The Paradox of When Bad Is Good
You don't have to like it, but facts are facts when it comes to Fed policy. Let's discuss the latest 'bad' numbers, the small-caps rally and my medium-term outlook.
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Wednesday really does not look too much different from Tuesday on the chart. At least when one only considers the S&P 500 or the Nasdaq Composite. Both of those headline-level equity indexes have posted seven green candle sessions in their past eight. Both of those indexes have appeared to move sideways as much as, if not more than higher since the half-day session last Friday.
It was the smaller-caps that broadened the rally on Wednesday and the smaller-caps that reacted well to the likelihood that easier money could be headed their way. First, without a public announcement, there was the general understanding by traders and investors that the president's dovish economic adviser, Kevin Hassett had become the frontrunner to take over central bank leadership in the U.S. as soon as May.
Second, there was a case of "bad is good." Traders and investors have long understood the paradox that when it comes to impacting forward-looking policy decision making, lousy economic data produces the best outcomes. You don't have to like it. Heck, nobody likes it, but facts are facts and struggling economic performance forces those charged with crafting monetary policy for the nation to prioritize the Fed's full employment mandate over the mandate that calls for price stability.
The Data
Most profoundly, without BLS employment survey results for November available this week, the ADP Employment Report for November private sector job creation took center stage for investors. Not much was expected. The consensus view for professional economists had been for something positive, maybe just 5,000 jobs created. As it turned out, 5,000 would have been nice. The good news was that October private sector job creation of 42,000 new jobs was revised upward to 47,000.
The bad news? November hit the tape at -32,000 jobs. For the third month in four and the fourth month in six, according to ADP, the U.S. posted net private sector job losses. Making matters worse, for those who look into the numbers, small businesses (less than 50 employees) shed 120,000 jobs in November. Medium sized and large businesses added enough jobs to get the net result up to -32,000.
The problem there is that, at least historically, small businesses, in aggregate, support U.S. demand for labor. Wage gains slowed in November for both "job stayers" and "job changers" as well. The fact that wage gains are moderating, while not an outright negative, is also reflective of waning demand for human resources.
Enter Kevin Hassett. Enter an 87% probability for a 25-basis point rate cut next week and a 63% probability for another rate cut as soon as April, before Hassett could possibly impact policy and you had the ingredients for a small-to mid-cap rally. The Russell 2000 gained 1.91% for the day and closed at its highest level since October 27. The S&P SmallCap 600 gained 1.45% on the session and closed at its highest level since (are you ready for this?) December 16th of 2024. Holy Moly, Batman.
It Wasn't Just Jobs
In addition to the weak payroll data for November, the Federal Reserve published September data for Industrial Production. Though September data is obviously dated, capacity utilization hit the tape at a paltry 75.9% as August had been revised all the way down from 77.4% to 75.9%. The twin 75.9% prints are the weakest utilization numbers for the U.S. manufacturing, mining and utilities sectors in aggregate since September 2021. Yikes.
Even the ISM Non-Manufacturing (services) Index of PMI for November, which looked good on the surface, showed some warts. While New Orders still showed growth, albeit at a slower pace, backlog of orders printed in contraction for a ninth consecutive month as services sector driven employment contracted for a sixth straight month. Yes, prices remained hot, and hit the tape in a state of expansion for an incredible 102nd consecutive month. That's eight and half years, gang.
Marketplace
While small-to mid-cap stocks hopped happily along the bunny trail, larger-caps and AI-related stocks in particular, struggled early in the session after The Information reported that Microsoft (MSFT) was reducing software sales quotes tied to artificial intelligence.
Tech stocks and larger-caps rallied later in the regular session as Microsoft refuted the story, telling CNBC that the company had not lowered its sales quotes or targets for its salespeople. Just an FYI, I did complete my exit from that name around midday on Wednesday. I am flat Microsoft.
Not all of tech was weak though. While the S&P 500 gained 0.3% on Wednesday and the Nasdaq Composite added just 0.17%, the Philadelphia Semiconductor Index posted a gain of 1.83% led by On Semiconductor (ON) and Marvell Technology (MRVL) .
The KBW banks were up 2.32% for the day as the Dow Jones U.S. Bank Index gained 2.13%. Regional banks dominated Wednesday performance. The truckers, airlines and rails were all strong as well as the Dow Transports tacked on 2.01%. Guess prospects for lower rates are a positive for a broad swath of industries. Who knew? (Said in jest.)
Breadth
Nine of the 11 S&P sector SPDR ETFs closed out the Wednesday session in the green, led north by Energy (XLE) and the Financials (XLF) . As a matter of fact, all five "cyclical" sectors placed in spots one through five on the daily performance tables as prospects for easier money and increased economic activity improved. Keep in mind that lower taxes and reduced regulation will also hit in 2026. Defensive sectors placed in four of the bottom six slots as the Utilities (XLU) rode in the caboose.
Winners beat losers by a 5 to 2 margin at the NYSE and by an 8 to 3 margin at the Nasdaq. Advancing volume took a 72.2% share of composite Nasdaq-listed trade and a 69.7% share of composite NYSE-listed activity. The good news would be that aggregate trading volume increased on a day-over-day basis across NYSE listings, Nasdaq listings and across the membership of the S&P 500.
So, do we have a new day of bullish trend confirmation? Technically, we do. While I would love that to be true and it very well may be, I mean I have told viewers and readers multiple times that this is a risk-on environment and will be well into 2026, the volume remains below pre-holiday levels. Does that mean I want to be stuck in cash or defensive-type equities?
Not beyond normal levels, no. I want to participate in what I think we are going to see over the next six to eight months. That's a medium-term outlook. I remain short-term cautious as I do not like the volume. I know. Some portfolio managers are just trying to protect their years and may be shutting their algorithms down. I just think it may be a week or two early for that sort of non-activity.
Economics (All Times Eastern)
07:30 - Challenger Announced Job Cuts (Nov): Expecting 100K, Last 153.074K.
08:30 - Initial Jobless Claims (Weekly): Expecting 219K, Last 216K.
08:30 - Continuing Claims (Weekly): Last 1.964M.
10:30 - Natural Gas Inventories (Weekly): Last -11B cf.
The Fed (All Times Eastern)
Fed Blackout Period.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (DG) (.92), (HRL) (.30), (KR) (1.08)
After the Close: (COO) (1.12), (DOCU) (.91), (HPE) (.58), (S) (.05), (ULTA) (4.56)
At the time of publication, Guilfoyle had no positions in any securities mentioned.
