The End of the Beginning or Beginning of the End (Redux): Written Commentary

For those of you who did not have the time to watch the video on this topic, below is a more complete text of what I had to say:

  1. Tragedies in Orlando and in England by themselves are difficult to comprehend and clearly represent elements of extremism that indicate some “permission” to behave at the raw end of emotions. This has on the margin an impact on the US elections and the Brexit vote. The next few days may tell us what direction this pushes voters’ thought process.
  2. This adds to the near-term elements of uncertainty. But, what happens if the first event, the Brexit vote, is REMAIN as opposed to EXIT? This removes an element of uncertainty against a backdrop of central banks already having provided liquidity to deal with a negative vote. This reminds me a little bit of Y2K. If the vote is EXIT we may already be set up for that. If it is REMAIN we have a lot of “excess liquidity” in the system.
  3. In the meantime, while economic data, as always, is mixed globally—in the US, with the exception of some of the employment numbers which we can’t ignore, other numbers could be said to support Fed action: Core CPI is up 2.2%, year-over-year unemployment claims remain low, wages and housing seems to be fixed, GDP may surprise, and wages are up not just in the US but elsewhere, up 10% in China, about 2% in Europe, and even up in Japan.

All this would support rate increases by the Fed, but as I said in a recent video, it may wait for the July employment report which isn’t available until first week in August. Why July? We are seeing major shifts in hiring, firing and exit patterns in the employment rolls. If nothing else, this makes it very difficult to “seasonally-adjust” (SA) any reported numbers. We had a reported seasonally-adjusted number for May of +38,000. As one can see in the tables below, 651,000 not-seasonally-adjusted (NSA) persons actually joined the payroll, which is well below the 900,000 number for May, 2015. YTD, the total employment numbers SA and NSA are 748,000 and 476,000 respectively. This compares to final numbers for 2015 for the same period of 1,033,000 and 881,000.

There will be further adjustments when the BLS adds the pluses and minuses from the data on another 20% of its 650,000 establishments as it completes the May survey over the next two months. Given the first seasonal-adjustment to 38,000, which is less than 6% of the NSA number, it wouldn’t take much to move the month into a negative number. The last time May was a negative number was in 2009 (-303,000 SA) when the NSA additions to the payroll that month were only +384,000. On the other hand, July could be an upside surprise. As one can see from the table for 2015, July is a big month for reduction in real payrolls. This is a result of reductions in the educational field and changing patterns in retailing. And, it is typically a big shutdown month for manufacturing entities to make changes to processes. Given that the industrial sector has become a smaller part of the makeup of the work force while more in-line changes are taking place, this number could surprise. How this gets translated into a seasonally-adjusted number is difficult to judge. It continues to amaze me that so much weight is put on this seasonally-adjusted number. Seasonal adjustments are difficult enough in a stable environment. When patterns of hiring, firing and exits from job participation are changing and the mix of services versus industrial continues to favor services, any single number has to be viewed with some circumspection, but has to be recognized. There are other numbers that give a better view of what is going on in the labor market as the Fed ponders.

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However, markets may anticipate and the excess liquidity will be put to work in a risk-on mode if the Brexit vote is Remain.

We will be paying attention to employment to determine if this is the end of the beginning or the beginning of the end—an expression I stole from Anatole Kaletsky at Gavekal. I think we are at the end of the beginning of what has been a strange cycle. There is more to come. In the meantime, my comfort level with fundamental analysis is low, while the more sophisticated trend followers are seeing movements that to me support a continuation of the cycle. These uncorrelated sets of strategies deserve some attention as well as less liquid strategies of those who can handle the illiquidity and take advantage of the time arbitrage that exists for those managers who do not have to deal with the needs of investors who fall into the liquidity trap—something I just wrote about in Think Advisor.

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