The domestic labor market has been an increasingly insular island of strength in a receding sea of global growth expectations the last couple months.
Initial claims have continued to improve, the trend in aggregate income growth has been one of acceleration and monthly payroll gains have been solid.
As our Financials team commented earlier today,
This morning's claims data suggests the recovery in the labor market is ongoing. In fact, the rate of improvement accelerated to the fastest clip we've seen YTD. Rolling NSA initial claims were better by 17.2% this week vs the prior year comp. Admittedly, the comps from last year were easier, making the significance slightly less, but the conclusion is still the same. The labor data suggests all systems go.
Source: Hedgeye Financials
PEAKS ARE PROCESSES: Initial Claims have been a leading indicator for both the market and economy with peak improvement in the series occurring late in the cycle. We’ve profiled the primary labor market metrics in the context of historical market/economic cycles a number of times (see, for example: Patience or Penury)
Summarily, and assuming the prior seven (post-war) cycles are appropriate analogues (which is debatable), the pattern has been pretty consistent: The trough (i.e. peak improvement) in claims occurs 4 to 9 months ahead of the economic cycle peak and a few months ahead of the market peak.
With rolling initial claims making lower lows, at present, we are still putting in the trough. If cycle precedents hold, the implication is that the economic peak is still some months out.
Timing of the market peak is more tenuous - particularly given the more recent hyper-democratization of information and the shift towards a more meritocratic investing landscape.
FUNDAMENTAL & QUANTITATIVE INTEGRATION:
Labor drives income growth which supports household spending directly and indirectly via augmenting the capacity for incremental credit.
Income and credit growth drive aggregate demand and if trends in both are positive/improving then the fundamental support for bullish equity exposure is there.
As we’ve witness (again) in the last week/month, the equity and bond markets are not the domestic labor market, particularly in the short term and when volatility ramps, ROW is slowing and behavioral factors and price reflexivity predominate within an over-levered and illiquid market.
I detailed how our macro process functions in integrating our (sometimes conflicting) fundamental macro view with our quantitative view of markets in an Early Look last week. Please see Early Look: Conflations and Incongruencies for a timely case-study of our process in action.
Indeed, it’s the conflation of perceived fundamental trends into a convicted market call where economists-turned-strategists most often go awry.
We’ll be doing a flash call titled Bubbles or Bottom? tomorrow at 1pm updating our current view and 4Q14 Macro themes. Details for the call will be sent out shortly.
Christian B. Drake