Waiting for the August job numbers.

In This Issue.

* Waiting for the August jobs numbers.
* Will the jobs data force a move???
* Yesterday’s manufacturing data disappoints.
* Gold slides on a stronger US$…

And Now, Today’s A Pfennig For Your Thoughts.

Good morning. We will start Friday’s Pfennig with some thoughts from Frank who shares his thoughts from out west.

Edwards, CO – “Nice bike,” he said as he blew by me. I was half way down a single-track after grinding up to the top. I know the hidden message in the polite passing comment – “and why are you riding it knucklehead?” I’d heard it once before many years ago – that time riding a banana yellow rented bike uphill at high altitude after flying in from sea level. Deserved but it still hurts. These days the trails are so well laid out and constructed that they just beg for activity. I’ll try to comply.

Speaking of construction, when looking at building a portfolio in a systematic way, financial analysts must generate a large number of estimates. These are generally not done for the short term, but rather with a longer view. We all know that our estimations are likely to be incorrect, but without a framework there can be no investing. We won’t go too deep here, but these need to include the analyst’s best guess for: return of each asset class; a swag about how much volatility is likely to occur, and; how closely asset classes will behave like others (covariance). From this it’s just math to build the efficient frontier.

Even though I have for some time been commenting that the ten-year US Treasury yield bouncing around near 1.55% suggests that the market expects low growth and low inflation I was a little taken aback when a major equity manager emailed their expected return charts. Before I state their figures let’s take a step back. If one was to head to an advisor in the late 1990’s to plan for retirement, it is highly likely that a growth estimate of around 12% annual return might have been plugged in to the equations to show how far your money would go. A conservative firm might have said 8% just to be on the safe side. Well that didn’t work out all that great.

What a new world. In their estimation (it doesn’t really matter who published the numbers) core US equities are expected to return 0.3% annually for the next ten years. At the top of the ladder some of the very high volatility classes like emerging markets stocks are shown under 8%. Now these figures can turn out to be as badly estimated as the 12% net earning rate from the late 1990’s but . . . surely it demonstrates once again where the market stands on expectations.

Thanks to Frank for kicking things off today, and as usual his thoughts are a perfect lead into today’s market commentary. Expected returns on almost all asset classes begin with the ‘risk free rate’ and build from there. So when central banks keep rates abnormally low, that naturally leads to abnormally low expected returns pretty much across the board. Today the markets are trying to figure out if/when the next interest rate move will show up. If you are involved in the markets, you will be watching the news wires or cable news stations at 8:30 ET when the August jobs report is released.

But first we need to review what happened during yesterday’s markets, and Mike Meyer has all of that information for us, so take it away Mike:

Even though we’re heading into a holiday weekend, US economic data has kept the financial markets and participants on alert, especially with significant focus being placed on the August jobs report. Yesterday actually brought us a fair amount of data to digest, so let’s take a look and see where everything landed. Starting with employment related data, the weekly jobs numbers once again remained in a tight range and continues to indicate the labor market is on solid footing, which seems to contradict the recent economic growth pattern that we’ve seen over the past several quarters.

The Challenger job cuts report indicated employers plan to reduce payrolls by a much smaller margin in August as compared to July. Furthermore, we had the final revisions to second quarter unit labor costs, which is the price of labor per single unit of output, and productivity, which measures hourly output per worker. With that said, the labor costs were revised higher to 4.3% and productivity fell to -0.6% so neither one of those figures are considered good news for corporate profits.

Lastly, we had several manufacturing related reports that showed some disappointment. The August ISM Manufacturing report actually contracted for the first time in six months, dropping to 49.4, as there was a broad based slowdown among orders, production, and employment while new orders specifically fell to 49.1. Keep in mind that a reading below 50 implies shrinkage, but a persistently strong dollar and low oil prices have been a couple of headwinds for manufacturers for some time now. Construction spending came in flat for the month of July after we saw growth in the private sector offset the decline in government projects.

In looking at today’s data, the BLS has a captive audience until we see the August non-farm payroll and all of the related reports right out of the gates this morning. The experts are calling for 180k so it’s not going to take long to find out the verdict, but the markets seem to have an unspoken trading range in place with 150k to 200k seen as the sweet spot. More importantly, anything under 150k would cause traders to push expectations of a rate hike further down the road whereas a reading over 200k would put a September hike squarely on the playing field. Aside from that, we have factory orders and durable goods later in the morning and then next week is going to be extremely sparse for US economic data with nothing of any real substance on the docket.

