January 12, 2004
Low Interest Rates Dull Investor Senses

U.S. stocks closed lower last Friday following a weaker than expected jobs report. However, all three major U.S. markets still managed to end up on the week, and there is little evidence to suggest that investors have been spooked by the soft growth in payrolls. In fact, the argument that was being made by more than one individual last Friday was that since only 1,000 new jobs were created in December that this means the Fed can remain on hold for that much longer. So long as the Fed is able to keep interest rates at 45-year lows stocks will do well, or so the story goes.

U.S. Machine Tool Orders Rose by 34.8% in November, and Ralph Nappi, AMTDA’s President, says “The stars are aligned for a steady manufacturing recovery in 2004”.   The ISM Purchasing Managers Index previously confirmed Mr. Nappi’s speculations when it was clocked at 66.2% in December (the best monthly reading the manufacturing sector has enjoyed since December 1983).  However, last weeks jobs report contained no signal of a pickup in employment.  Rather, manufacturing employment declined by an additional 26,000 workers in December 2003, and the last time American factories added jobs was in July 2000.

Thomson Financial says that S&P 500 earnings were raised by 2% in 3Q03 thanks to positive currency translations. Expectations are that such translations will have a greater positive impact in 4Q03.  4Q03 earnings are expected to arrive up 22.4% - the best quarterly performance since 1Q00.  Buying stocks in 1Q00 did not turn out to be a wise decision.

Trimtabs estimates that $15 billion of new money flowed into stock funds in December (typically a soft month), up slightly from November’s inflows.  And although Trimtabs estimated last week that investors pulled an estimated $100 million out of stock funds for the week ended January 7, AGB Data estimates that stock funds (both domestic and international stock funds) attracted $3.8 billion for the week ended January 7.  Despite the $3.9 billion discrepancy in estimates, both Trimtabs and AGB conclude that international funds are receiving a larger percentage of new equity money.

Bulls Believe That Time is on Their Side

David Malpass, from the NRO, had this to say about 2003’s ‘Year End Bang’:

“Those who continue to focus on "idle capacity," joblessness, a consumer and housing crash, record trade and fiscal deficits, the end of tax rebates, and the government's measure of personal savings have got it all wrong. The U.S. economic expansion will continue its healthy evolution toward investment and inventory rebuilding.”

Although a couple of weaker than expected jobs reports (Nov/Dec) are hardly the gospel, even Mr. Malpass has to admit that there is a possibility that the inventory rebuilding cycle now taking place is not going to bring about a significant uptick in employment. 

Mr. Malpass goes on to say:

“Businesses will want to build inventories and borrow more at the first sign of a hike in interest rates — which should rise sooner and more than current market expectations.”

Written on January 6, Malpass should already be changing the above outlook.  After all, if the soft jobs report means that the Fed is not going to raise rates anytime soon, using Malpass’s logic businesses will not be compelled to borrow/invest more anytime soon.

Suffice it to say, the bulls that ignore weakness in the labor market do so because the Fed is holding rates at extreme lows and the inventory rebuilding cycle is in full swing. These optimists conclude that employment is a lagging indicator – they have been sticking to this conclusion for many months, and pointing at the decline in weekly jobless claims to conclude that the lag is almost over.

Although the themes of low interest rates and inventory rebuilding are not likely to disappear immediately, ‘those who continue to focus on "idle capacity," joblessness, a consumer and housing crash, etc’ nonetheless remain worried over corporate profit comparisons in the latter half of 2004.  It is unknown why the Malpass’s completely ignore the fact that 3Q03 was a superstrong quarter because of the potentially unsustainable stimuli that arrived from housing refi’s and tax refunds. Regardless, even the most optimistic agree that jobs/wage growth will be required for 3Q04 to be a good quarter.

Investors not concerned with the sustainability of the current U.S. expansion happily conclude that so long as interest rates remain at extreme lows mutual fund flows are not likely to shift out of stocks.  This is a difficult point to refute in the near term given that the proverbial ‘sidelines’ are flush with money that could move into stocks.  Nevertheless, those that continue to ignore weakness in the labor market and what should prove to be difficult 3Q04 profit comparisons could be doing so at their peril.  Time is not on the side of the bulls. Rather, job growth soon or a relapse in economic activity later this year. 

 

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