David Joy: Pressure on stocks continues ahead of Friday's jobs report

While the monthly employment report is always among the most important of all economic data points, it is especially so for the report due this Friday on January’s labor market conditions. Current concerns over the pace of U.S. growth can be traced back to the weak December employment report, and a stronger showing this Friday would help those worries recede.

Of course, slower U.S. growth is not the only thing bothering stocks right now. The recent downdraft in equity prices began on Jan. 23, after the report that showed contracting manufacturing activity in China. Since then, the S&P 500 is down 3.4%, accounting for almost all of its loss so far on the year. In addition, almost two-thirds of the 6.6% decline in the MSCI Emerging Markets index this year has come since the report was issued.

The acute nature of currency and political turmoil in particular developing countries is certainly a concern, as are the implications of the Fed’s decision to proceed with a second round of tapering. Nevertheless, the U.S. is widely expected to enjoy an accelerating economy in 2014, with growth approaching 3.0%, resulting in growing earnings and sheltering the U.S. equity market from the brunt of those negative influences. But the December jobs report has raised questions about that scenario.

To be sure, labor market conditions are not the only barometer of economic strength. They are generally considered to be a lagging, rather than leading, indicator. Other measures of activity are also important, including the pace of manufacturing and housing, retail sales, capital investment and so on. But the Fed has made it clear how important labor market conditions are to their policy deliberations, raising its profile even higher.

In the meantime, stocks have drifted lower, and likely won’t stabilize until a stronger jobs report confirms the suspected aberrational nature of the December report. If that happens this Friday, it could go a long way toward restoring that stability. On the other hand, if the January report is also weak, stocks could easily remain under pressure and more susceptible to those other worries.

According to Bloomberg, the consensus forecast calls for the creation of 181,000 net new non-farm jobs in January, with the unemployment rate remaining unchanged at 6.7%. That should be enough to calm a lot of nerves, after the paltry 74,000 jobs created in December. And don’t overlook the importance of the unemployment rate, if only because of the Fed’s reference to 6.5% as a benchmark point in its assessment of “substantial improvement” in the labor force.

The recent weakness in stocks has raised questions about whether we are in the early stages of a significant pullback. One interesting look at that question comes from the Bank Credit Analyst. In a report entitled, “Timing the Next Equity Bear Market”, dated Jan. 24, BCA  attempted to assess the likelihood of a 15% pullback that lasts at least three months, of which there have been 15 since 1950. The analysis focused on historical experience with five key variables, including: monetary policy, valuation, the economic outlook, technical indicators, and father time (market cycles and the magnitude of prior bull markets).

Their primary conclusion — with the appropriate observations that no model or factor has foolproof predictive power, and that the current environment is far from perfect for stocks — was that current conditions do not suggest the imminent start of a bear market. Monetary policy remains accommodative; valuations are elevated but not extreme; the economy is improving rather than declining; except for sentiment, technicals are neutral; and neither the extent of the rise in the current bull phase nor fiscal headwinds are problematic. That does not mean that a bear market will not happen, just that it seems less likely right now.

Bond Investors Seeking Quality
It hasn’t been only equity investors who have taken notice of global growth concerns. Bond investors have as well. This is, of course, reflected in the yield on the ten-year note which, following the China manufacturing report, dropped from 2.87 to 2.64% at Friday’s close.

It can also be seen in the widening spreads between government bonds and lower quality bonds over the same time period. From its twelve-month high of 536 basis points on June 25, the yield spread between the ten-year note and the BofA Merrill Lynch High Yield Master II index fell steadily to 398 on Jan. 22, the day before the China report. Since then it has widened to 434 basis points. So far this year, the Barclays U.S. Aggregate Bond index is higher by 1.5%, outpacing the 0.7% increase in the Barclays High Yield index, reflecting investor preference for higher quality, at least until the growth outlook becomes clearer.

While we wait for Friday’s jobs report, the economic calendar will provide a glimpse of some of those other, important indicators. The first of these, U.S. manufacturing activity in January, will certainly keep growth concerns alive as it proved to be much weaker than expected, although still expanding, and the prices paid component proved to be much higher than expected. It will also likely generate a lot of discussion about the Fed’s next move regarding tapering. And it will keep markets under pressure. The immediate reaction pushed the ten-year yield lower by five basis points to 2.62%, and pushed the S&P 500 lower by 11 points to 1768, a level not seen since early November.  

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The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.

The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The Bank of America Merrill Lynch High-Yield Bond Master II Index is an unmanaged index that tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.

The Barclays Aggregate Bond Index is a market value-weighted index that tracks the daily price, coupon, pay-downs, and total return performance of fixed-rate, publicly placed, dollar-denominated, and non-convertible investment grade debt issues with at least $250 million par amount outstanding and with at least one year to final maturity.
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