The Week Ahead: Buyers Best Advised to Show Patience

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At first glance, Friday’s jobs report, or rather the market reaction to it, suggests that we are back in that nether world of the Fed’s creation where good news is bad news and vice versa. If that is the case, then Friday’s data should be really bad news for the markets, since in the real world it was really good news on all fronts.

Employers added 280,000 jobs last month, a significant beat of expectations, which had forecast an increase of around 225,000. The headline unemployment number ticked up from 5.4 to 5.5 percent, but even that seemed to be, in its own perverse way, good news. The jump was generally considered to be the result of higher participation in the labor market which, in turn, was caused by previously discouraged workers coming back to the fold.

Even all of that paled in comparison to what many saw as the best news of all, a $0.08 rise in average hourly wages, meaning an annual rate of increase in wages of 2.3 percent. If the improving jobs picture is to really prove a spur to economic growth, this is the number that counts. More jobs only stimulate further growth when the people that have them spend their money, and the more they have to spend the better. Of course in the topsy-turvy world in which we currently exist, that jump in wages was, by dint of being the best news, the worst news possible. Higher wages hint at future inflation and it is that more than anything that will prompt the Fed to hike rates sooner rather than later.

None of this is new. There was an understandable and fairly easily explained wobble in the first quarter of this year, but the jobs picture has been improving steadily for some time now. What is confusing for investors, however, is that the market reaction to that improvement has been incredible inconsistent. Until now, good news has sometimes caused a rally, while at others it has prompted a selloff. In the past I have generally advised readers to ignore the market gyrations that accompany a jobs report and focus on the big picture: Good news is good news, plain and simple.

The thing is that when the jobs report can be read as either good or bad for stocks regardless of the actual print, which way the stock market moves is a product of traders’ moods going into the release rather than the numbers themselves. That is true this time as well, where, going into Friday, there was a widespread feeling that a correction was somewhat overdue. That is why, when the good report was released, traders focused on the potential negative implications, not the positive. Basing long term decisions on the immediate mood of traders would obviously be silly, which is why in the past I have seen these dips as a buying opportunity. This time, however, there are a few things that suggest that potential buyers should hold off a while.

First, the 3 month chart above suggests that Friday’s price action was a continuation of a move that should, logically, see a test of the lows around 18,600 on the Dow before a bounce back is possible. Secondly, and much more importantly, stocks did not move independently this time.

In the past, these negative reactions to good news have been confined to the stock market. The far more interest rate sensitive bond market has, in most cases, reacted in a much less negative manner. This time around, however, the bond market, as it often does, seemed to see this one coming. Bonds were sold off quite heavily last week, seeing yields in the 10 Year go back above 2.4 percent for the first time since October of last year. That matters because, at yields approaching 2.5 percent, bonds once again become a viable alternative to stocks for large investors. The “best of a bad bunch” appeal of U.S. stocks is beginning to fade.

There is, however, one even more convincing reason for potential buyers to be patient this week; CPI, the inflation data, will be released on Friday. Given that the lack of inflation is what has allowed the Fed to delay the normalization of interest rates and that the hourly wage data released last week indicate a return to at least some degree of inflationary pressure, those numbers will be enormously significant.

This all adds up to a situation where this week, without the stimulus of earnings, will see reduced volume in the stock markets and at best a limited upside. Barring any other positive news the overall sentiment is likely to remain bearish as we await the CPI data. That release will be closely watched and could well prompt more selling. For those with cash to deploy, this week looks like a continuation of the waiting game.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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