Dealing With Economic Wild Cards 

Kristina Hooper 

The Upshot 

11/11/2013 

US investors have witnessed a string of surprises lately ranging from Fed policy to job growth. Parsing conflicting news on the health of the economy can be challenging, but not impossible, writes Kristina Hooper.
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Kristina Hooper, US Investment Strategist and Head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

In today’s economy, surprises seem to be the norm.

On Friday, the Bureau of Labor Statistics released a surprisingly positive jobs report, which showed that the US economy added 204,000 jobs in October, well above the 120,000 jobs economists were expecting. It was the first time non-farm payrolls exceeded 200,000 jobs since March. And private payroll growth was even better, adding 212,000 private-sector jobs. Further, September non-farm payrolls were revised upward to 163,000, and August non-farm payrolls were revised upward to 238,000. That’s a net gain of 60,000 jobs in two months. Stocks rose in response to this report, while Treasuries sold off in anticipation of the Federal Reserve paring its bond purchases sooner.

The November jobs report would have to confirm the positive surprises seen in October—and some improvement in the areas of weakness—before the Fed acts.”

Perhaps this is the season for surprises: The Fed’s decision not to begin tapering in September. The glitches plaguing the launch of the Affordable Care Act website. And the ECB’s unexpected interest-rate cut last week.

Conflicting Signs

Logically, there are sound reasons to be shocked and somewhat incredulous about this jobs report. First, the October ADP report, which has become a good predictor of private-sector job growth, showed a smaller-than-expected rise of 130,000 jobs. And the September ADP report was downwardly revised by 21,000 jobs to 145,000. Second, we’re seeing headwinds for job growth. For example, Challenger, Gray & Christmas found that US companies averaged more than 45,500 layoff intentions in the past three months, an increase from the less than 38,000 in the four prior months. But it’s not just job growth. Initial jobless claims have also spiked recently.

Still, business confidence has rebounded significantly, as we’ve seen in recent PMI readings, suggesting companies’ greater willingness to hire. But if there was such robust job growth, one would think we would see it reflected in consumer sentiment and spending. Yet consumer confidence is down. The University of Michigan’s consumer sentiment index came in at 72, extending its recent free fall. The biggest area of weakness was in expectations at 62.3—a big drop from July's peak of 76.5—which usually reflects employment conditions and outlook. This is borne out in spending statistics. For example, in September, consumer credit rose $13.7 billion, higher than expectations. But in a continuation of a trend we’ve seen for a while, the growth came entirely from non-revolving credit, which rose $15.8 billion. Drilling down, the increase in credit was largely due to the government’s student loan purchases. Meanwhile, revolving credit is down $1.2 billion, marking the fourth straight monthly decline, and suggesting anemic consumer spending.

The labor force participation rate dropped to 62.8%.”

Taper Timeline

Undoubtedly, the latest jobs report raises questions about the Fed’s next move. Keep in mind that, while there were some positive surprises in the report, there were also some disappointments. The unemployment rate rose to 7.3% while wage growth gained only 0.1% for average hourly earnings, which was lower than expectations and flat from the previous month. The average workweek remained at 34.4 hours, in line with the previous month but below expectations. And perhaps most notably, the labor force participation rate dropped to 62.8%. It’s important to note that this drop in the participation rate could be due to a misclassification of federal workers temporarily laid off, which means they avoided contributing to the higher unemployment rate. In other words, the 0.4% drop could have prevented the jobless rate from rising more than 0.1%.

Shrinking Work Force

So, while the October jobs report increases the chances of tapering beginning in December, it seems that central bankers want to see more affirming evidence. The November jobs report would have to confirm the positive surprises seen in October—and some improvement in the areas of weakness—before the Fed acts. Remember, the Fed said in October that it would wait for the labor market to improve “substantially.” It certainly has the luxury of time given that inflation remains low. In addition, we think it’s quite plausible that when tapering begins, the Fed will also lower its unemployment target—as suggested by several reports from Fed officials last week—to ensure rate expectations remain very low until 2015.

It’s been said that, “There is only one kind of shock worse than the totally unexpected: the expected for which one has refused to prepare.” While the October jobs report was a stunner, we need to brace for the known risks that we’re ill equipped to manage.

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Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. It is not possible to invest directly in an index.

Purchasing Managers’ Indexes (PMI) are economic indicators derived from monthly surveys of private sector companies. The Chicago-PMI survey registers manufacturing and non-manufacturing activity in the Chicago region. Investors care about this indicator because the Chicago region somewhat mirrors the nation in its distribution of manufacturing and non-manufacturing activity.

Thomson Reuters/University of Michigan Surveys of Consumers is a consumer confidence index published monthly by the University of Michigan and Thomson Reuters. The index is normalized to have a value of 100 in December 1964. At least 500 telephone interviews are conducted each month of a continental United States sample (Alaska and Hawaii are excluded). Five core questions are asked.

Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.


A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
 
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 

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