Trying to Improve Upon Boring
This week's claims print is boring so we've tried to make our weekly note on the subject a bit more interesting by looking at claims' relevance to both the market and the XLF over differing time intervals. That sounds boring too, but if you'll bear with us we think you'll find the conclusion at least somewhat interesting.
The first chart below shows the relationship between rolling initial jobless claims and the S&P 500 from the start of 2007. The relationship is strong with an R-squared of 0.8866 on a zero-lag basis. In other words, the level of jobless claims has explained 88 percent of the S&P 500's value each week over the last five and a half years. It's clear that claims are a good proxy for the health of the economy and that the market is a reflection of sentiment around the economy's health. As an aside, it's interesting to note that the strength of the relationship didn't improve much when we lagged claims. In other words, the common wisdom that the market is the leading indicator for the economy is not supported by the data in this particular case. While we saw very small increases in the R-squared value (an improvement from 0.8866 to 0.8974) by having the S&P 500 lead claims by 3 weeks rather than zero, we don't consider this difference significant. For reference, the market is overvalued, albeit slightly, based on the current level of jobless claims. This assumes that claims are in fact the x-variable (independent) and not the other way around. This model suggests a fair value for the S&P 500 of 1364, or roughly 3.3% below present levels.
The next chart looks at the XLF vs. the same jobless claims series since 2007. Note the correlation breakdown vs. the relationship with the S&P 500. The R-squared value here is only 0.54, far less exciting. We suspect this owes to the substantial balance sheet restructurings that took place amid the large cap banks, Citi and Bank of America as glaring examples. This would partially explain the divergent path for the XLF relative to its historical relationship.
We actually find the next chart the most interesting. This is the relationship between the XLF and jobless claims over the past two years. Note the correlation: zero. In other words, the improvement in jobless claims in the past 104 weeks from roughly 488k to 355k has done nothing to move financials stocks higher. This is counterintuitive. For reference, that same move has driven a 302 point rise in the S&P 500 (+27.4%). Financials have been and should be more sensitive to changes in jobs than other sectors as their primary P&L driver is credit, which reflects frequency and severity of loss. Frequency of loss is driven by newly unemployed people, which is reflected in initial jobless claims.
Our suspicion is that the confluence of European counterparty fears, higher capital standards equating to lower returns, compressing top lines (NIM & Fee Income), and higher regulatory/litigation/personnel expenses are now large enough, on a combined basis, to completely negate the huge improvement in credit we've seen over the past two years. Looking ahead, the outlook for claims to improve further is small. Jobless claims rarely break below 300k on a sustained basis, a move from current levels roughly one-third the size of what we have seen over the last two years. This is another way of saying that the credit tailwind is coming to an end. This is troubling because the alternative interpretation of the below chart is that the only thing that's held the XLF flat (as opposed to breaking lower) over the past two years is the improvement in credit.
The Boring Details on This Week's Print
Initial claims rose 5k to 366k last week, but only 2k after incorporating the 3k upward revision to the prior week's data. Meanwhile, rolling claims fell by 5.5k to 364k.
We've been chirping lately about the slowdown in improvement in the year-over-year measure of rolling non-seasonally adjusted claims. We prefer this method as it gets around what are considerable seasonality distortions in the data. For the last several weeks this year-over-year change had been worsening, in that the rate of improvement was slowing. This most recent print marked a small reversal of that trend. The year-over-year change in rolling NSA claims was better by 7.9% this past week, which is an improvement from the 6.1% improvement YoY in the previous week's results. We wouldn't get too excited here as it's just one print and the prior trend had been in place for a few months. Nevertheless, we're keeping a close eye on it.
Spreads continue to widen for now, pushing the 2-10 spread out another 15 bps to 153 bps in the latest week. Much of this is coming from the long end of the curve, where 10yr yields have risen 17 bps to 182 bps. This recent rally in yields is driving a rotation out of REITs back into Financials.
Financial Subsector Performance
The table below shows the stock performance of each Financial subsector over multiple durations.
Joshua Steiner, CFA
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