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A Huge Miss on Payrolls – Now What?

By:

Chief Strategist at Interactive Brokers

Earlier this week I proposed a drinking game for bored, pre-holiday weekend traders that required imbibing when the phrase “Friday’s key non-farm payrolls report” or similar was mentioned.  A dopey game to be sure, but it is now time for sober investors to consider the ramifications of a significant shortfall in the headline number.

I’m quite sure that many were as surprised as I was when the Bureau of Labor Statistics (BLS) released their August payroll report this morning at 8:30 EDT.  Economists surveyed had a median estimate of a 733,000 increase in non-farm payrolls.  Instead we got 235,000 – only about 1/3 what was expected.  While there was a positive revision of 110,000 to the July report, that still put us nearly 500,000 jobs short of expectations.  That sort of miss is eye-catching, head-scratching, and potentially detaching us from the economic narrative that has persisted for months.

But the full set of statistics was not nearly as gloomy as the headline indicated.  The unemployment rate fell 0.2% to 5.2%, which met expectations.  Remember that unemployment statistics measure those who are looking for work but not finding it and excludes those who left the workforce.  Average hourly earnings rose 4.3% on a year-over-year basis vs. a 3.9% expectation, up 0.2% from last month after an upward revision to last month’s figure.  The underemployment rate fell to 8.8% from 9.2% and the labor force participation rate was unchanged at 61.7%. 

The labor picture may in fact be much healthier than the payrolls number indicates.  We can create a scenario where people have reoriented their priorities to work less or demand more from employers.  Wealth effects from buoyant asset markets are likely playing a role here.  Under those circumstances, employers would be reluctant to add new jobs at higher prevailing wage rates, suppressing payrolls growth but supporting wage growth.  We don’t know precisely the Federal Reserve’s metrics for gauging full employment, though it is likely to occur at a point when continued reductions in the unemployment rate require wage boosts.  (Higher wages are considered a harbinger of non-transitory inflation, even though they benefit workers).  Although the current unemployment rate is above the lows seen before the Covid crisis, it is a historically low level and we can argue that any reductions in unemployment might indeed require higher wages.

I believe those crosscurrents led to the disjointed reaction that we have seen thus far in financial markets.  The immediate reaction in stock and bond futures like was to rally before selling off.  I have every reason to believe that most traders and news reading algorithms were programmed to buy stock futures on a headline miss, based on the potentially convoluted notion that a weaker number delays Fed tapering, which keeps stimulus flowing into markets.  It now appears that markets are trying to digest a complicated scenario ahead of a long weekend in the US.  That is hardly the best timeframe for traders and investors to make complex decisions.

In the very short-term, it will be interesting to see how equity markets react this afternoon, when trading volumes are expected to be relatively light.  We noticed a pattern change to afternoon trading in the US over the past few days (and tweeted about it yesterday after the markets closed). 

For most of the summer, if not the past few months, we have seen markets rally after European markets close at 11:30 EDT.  It’s almost as though US traders couldn’t wait for those dour Europeans to head home before having some fun in their absence.  Yet over the past few sessions, ever since the volatility and minor selloff that we saw around August expiration, we have seen major indices trend lower after that time. 

We created a series of graphs showing the intraday movements in the S&P 500 Index (SPX) from 11:30 to 4:00 EDT to illustrate this effect and the changes in the patterns.  First here is a chart from early this month:

SPX Intraday Chart, August 3rd-16th, 11:30 AM – 4:00 PM Daily

SPX Intraday Chart, August 3rd-16th, 11:30 AM – 4:00 PM Daily

Source: Bloomberg

On 9 of the 10 sessions we saw rallies, or at worst sideways movement, after 11:30 AM EDT.  Even the session on August 4th showed only a minor dip in that timeframe.  Markets became much more volatile as expiration week proceeded, and few patterns emerged:

SPX Intraday Chart, August 17th-20th, 11:30 AM – 4:00 PM Daily

SPX Intraday Chart, August 17th-20th, 11:30 AM – 4:00 PM Daily

Source: Bloomberg

The action that week was highlighted by the usual “buy-the-dip” attempts, which proved to be rewarded once again after the short-term bottom on the 19th.  Since then, major indices have continued their relentless advance to new record highs, but the trading pattern in the afternoon has changed dramatically

SPX Intraday Chart, August 23rd – September 2nd, 11:30 AM – 4:00 PM Daily

SPX Intraday Chart, August 23rd – September 2nd, 11:30 AM – 4:00 PM Daily

Source: Bloomberg

This should strike many as a sharply different pattern than the one shown in the first chart.  With the notable exception of the August 27th, we see lackluster or weaker performance after 11:30.  Instead of afternoon surges, we are now seeing slumps. 

Traders who notice this pattern must now try to determine why this is occurring.  My theory is that institutions are not buying as actively.  Large funds tend to work their orders throughout the day, and those traders try to beat either the close or VWAP.  I suspect that smaller traders are driving up futures overnight and not getting follow through from institutional buying in the afternoon.   It could be the result of nothing more meaningful than portfolio managers taking late summer vacations.  But if we see the pattern persist, based on declining institutional buying in the marketplace, that could bode trouble as we enter a seasonally difficult period.

Disclosure: Interactive Brokers

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