WATCH: The 4 Stage Stock Market Cycle


December Taper? Tomorrow We May Know...

By Costas Bocelli December 5, 2013 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

The Thanksgiving Day holiday was an indulgent feast for the equity markets.

The S&P 500 and the Dow Jones Industrial Average both posted another round of all-time record highs. 

There even were plenty of leftovers with all the trimmings for world markets too.  Japan’s Nikkei 225 index set a new six-year high, while the Eurozone blue chip index made a five and a half year high.

But for such a traditional holiday that brings families together, for stock market investors, it has felt more like a Bacchanalia.

With the Fed pumping $85 billion a month of stimulus into the system, the market landscape has actually become overly indulgent to say the least.

And since the holiday break, perhaps markets are now reeling as a sudden case of indigestion sets in.  The S&P 500 has declined in the past four sessions, and the way today’s turning out, we’re likely heading for five straight.

What’s the problem all of a sudden?

The problem is that the economy is finally starting to show signs of significant improvement.  And that could only means one thing... less stimulus from the Fed!

Yes, market sentiment remains in a perverse state where good news is perceived to be bad news because of the fear that the ultra-accommodative monetary conditions will be taken away.

Since the holiday break a week ago, consider the latest economic data that’s been released.

Private sector manufacturing expands at the fastest pace in over two years.  The ISM manufacturing survey for November was 57.3 (readings above 50 signify growth), the best since April of 2011.  New orders and exports were seen particularly strong when you break down the survey, both encouraging leading indicators for future output.

ISM Manufacturing Index expands for six-straight months...

GDP growth is picking up and gaining momentum.  Gross Domestic Product (GDP), which is the broadest measure of economic activity, has now risen for three consecutive quarters.  On an annualized basis, the US economy has expanded (in Real terms, stripping out inflation) by 1.1% in Q1, 2.5% in Q2 and, just this morning, the revised reading for Q3 came in at 3.6% -- that’s the best quarter of economic expansion since Q1 of 2012!

US economy has expanded in 10 consecutive quarters...

The labor markets continue to show signs of improvement, which is a major focal point for the direction of Fed policy since the great recession.

Also this morning, the weekly initial jobless claims were reported and the data is trending in the right direction -- down!

New claims for (the week ended) November 30 were 298K, which is the second lowest weekly total of the recovery.  Sure, last week was a holiday and filings were likely affected, but the four-week average declined to 322K and continues to trend lower (disregarding the weeks that included distortions from the government shutdown).  Also encouraging is that the level of Continuing Claims are also moving lower, and the latest tally of 2.74 million unemployed workers collecting an insurance benefit is a recovery low.

Fewer jobless claims should boost hiring in a growing economy...

With claims trending lower and fewer people receiving unemployment benefits, the labor market should continue to gather strength in an economy that is expanding.  That’s the Fed’s master plan -- to promote financial conditions very accommodative for businesses that will see their success translate into more robust hiring.

The ADP private payroll report was released yesterday and showed a big jump in new hires for the month of November.  ADP estimates that companies added 215K new net employees last month -- the best monthly gain in a year.  And the prior month, which was previously reported with 130K additions, was revised 54K higher to 184K.

This of course leads us to probably the most important piece of data and likely the last significant read on the economy before the Federal Reserve conducts its final FOMC policy meeting on December 17-18.

Tomorrow morning, the November jobs report will be released.  The expectation is that 180K new net jobs were added to the economy, and the unemployment rate to have declined by 0.1% to 7.2%.

With the recent strength in the economic data coupled with asset prices vaulting to all-time highs, the Fed will be considering whether to announce a reduction in asset purchases.

This jobs report will likely be the final nugget of information that will tip the scale in either direction.  The Fed has signaled its intention to begin winding down the QE program, but the clarity of the timing has remained otherwise elusive and continues to confuse the markets.

That said, tomorrow’s report could signal to the markets whether the Fed will be inclined to taper or remain on hold until sometime in early 2014.

Fed Taper could be decided tomorrow depending on the jobs report...

What to look for in the November jobs report

The expectation is that 180K jobs were added, which is on par with monthly job creation over the past twelve months.  The past three months, jobs creation has actually averaged 200K (including prior revisions).  We would need to see a number north of 250K to push the scales towards a December taper.

The unemployment rate is seen dropping back to 7.2%, which would match a new recovery low from the September reading, so if we happen to get an unexpected decline to 7.1%, that could also compel the committee to begin reducing the monthly asset purchases.

You should also be intently following the yield on the Ten-Year Treasury Note.  With the recent strength in the economic data, the yields have been creeping higher on the long end of the curve and will likely see more volatility come tomorrow after the jobs report.  If you see a rise towards 3% that could signal that the Fed may lean towards a taper sooner rather than later.  If on the other hand, you see bond prices rally which in turn pressures interest rates lower, look for the yield to quickly fall back below 2.75% and likely drift towards 2.5%.

Watching the 10-Year Treasury yield should be your Fed barometer...

That scenario would likely coincide with a weak jobs report tomorrow, but if we happen to indeed get a disappointing labor report, that would likely result in a stock market rally -- and probably leading to fresh new highs.

Bad news is good news...

The perverse nature of the markets will only be remedied when the Fed actually begins an attempt to normalize policy...

And tomorrow’s jobs report could very well be the deciding factor.