Monday, November 06, 2006
Over the past week have been discussing the economic trend as compared to the trends in the stock market and the bond market. To recap, the bond market has been projecting a hard economic landing from the last round of interest rate hikes and its inverted yield curve has been projecting a coming recession. Contrarily, those buying stocks have been betting on a soft landing and more stable conditions. Economic data over the past couple of weeks has born out that the bond market was correct and that the stock market was not. On Friday, however, stocks received a boost from the jobs report, which may vindicate the position of stock buyers and show that it was in fact the bond market which had it all wrong. Friday's jobs report surprised the market (yet again) by adding jobs that had been missed in prior reports. The adjustments in this report over the past two months seem to indicate that the economy is growing much faster than other data has been showing over the past months. In other words, it now looks like the stock market was right; we are in for a soft, not hard economic landing. What this does is put the future rate hikes question back on the table, meaning that the blue chip sectors may once again become less attractive. On the other hand, it makes the more speculative small caps more attractive since they offer the potential to outperform the averages and create returns that offset the earnings erosion from rising rates. The stock market still needs to digest the news and could be quite volatile this week as it works through the implications. We should start to see some of the small caps produce good opportunities on the long side though and the impending strong leg down we had been looking for may now be off the table.