Despite Breaking Out, The Markets Are Still Nervous (Technically Speaking For 9/28-10/2)

My Friday column is divided into two sections. The first uses the long-leading, leading, and coincidental indicator method developed by Arthur Burns and Geoffrey Moore. The second looks at the large equity index ETFs.

There are a large number of credit market numbers in the long-leading and leading indicators and with good reason: credit market problems typically pre-date an economic downturn. Thankfully, the Federal Reserve’s early and aggressive intervention calmed the credit market, which lowered yields across the board.

The yield on all manner of credit rose sharply at the beginning of the recession. But all are now lower. AAA (upper left) and BBB (upper right) are now near 5-year lows. CCC (lower left) rose to just shy of 20% but are now back to the 12.5% level.The shorter-end of the corporate yield curve (1-10 year yields; left) and longer-end (10+ years; right) all spiked at the beginning of the lockdowns. But all are now back to low levels.

The following three indicators sum up the above charts:

The St. Louis (in blue), Kansas City (in red), and Chicago Fed (in green) financial stress indexes all rose at the beginning of the pandemic. All are now back to low levels.

In general, other leading indicators are mostly positive: new orders for consumer durable goods and non-defense capital goods have returned to pre-pandemic levels; weekly hours of manufacturing employees are on the mend; building permits are above pre-pandemic levels (in fact, the housing market is doing very well); the yield curve is positive; and, the stock market has rallied.

Turning to coincidental data, this week, the BEA released its final estimate of 2Q20 GDP.

Real gross domestic product (GDP) decreased at an annual rate of 31.4 percent in the second quarter of 2020 (table 1), according to the “third” estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP decreased 5.0 percent.

Here’s the graph of the data, broken down into major components;

Only federal spending increases last quarter.

Yesterday, the BEA also reported on personal income and spending. The former decreased while the latter continued to increase:

The following graph shows the relationship between private industry income and unemployment benefits:Personal income (blue line; left scale) dropped from $9.6 trillion to ~$8.6 trillion but has since risen to ~$9.3 Trillion. At the same time, unemployment payments (red line; right scale) increased from $74 billion to $1.4 trillion before falling to $633 million. Expect this trend to continue. The main question is will wages increase fast enough to offset the decline in unemployment benefits.

The pace of growth in personal consumption expenditures is still positive but continues to slow:

In May and June, all three types of personal spending rose strongly due to a combination of pent-up demand and the increase in unemployment benefits. Last month, spending on services and durables goods continued to grow (+14.% and 0.9%, respectively) while spending on non-durables decreased (-0.14%).

And that brings us to today’s employment report, which reported an increase in 661,000 jobs. Let’s dive into the numbers, starting with the household survey:The labor force participation rate (left) dropped 0.3% last month due to 695,000 people leaving the labor force. The employment/population ratio (right) only increased 0.1%. The drop in the participation rate is concerning, as it indicates that a large number of people view job prospects negatively. Let’s place both of these numbers into a historical perspective:Both are far off of their pre-pandemic levels. This report indicates that it will take some time to return to “normalcy.”The U-6 and U-3 unemployment rates are still near some of their higher levels of the last 20 years.Finally, the pace of establishment job gains is decreasing.

This report shows that the easy job gains are probably over.

Economic data conclusion: overall, the data continues to move in a positive direction. The credit markets have healed, the leading indicators have “turned the corner,” the coincidental data is mostly positive. However, slowing job growth is an issue going forward. Should the pace of job creation continue to decline while the labor force participation rate and employment/population are stuck at low levels, it will take a long time for the labor market to heal.

Let’s take a look at this week’s performance tables:Overall, a positive week for the bulls. The best news is that mid, micro, and small-caps led the market higher. That potentially means there’s a strong bullish undertone to trading. Larger-caps — while up — gained a bit less. The long end of the Treasury market sold off a bit.10 out of 11 sectors were higher. Real estate was the top gainer, followed by financials and utilities. The only sector to drop was energy, which has been the biggest loser for most of the last few months.

While the markets have broken through resistance, the breakout has been mixed. Let’s start with the SPY:The SPY has broken through resistance. But it has traded mostly sideways, instead of moving higher.This week’s 5-day chart shows that there were a lot of sharp drops. On the plus side, the 331-332 level has provided support this week.The QQQ has also broken out but the QQQ has printed very small candles. Unlike the SPY, the QQQ had fewer drops. The biggest ones occurred today due to heightened political risk.However, small-caps printed a solid bar today while the index has also trended somewhat higher during the week.

Earlier this week, I noted that economic cross-currents were freezing traders. I still think that’s the case. While the economy has rebounded, there are warning signs. Fiscal talks have stalled; leisure and hospitality job losses are increasing; job growth is slowing; the political situation is unstable. Add it up, and you have plenty of reasons to be hesitant.

Have a good weekend.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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