Equities weaken as contraction returns to services

A late sell off for stocks on Thursday came at the end of a strange day for trading. On the one hand global yields began to rise following the European Central Bank’s latest admission that it was seeking ways to withdraw the bundles of cash it has wedged into the pockets of its banking system. While on the other a key reading of American service sector data unexpectedly sent up a rather large red flag about the prospects for the U.S. economy.

We’ve been bearish for some time on Fed policy, by which we mean that at some point we expect higher market interest rates on account of the oodles and oodles of government debt being issued to plug a gaping hole in the nation’s finances. To be clear we don’t see a rise in official rates out of the Fed for the longest time. We don’t necessarily anticipate a massive wave of inflation as a result, but we just are not big believers in money creation without consequences.

The impact of last week’s surge into bonds, sending yields dramatically lower has been completely reversed by now as global stock markets claw continually higher in anticipation of precisely what, we’re not sure. But it makes no sense to fight a trend you can’t explain.

The 10-year government note yield rose in the U.S. to 3.37% on Thursday as investors around the globe decided that with the ongoing yet admittedly tepid pace of recovery in place, it makes little sense to start looking for yet cheaper borrowing costs at a time when the risk to the data is to the upside.

Take the Fed’s beige book report from earlier this week. This report is a collection of anecdotal evidence collected on behalf of the Fed’s 12 regional branches. The Fed’s regional officers survey local businesses to find out how well or otherwise the state of surrounding activity is. It’s used to help guide the Fed’s Open Market Committee (FOMC) as they decide on monetary policy changes at each meeting.

The results, which were reported midweek showed that twice as many regions had reported growth thanks to a rise in consumer spending while four regions said little had changed in terms of activity between meetings. Meanwhile commercial real estate remained a worrisome sector.

The conclusion emanating from this report is that, as we’ve been saying for some time, the worst is clearly over for the economy, which is why investors wholeheartedly agreed with us as they continued to make a sharp exit from bonds on Thursday.

And here comes the “but.”

What should we make of yesterday’s dreary reading ISM services sector survey? The services sector comprises business conducted at banks, airlines, hotels and restaurants and so covers about 80% of national activity. The survey was supposed to deliver confirmation of another expansion in activity, but actually fell short and so indicated contraction making November the weakest month since July.

On the manufacturing side of the economy, growth has been pump-primed on account of a huge inventory run off. Depletion of stockpiles is ultimately unsustainable, which is why the same manufacturing survey has gone off to the races ever since the first quarter of this year. It would appear that it is harder to make expansion stick on the larger component of the American economy.

Yet it’s too soon to give up hope economically speaking and call it a day. Today is the first Friday of the month, which means it’s jobs day – the day when the government reveals the latest loss of jobs. Economists are looking for the smallest pace of job losses in over a year for November. Once again, the pace of contraction around the economy is weakening and a good (low) number of job losses will spark a stock market rally and help send bonds lower.

The Supreme Council of the Secret Order of Jurojin

 Tyche Research

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