by Brooke Thackray, AlphaMountain Investments
Initially, the stock market was expected to respond negatively to the April 3rd weak Non-Farm Payroll numbers which came in at 146k jobs versus the expected 245k. On the first trading day after the report was released the stock markets in North America ended up strongly in the black. Investors are battling back and forth between the ramifications of weak economic numbers on the economy and the stock market, and the possible counter effect of the Federal Reserve putting off its first rate hike to a date further out than currently expected.
There are many different ways to measure investment sentiment, including gauging investorsā reactions to bullish or bearish news. The fact that investors responded positively to the weak March Non-Farm Payroll report was a bullish signal for the stock market. Normally, a weak employment report is bearish by itself as it indicates a weakening economy and ultimately lower corporate profi ts. When investors respond positively to a bearish report, this is bullish for the stock market. It indicates that investors are expecting a counter party to take a bullish action that outweighs the original bearish report. In the case of the recent bearish Nonfarm Payroll report, investors are anticipating that the Federal Reserve will push out the date that it is planning to raise interest rates which will in turn provide a better environment for the stock market to rally.
In my last monthās newsletter I discussed how investors responded negatively to the stronger than expected February Non-Farm Payroll report. In this case the reaction was bearish as investors were once again playing the anticipated action of the Federal Reserve rather than the report itself. If stronger than expected economic reports continued to be released, this would have pushed the investor sentiment into a bearish bias as investors would have feared that the Federal Reserve would have no choice but to raise rates in the short-term horizon.
This weighing process of bearish and bullish actions goes on all of the time. When the bullish case scenario wins out, it is evidence that investors have a bullish bias which is positive for the stock markets. It can be argued that since the Greenspan era, the Federal Reserve has created a moral hazard scenario, where investors anticipate that the Federal Reserve will bail them out after a major economic or stock market problem; consequently, investors have adjusted their behavior to take on more risk than they would have otherwise. This phenomenon has had a spill-over effect into the realm of smaller decisions by the Federal Reserve and as a result, investors tend to believe that the Federal Reserve will err on the side of loose monetary policy and when a weaker than expected economic number is reported, the expectation is that the Federal Reserve will take an offsetting action. Please note that it is not the Federal Reserveās action, but rather the expectation of their action that is important. There is a difference.
At some point, investors will make the decision that the Federal Reserve action will not be able to offset a weak economic report and start to push the stock market down. In addition, investors realize that the Federal Reserve does not have too many loose monetary tools left to use at this economic juncture. The Federal Reserve cannot delay raising interest rates forever, at some point their hand will be forced.
When investors start to establish a trend of responding bearishly to economic releases the shift in investor sentiment will carry momentum and could result in a substantial correction.
This may take place in three weeks, or six months, or even a year. It is always difficult to determine when investor sentiment is going to shift. One or two data points of bearish reaction to bearish economic news does not indicate a shift in sentiment trend. It is not a golden rule, but three data points will often signify that a shift is taking place.
Will earnings rescue the stock market? Probably not. This quarter earnings are expected to contract. As of April 2nd, Q1 2015 earnings are expected to contract by 2.8% (Thomson Reuters). With an expected contraction, the bar is set very low for companies to beat expectations.
Nevertheless, collectively, companies will have to beat the expectations by more than just a bit to move the stock market substantially higher.
Read/Download the complete report below:
Thackray Market Letter 2015 April
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