Feels great to be under 8

By David Andrews | October 9, 2012 | Last updated on October 9, 2012
4 min read

Last week, the U.S. unemployment rate hit a 44-month low of 7.8%. It’s the first time unemployment has been below 8% since Obama took office. The U.S. added 114,000 workers and revised up the gains in August.

The markets liked the report. It speaks to a healing job market despite the tepid average hourly wage gains and the continued weakness in private-sector hiring.

But although the rate has drifted lower, the percentage of people working has stayed near its recessionary lows, indicating there isn’t a real recovery in jobs.

When discouraged job seekers stop looking for work, the unemployment rate falls. If the economy were healthier, a far higher percentage of the population would be employed.

The Fed’s QE3 specifically targets bringing the unemployment rate down, and Bernanke says that unemployment falling because the participation rate falls is not necessarily a sign of labour market improvement.

Read: 5 reasons the Fed is wrong

Meanwhile, Canada’s employment gains also beat expectations, increasing by 52,000 new jobs where only 10,000 were expected. Our unemployment rate ticked up to 7.4%, but oddly that was a good thing because the increase was due to a higher participation rate.

Manufacturing data was also a pleasant surprise in North America last week. The U.S. manufacturing PMI index emerged from below the 50 break-even mark for the first time in three months while Canada’s Ivey PMI index came in above expectations for a third consecutive month.

In Europe, manufacturing PMIs were more mixed. German manufacturing PMI was the best performer, up to 47.4, while the Spanish (44.5) and Greek (42.2) indices were little changed. A read below 50 indicates factory output is contracting.

Read: Markets hoping for job gains

The Bank of England and the European Central Bank left policies unchanged. The Reserve Bank of Australia surprised the market with a 25 bps rate cut as they join other central banks in what is becoming an increasingly coordinated policy response to anemic growth.

Stocks mostly gained on the positive employment news, pushing the S&P 500 Index above its highest close since 2007, while the U.S. dollar and government bonds fell. The S&P500 had yet to have a down session in October.

The resource-heavy S&P/TSX has not fared as well with the entire North American energy complex (except Natural Gas) falling for a third week The Canadian equity benchmark was essentially flat for the week. The Canadian dollar rose with employers adding five times more jobs than were forecast, fueling speculation the Bank of Canada will raise its target interest rate soon.


Equity markets had a terrific showing in the third quarter and in doing so, crossed a fundamental divide. Markets have largely ignored weak economic data and the increase in earnings warnings, choosing instead to fixate on the notion that central banks can save the world and boost profit margins with their accommodative monetary policies.

Weakening aggregate demand has already led to weak revenue growth (Q2) which ultimately will lead to weaker earnings unless companies find a way to expand profit margins that are already near record high levels.

This week, Alcoa kicks off what should be a very interesting third quarter earnings season. Concerns over softer demand in China, a weaker North American backdrop, and the ongoing Eurozone mess have forced analysts to lower their earnings expectations.

Read: Managers bullish on U.S. equities

The question is: have expectations dropped enough? We will begin to find out when Alcoa reports on Thursday. It is in a position to surprise the Street if profits can marginally top lowered consensus expectations. Alcoa’s influence on the markets has waned in recent years, so the results are more of a litmus test for the ensuing reporting period and not a true barometer to the health of the economy. Also reporting this week are several bellwether banks and consumer stocks.

The U.S. dominates the economic calendar this week. By making its latest stimulus program (QE3) explicitly conditional on the job market so the employment discussions in the Beige Book are likely to attract interest. October consumer sentiment may have waned as consumers got a little ahead of themselves in September. The September inflation data should be dominated by higher energy and food prices, while core price pressures should look to have moderated.

What are the next catalysts investors should look for?

The macro-driven market will continue for the most part in the fourth quarter. In that vein, the two key events for investors to focus on are the U.S. presidential election in November and the expiry of the Bush-era tax cuts and spending initiatives.

Both these catalysts are likely to have an either/or outcome on a fixed date. On November 6th, President Obama either wins re-election or he doesn’t.

The fiscal cliff debate could (likely will) extend into 2013, but investors have to make buy/sell decisions affecting 2012 taxes by December 31st.

Read: Tax-loss harvesting deadline looming

As we get closer to these events, if they’re still unresolved, the markets will likely grow more volatile. Small things, like a Romney debate win, can cause big changes in expectations in a tight race.

Consider what happens to an equity investor thinking about the fiscal cliff as year-end approaches. She’s going to be concerned about selling stocks with gains, and book those gains in 2012 in case future tax rates go up a lot. If it appears that Congress is starting to resolve some issues, then this selling pressure may relent and the market could rebound.

David Andrews is the Director, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @David_RGMP

David Andrews