Today’s release of the results of the February 2012 Thomson Reuters/University of Michigan Consumer Sentiment Survey suggests that consumers feel modestly better about forward prospects for the U.S. economy than was the case in January, as the Index of Consumer Sentiment inched up to 75.3 from a previous reading of 75 (though the measure is down 2.8% versus a year ago).
The progress in February has been attributed to recent improvement in the jobs numbers and expectations for continued meaningful private sector job creation. This optimism may be misplaced over the longer-term however. Richard Curtin, Director and Chief Economist for the Thomson Reuters/University of Michigan Survey of Consumers, had following to say about the most recent data:
“Consumers have shrugged off concerns about rising gas prices, the European crisis, and election year politics, preferring to focus on the favorable impact of job growth. A potential threat is that consumers expect too much too soon. Improved job prospects may entice many more people to seek work, easily outstripping the number of new jobs created. While election year politics typically raise economic prospects, it may also increase the negative consequences if the promised gains fail to materialize. While growth prospects for consumer spending have improved, the new pace of gains may only edge up to a brisk walk, at best.”
My view is that the employment landscape will deteriorate, perhaps sooner than later. For one, the recent rate of growth for non-farm payrolls has been much better than is warranted by GDP growth of 2.3% (the 1Q Philly Fed’s Survey of Professional Forecasters indicates this level of growth as consensus). Accordingly, it appears highly unlikely that this pace of employment adds is sustainable.
Additionally, some weakening is already evident in credit trends—particularly in Europe (see the Fed’s January 2012 Senior Loan Officer Survey). My own technical work calls for an intermediate degree widening of spreads in the U.S. This is meaningful, as Tobias Levkovich, U.S. Equity Strategist at Citi Investment Research & Analysis, has demonstrated that credit trends lead employment.
Further, in February, the Number of Employees component of the Federal Reserve Bank of Philadelphia Business Outlook Survey tanked from 11.6 to 1.1. Jack Ablin, Chief Investment Officer at Harris Private Bank and widely regarded as among the most accurate estimators of non-farm payroll data, relies heavily on this gauge in his assessments of where the official employment data is likely headed. Exhibit 1 below shows the Philly Fed Number of Employees Index (six-month change) and the non-farm payrolls series. Notice that trends and inflections in the two data sets are fairly well aligned. In a recent interview with Politico Morning Money, Ablin suggested that the lowball February print for the Philly Fed Number of Employees Index is consistent with a NFP increase of only 50,000 for the month (243,000 jobs were added in January).
Gallup’s measure of the unemployment rate in the U.S., which has also demonstrated a strong historical correlation with the government data, likewise implies imminent weakness for jobs. Their data show a sharp month-over-month increase in the February unemployment rate, from 8.3% to 9.0% (see Exhibit 3). The Gallup methodology makes no adjustment for seasonality, so some portion of this increase is attributable simply to this time of year. However, the magnitude of the current one-month jump suggests that the BLS data will probably show some degradation when released on March 9th.
But regardless of the near-term path for jobs, the University of Michigan Consumer Sentiment Index (a long-term measure of sentiment) appears likely to demonstrate strength into the fourth quarter. This is to say that if the landscape for jobs does indeed worsen as I expect, rather than turn dour, market participants will adopt a new rationale to justify their optimism. Consistent with this notion, I anticipate that equity markets can gain ground into late 2012, at which point longer-term sentiment trends appear likely to break down. Exhibit 3 below shows the S&P 500 Index (in the upper-most pane), the University of Michigan Sentiment Index (in the middle) and the Coppock Guide for the sentiment data (in the bottom pane). Observe that the large equity market declines of 2000-2002 and 2007-2009 occurred only as the sentiment index moved from peak to trough. As such, I believe it unlikely that equities will suffer losses sufficient to reverse the big trend in the context of strengthening long-term sentiment.
To be clear, I am not backing away from the the position that the market is overbought on a short-term basis, and is likely in the process of forming a small degree top. It is clear now that I was woefully early in suggesting that the top was in on January 16, however, there has been no reversals in my indicators that might force cause me to second-guess the view that a short-term pullback is due and increasing likely. In fact, new studies accrue almost daily in support of the nearer-term bear case. My current view is merely that any coming correction will not mark a turning point for equities, and that a new leg up will follow weakness that manifests in the days and weeks just ahead.
Worth mentioning (but admittedly off topic), note in Exhibit 3 how the big-picture trends in sentiment tend to define secular equity market cycles. To illustrate, consider that sentiment moved from a low in 1980 to a plateau in 2000. This period approximates the last complete secular bull market. Conversely, from 2000 to current(?), sentiment has been trending downward–essentially within the indicated channel. This latter period represents the current secular bear. At the depths of the 2009 low, as depressed as sentiment was, the series held above levels that marked the end of the previous secular bear run. I still believe that another material leg lower is required before the current bear draws its last breath. Perhaps prints in the 50ish zone will once again indicate that the our economic excesses have adequately been worked off to engender another bull run of secular proportion…but I digress.
At this point, suffice it to say that, as far as I can tell, long-term sentiment measures such as the Thomson Reuters/University of Michigan series look slated to record higher highs for months to come—in spite of the dark clouds hovering around employment. Improving sentiment should support equity prices throughout most or all of 2012, however, short- and intermediate-term gauges suggest that caution is in order at the present juncture.
Stay nimble and trade safe!