Thanks to Mike who did an absolutely fantastic job setting up this morning’s big data point – the August Job report. As he stated, a number over 200k will lead many to increase their bets of an imminent rate increase while a number below 150 will shift the focus back to the December meeting. But the chances are that we will end up with a number between those two goal posts, and that will lead to more debate amongst the ‘experts’ who are trying to read the fed.

The dollar has been trading in a fairly narrow range, waiting on the FOMC to either break it out on the topside or for a non-move to lead it back into the downward glide path it was on during the first four months of 2016. The biggest currency mover overnight has been the Brazilian real which got a ‘relief rally’ after the senate officially impeached President Rousseff yesterday. This was somewhat expected, as the possibility of a delay or even a no-decision would have extended the uncertainty regarding Brazil’s top job and currency investors do not like uncertainty.

Another winner vs. the US$ overnight was the New Zealand dollar which pushed higher along with the Australian dollar as investors focused on some positive economic data. Record export volumes boosted the kiwi, and the New Zealand currency got another boost after a senior ANZ economist pointed to upside risks for the 2nd quarter GDP reports which will be released in two weeks. The Australian economic data was a bit more mixed, but the strong rise in home prices and better business confidence outshone disappointing retail sales and lower business spending.

Both currencies were also helped by a stronger than expected PMI report out of China. China’s manufacturing sector is again recovering as shown by the official PMI number which rose back above 50 in August, coming in at 50.4 after a reading of 49.9 in July.

Another big mover overnight was the Swedish krona, but it’s moves were on the downside vs. the US$. The SEK hit a one year low vs. the euro after a report showed Sweden’s current account surplus fell during the second quarter and another data report showed the manufacturing sector expanded at the slowest pace for more than three years. Sweden is a major manufacturing hub for Europe, and the slowdown and worries regarding the EU have definitely impacted Sweden’s exports. The Riksbank (Sweden’s central bank) is due to publish a new rate decision next Wednesday but is expected to keep rates at a negative 50 basis points as they continue to try and stimulate their economy.

The pound sterling rose a bit yesterday and continued to drift higher vs. the US$ overnight after a survey showed Britain’s construction sector was beginning to recover. The Markit UK Construction PMI (they have these indexes for everything!!) rose to 49.2 last month from 45.9 in July. This followed data released yesterday which showed the British manufacturing sector is staging one of its strongest rebounds on record. The Market manufacturing PMI jumped to a 10 month high of 53.3 in August and the services PMI (I told you they measure everything) which is due out Monday is also expected to show a big jump higher. The pound sterling seems to have settled into a nice range after being pummeled following the BREXIT vote, and many believe it will continue to recover in the coming months.

Gold hit a two month low overnight as interest rate expectations here in the US pushed the dollar higher. Gold and the US$ have been reacting differently to interest rate expectations with gold selling off and the dollar rising when investors increase bets of a rate rise. I would expect the precious metals prices to come under additional short term selling pressure if the jobs numbers come in stronger than expected. But since this is a holiday weekend here in the US, the moves may be a bit more muted following the payroll data and the big moves will probably come in the Asian markets on Monday morning.

Basically we are all sitting here waiting on the August jobs report. Should make for an interesting morning.

Currencies today 9/2/16. American Style: A$ .7554, kiwi .7296, C$ .7637, euro 1.1191, sterling 1.3254, Swiss $1.0215 European Style: rand 14.56, krone 8.3193, SEK 8.5475, forint 276.92, zloty 3.9110, koruna 24.125, RUB 65.695, yen 103.44, sing 1.3581, HKD 7.7560, INR 66.82, China 6.6727, pesos 18.748, BRL 3.2425, Dollar Index 95.766, Oil $43.68, 10-year 1.583%, Silver $18.83, Platinum $1,051.20, Palladium $666.72, and Gold $1,312.60.

That’s it for today. I snuck out a bit early yesterday to head out to a friend’s farm to shoot some doves. September 1st is the first day of dove season here in the Midwest and the weather cooperated last night with some cooler temps and a light breeze. Our partners down in the Jacksonville area also headed home a bit early yesterday, but not under the same pleasant conditions; they were getting hit with heavy rains from Hermine which passed just north of them overnight. Hopefully everyone has made it through and the rains will ease a bit today. Lots of BBQs this weekend – but first we have to get this jobs number in the rear view mirror. Thanks for reading the Pfennig and make sure you have a Fantastic Friday and a great Labor Day weekend!

Chris Gaffney, CFA
EverBank World Markets