way ahead of fixed income. Right now what’s going on is you’ve heard of this old expression on Wall Street ‘up a staircase and down an elevator.’ We’re going up the staircase. I don’t know when the elevator is going to come. But it looks like a momentum trade in the sense that it just keeps on going up a little bit every day, no real news to propel it. And a lot of momentum players piling on. We’ve had this before. And, you know, it’s very hard to say when it might end.”

Tom Forte, senior research analyst at D.A. Davidson, discusses one critical issue for the largest publicly traded company on Wall Street — Apple.

“My thesis is that over time that 30% commission that Apple collects from the App Store to decline to a lower number such as 10%. I think maybe the hope from some investors is that if Apple can make these adjustments on its own, it won’t require the government to step in and maybe come up with a more onerous solution for Apple. But I do think it’s curious that investors are giving the stock a pass on that important development.”

I wish all of you a great long weekend.