Jobs Report Laid An Egg and PIIGS Interest Rates Climb. Risk Profile Changed In Last 3 Days.

April 6, 2012
Author: Peter Stolcers, Founder of OneOption

Somebody stepped on my Easter basket! This morning, the Unemployment Report missed expectations by a wide margin and the S&P 500 fell 15 points after the release. The character of the market has changed in just three days.

Earlier in the week, we were bumping up against multi-year highs. The PMI’s in China and Europe were better than expected and ISM manufacturing, ISM services and retail sales were decent. Europe had added €200 billion to its “firewall” and the market seemed satisfied with Spain’s 2012 budget.

Initial jobless claims have been declining steadily for months and that should have translated into a good jobs report. Stocks have traditionally rallied into earnings season and the table was set for a good week.

First let’s talk about the Unemployment Report. January’s number was revised lower and February’s number was revised upwards. Those adjustments were a “wash”. Consensus estimates were for 210,000 new jobs in March and only 120,000 jobs were created.
I am always skeptical of government releases because they are filled with adjustments. This month’s number seems way off and I would not be surprised to see it adjusted upward next month.

ADP processes payrolls for small and medium-sized businesses. They have their finger on the pulse of this economy and I trust their number more than I do the government’s. In the last few months, ADP’s number has become more relevant and traders are embracing the release. Initial jobless claims have been dropping steadily and these applications are processed weekly by states. The four-week moving average has traditionally been an excellent predictor for job growth and claims fell 5,000 yesterday.

Without question, the Unemployment Report will weigh on the market Monday. Regardless of whether or not it is off, stocks will decline. There is not much of a bright side, but this will revive hopes for QE3.

The bigger surprise this week came after a single dismal bond auction in Spain. Interest rates spiked to four month highs and European stock markets fell more than 3% in a matter of days. The ECB’s LTRO was a temporary fix. Now that the “genie is out of the bottle”, the risk profile has changed dramatically.

European banks have beefed up their balance sheets but they still have mountains of sovereign debt. Those assets continue to lose value and European banks do not want to buy additional sovereign debt. Interest rates in Spain and Italy will continue to grind higher in coming months.

Rumors circulated last week that European central banks will stop accepting PIIGS debt as collateral. When I red this it immediately raised a red flag, but Germany quickly dispelled this rumor. The mere thought of this action sent a shock wave through the European bond market.

The ECB can launch LTRO3 and it might have a very short-term psychological impact. European banks are running out of collateral to pledge and the standards have been lowered. Even if banks have a pile of money, they won’t purchase sovereign debt. They already have enough of this crap on their books and they don’t want anymore. The CEO of Société Générale said two months ago that they will not be participating in sovereign bond auctions in any major way. He does not feel that European banks should be the “buyer of last resort”.

I’m certain that other European banks feel the same way. CEOs watched 200-year-old Man Financial go up in flames and they don’t want to share the same fate.

Eurocrats will drag their feet for a couple of months while conditions deteriorate. At the moment of truth, they will go on vacation. If I sound overly critical, this is exactly what has happened the last two years.

Now it’s time to come clean. I was looking for a rally this week and I was wrong. I thought the market would have one last push higher before it rolled over. One bad bond auction and a weaker than expected jobs report is all it took. The market will break below major support at SPY 138 on Monday. That price point was the breakout from two months ago and it represents horizontal support. It is also the uptrend line from November.

For more than two years, stocks have rallied into earnings season. That long-term pattern will be broken and I pay careful attention to changes like this.

A few days ago, Asset Managers pulled bids so that they could assess the selling pressure. Given the news this week, their mind-set has changed. They will be more risk adverse and they will start rotating out of growth and back into fixed income/high-yield stocks.

Outside of a few warnings from the tech sector, the pre-announcements have been minimal. Earnings should be decent, but the market will have a stiff head wind. The market might be able to get back above SPY 138 in a week or two, but I doubt it will come anywhere close to the highs.

Monday I will be in damage control mode. The SPY did not close below 139 on Thursday so I did not pare back positions and I did not buy the VXX hedge. I feel Friday’s move might be a little over-exaggerated because the market was closed and the only hedge for Asset Mangers was to short the futures.

I will take my lead from China and European markets Monday morning. Interest rates in Spain and Italy will be of even greater importance. I don’t see any way that rates will reverse the trend; it is simply a matter of how quickly they climb. If the yields are flat, I will have a little time to close out my longs. If global markets are tanking on higher PIIGS yields, I will take my lumps and go to the sidelines.

As earnings season unfolds I will be evaluating the guidance for Q2. If the rally looks tenuous and Euro rates are inching higher, I will start to line up shorts.

First, I need to get out of my longs and assess the damage. I don’t want to follow a mistake with another mistake so I will not be plowing back in. I need time to evaluate the momentum and the macro events.

Monday I will try to save as many eggs as possible.

Happy Easter!

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