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U.S. Equity And Economic Review: The Market Retreats From A High (Again)

Published 05/16/2016, 12:42 AM
Updated 07/09/2023, 06:31 AM

This week’s employment news was mixed. Initial unemployment claims increased for the third consecutive week, this time to 294,000. While some commentators argued that the Verizon Communications (NYSE:VZ) strike caused this week’s increase, the DOL release did not specifically mention a primary cause. This gain combined with last week’s lower than expected employment report is cause for modest concern. In contrast, the JOLTs report was positive, with more openings than hires. This relationship is positive for wages; it indicates not only that employees should have additional leverage in negotiating pay but also that employers will be more willing to increase salaries to keep current workers and attract new ones. However, JOLTs is a less significant report; the recent increase in initial unemployment claims is more important.

The week’s best news, however, was the 1.3% increase in retail sales:

Retail And Food Services Sales

The chart shows this data series moved sideways for the last year, a potentially concerning pattern. This makes the strong upside move all the more important. The following table from the report shows broad-based increases:

Broad Based Increases

All sectors save two (building materials declined 1% while general stores sales were “0”) were positive.

The Atlanta Fed’s GDPNow model – which has been fairly accurate -- increased to a strong 2.8% in the second quarter. But it’s still too early to place too much emphasis on this report.

Economic Conclusion: It’s possible the employment situation is weakening, but we have insufficient data to draw a firm conclusion. However, weekly initial unemployment claims data has quickly risen in significance. The retail sales report is very noisy, so arguing that we’ve seen a “turnaround” is premature. But at minimum, last week’s strong number indicates the U.S. consumer is still willing to spend.

Market Analysis: This week, two bond market charts provide the best explanation for the equity markets:

IEF Daily Chart

TLT Daily Chart

The iShares 7-10 Year Treasury Bond (NYSE:IEF) (top chart) and iShares 20+ Year Treasury Bond (NYSE:TLT) (bottom chart) are both forming pennant patterns at the top of rallies. And both ETFs are about to break out to the upside, indicating investors expect slower economic growth. This conclusion does not support strong upside equity moves, which partially explains this week’s weaker equity performance, starting with the transports:

IYT Daily Chart

Three weeks ago, the iShares Transportation Average (NYSE:IYT) (transports) broke an uptrend. Last week they crossed below the 200 day EMA and, at the end of this week, moved lower on increasing volume. The Russell 2000s (IWMs) confirmed the move lower:

IWM Daily Chart

The iShares Russell 2000 (NYSE:IWM) are fluctuating around the 200 day EMA. But the declining momentum implies they will continue moving lower, which is bad news for the SPYs:

SPY Daily Chart

For the third time in a year, the SPDR S&P 500 (NYSE:SPY) couldn’t break through the 210-212 price area. Now they are moving lower, currently using the 50 day EMA for technical support. Weak earnings are the primary reason for this decline:

With some 90% of S&P 500 companies having reported first-quarter earnings, 71% have turned in bottom-line numbers that are better than mean estimates, according to FactSet. However, this may be more due to subdued expectations than improved performance.

"For first quarter 2016, the blended earnings decline is negative 7.1%. The first quarter marked the first time the index has recorded four consecutive quarters of year-over-year declines in earnings since fourth quarter 2008 through third quarter 2009," said John Butters, senior earnings analyst at FactSet.

When viewed through a longer historical lens, the latest market action is completely understandable. The market is expensive: it needs increasing revenue to continue rallying. But that isn’t happening. Instead, a strong dollar, weaker overseas economies and oil market slowdown are lowering revenue growth. This leads to the market selling off at higher valuation levels, which is exactly what occurred last week. And until corporate earnings meaningfully increase, we can expect the cycle to occur again.

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