Buy when there is blood in the streets

**first published 2.8.16**

“Buy when there’s blood in the streets, even if the blood is your own.” is the original quote from Baron Rothschild, and 18th century British nobleman, as he referred to taking advantage of panic stricken times. And nothing could be more fitting for the carnage which took place in equities this past week. The S&P 500 finished down almost 2% on Friday alone, giving up a tad over 3% for the week and is now resting on its short term support level of 1880. At the end of the proverbial day, lower stock prices are lower stock prices, but the reason why they are lower is what makes all the difference. Unfortunately, there are many potential candidates for what caused the sell-off last week ranging from a strong dollar to hedge fund liquidations to sovereign wealth funds selling assets. The truth is probably some combination of all of those items along with something else that we may not even be aware of yet. However the good news in all of this is that the element which ultimately determines the fate of U.S. equity prices, the economy, is indeed doing well. That’s what makes this sell-off the kind you want to take advantage of.

We got a great read on the economy with Friday’s nonfarm payroll report. The foundation of a consumption based economy like the U.S. is employment. Without a healthy labor market, everything else falls apart. Up until Friday, we knew that overall employment was strong, but that wage growth was not picking up the way we expected. So finally, in the payroll data we got Friday morning, there was confirmation that wages are indeed picking up. Average hourly earnings (AHE) for January came in at 2.5% year over year with December being revised up to 2.7%. To put that in perspective, the average year over year gain for 2015 was just 2.3%.

NFP Pic 2.6.16


That said, based on historical relationships with wages and employment, we should see an acceleration in wage growth going forward. Basically, the economy reached full employment several months ago and we are now seeing wages rise as employers are forced to pay more to keep workers.  This change in labor force dynamics brings one of Fed chairperson Yellen’s favorite labor reports, the Job Opening and Labor Turnover Survey (JOLTS), front and center. One of the components in JOLTS, the quits rate, represents “voluntary separations initiated by the employee.” As you can see in the graph below, the historical relationship between quits and AHE depicts that we should see a significant gap up in wage growth.

Jolts 2.6.16


This really is intuitive as a higher quits rate shows leverage shifting to workers. We’ll be getting December JOLTS data on Tuesday, so even though we’ll be looking backwards, it’s the historical relationship that counts. Given the rise in AHE, we should see a higher quits rate.

Already, we are seeing the significance of AHE gains as the Atlanta Federal Reserve Bank has raised their consumption projections in the GDP Now forecast. Because of the jump in AHE, the Atlanta Fed upped its forecasts for Q1 2016 GDP and consumer spending from -.4% and 2.5% all the way to 2.1% and 3% respectively. So you can see how highly regarded gains in AHE are for consumption figures and by default, Fed policy going forward.

We did a get a bit of disappointing news this past week with the January  ISM Non-Manufacturing (NMI) report coming in lower from last month down to 53.5. The current reading of 53.5 is still well in expansionary territory as defined by ISM, because anything above 48.9 in the NMI indicates an overall economic expansion. The commentary in the survey definitely showed that the equity sell off in January impacted responses. That being said, we should see a bounce back in February as markets stabilize. However, if the NMI continues to drift lower then there will be more cause for concern. Given the labor market backdrop, I expect that things will be fine.

Here we go into a new week with earnings coming from consumer favorites KO and DIS just to name a few. On the economic data front, we get a personal favorite of mine, the NFIB Small Business optimism Index, along with JOLTS, weekly claims and retail sales to finish up on Friday. There were some rumblings over the weekend of Venezuela and OPEC reaching some kind of an agreement that will hopefully stabilize oil. If that happens, the bleeding should stop and we might actually get a look at what equities can trade like based on good economic news and solid corporate earnings. So let’s stay focused on the data and do some more homework with that extra free time we now have since football season is over.

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