Avalon's MarketWeek

Summer Slide


“How shall summer’s honey breath hold out against the wreckful siege of battering days?” – William Shakespeare, Sonnets (18)

Once Greece finally exited the front pages (for now), we were supposed to go back to watching the markets resume their inevitable rise to the newest highs. After all, we are coming into the high week of earnings season, and should be basking in positive “surprises.” Beating estimates is a traditional ritual in the land of Wall Street, with about two-thirds of companies reporting so-called earnings surprises year in and year out.

The good news is that earnings are climbing steadily out of the well of projected red ink for the second quarter. It would appear at this point that analysts played it extra-safe again this quarter, much like the last one, with an increased cushion of about five hundred basis points for estimates in place of the usual three hundred. As the reporting season got underway, S&P 500 earnings were projected to have fallen by about 4.5%, not very different from the original projections for the first quarter. According to FactSet, the “blended” rate (the mix of actual results and estimated ones for those yet to report) had risen to a loss of 2.2% through Friday. With more than two-thirds of companies left to report, the clear implication is that the quarter will finish in the black, just as the first quarter did (by about seventy basis points).

If you follow the market at all, you’ve heard about the recent, wondrous great leaps forward by the stock prices of Amazon (AMZN) and Google (GOOG). Alas, the leaps were not quite enough to offset disappointment elsewhere, most notably from Apple (APPL). The maker of i-stuff reported a perfectly respectable quarter and confirmed once again its ability to make gobs of money – $10.7 billion in profit for the second quarter alone, nearly fifty percent more than it made in the second quarter of 2014. So of course the stock tanked. The problem, you see, is that it didn’t report results and guidance that topped every estimate everywhere.

Amazon did. The company reported a heroic profit of $92 million, versus a loss of 126 million dollars a year ago. For that, it was awarded an extra $20 billion or so in valuation. Why, it can make that back in a mere two hundred quarters.

For fifteen years, Amazon has proved several things in a consistent manner. One is that it is possible to grow sales rapidly by making it easy to buy products at or below cost. The second, not surprisingly, is that a company rarely makes any money this way. A third is that an occasional profitable quarter, however little the profit, is all that is necessary to get momentum investors to positively slap themselves silly in excitement. The company’s has also proved to be a double-edged “widow-maker,” lethal to short during a bull market, fatal to hold during a bear. Years from now, wonks like the CFA institute will have case studies on how it was possible for Amazon to have a valuation in defiance of reality for so long. Traders, though, will talk reverently of the money that was there to be made.

Not so much when it comes time to talk about the stock market of the second quarter of 2015. As we come into the big week, prices are definitely behind schedule. The normal rhythm of the market at this point is to be watching a couple of weeks of gains crest, though they often start to melt away in the last week of July. It’s a pattern that typically gives way to early August weakness, followed by a “silly season” of light volume, vacation-fueled price levitation in the run-up to Labor Day and its immediate aftermath.

But the run-up in the S&P that only a week ago looked set for a break-out to another level stalled out, leaving prices barely above their June lows. Such weakness isn’t that unusual, to be sure, and it is surely perilous to attempt to be precise about the days the earnings rally will stop and start. Still, earnings haven’t been an inspiring show so far, with a lot of weak results and weak guidance from a lot of big companies, particularly the ones that make up the venerable Dow Jones average.

A sign of imminent doom it isn’t, but a further sign of a waning cycle is a more than plausible possibility. That said, I’m still not ready to bet that the cyclical high is in. The time will come in the dying days of the current cycle when the Fed’s words will no longer matter, but that time is not upon us yet. Until then, a mix of mildly positive news and mildly encouraging Fed-speak could still encourage the money river to rush into equities for one last go. The river has been looking about for the last races to bet on these days – hence the very narrow breadth of the market – yet while there have been some flirtations with the T-bond haven trade, we’re not there yet.

The Economic Beat

A quiet week for non-earnings data was centered around housing. Existing home sales for June were estimated at a 5.49 million homes annual rate, a nice pickup from a downwardly revised May and the highest rate since 2007. The year-on-year rate rose to 9.6% with median prices rising 6.5%; the U.S. housing agency folks reported a similar price gain of 5.7%. Not so fast, said Seattle-based home broker Redfin, which announced that its own new index showed that sales were about to cool off sharply due to sticker shock and buyer fatigue. The company’s report looked prescient on Friday when the new home sales report surprised to the downside on all cylinders.

The totals for new home sales for March, April and May were all revised downwards, and the June rate came in at an annual rate of 482,000, dipping back below 500K and the lowest rate since last November. That’s below the rate of 485K of actual sales over the last twelve months, and while that kind of cross isn’t the death knell for the sector, it isn’t cause for celebration, either. Yet beyond bearing out Redfin’s assessment of buyer fatigue, I wouldn’t get too excited about the numbers. To begin with, June sales are still up 18.3% on a year-over-year basis, and year-to-date 2015 sales are still up 20.4% over 2014. Going by what’s happened with the last few months, those numbers may come down a bit with revision, but they should still show a healthy gain.

New home sales aren’t much of a leading indicator anyway, with the exception of the last business cycle that was centered on a housing bubble. Normally home sales rates, like employment, don’t decline until we are actually in recession. Granted the fact that the recent rates have declined is by no means a plus or sign of economic strength, but the sales rate for new homes dipped last summer as well before resuming its upward climb.

Housing isn’t going to lead us into a recession this cycle, nor is it going to prolong it. If history is a guide, it will take some time, at least one or two cycles and possibly more, before home-buying and borrowing behavior return to long-term norms.

Business survey news was mixed, with the Chicago Fed’s national activity index creeping back into positive territory and the 3-month average at about even (-0.01). The index is frequently revised, often significantly, but doesn’t seem to indicate anything big in either direction. The Kansas City Fed survey reported another dreary result, (-7) versus the previous month’s (-9). The Markit Economics “flash” manufacturing index showed no change from June levels.

Weekly claims were said to have reported the lowest total (255K) since 1973, but there was so much seasonal adjustment into the result that I am skeptical. The raw data looked right in line to me with the broad trend for claims in 2015. Nevertheless, it could affect the July jobs reporting figure two weeks hence.

Things get exciting again next week on the economic news front, highlighted by the Fed’s July meeting and its statement due Wednesday afternoon, followed by the first estimate of second quarter GDP on Thursday morning (which the Fed will presumably have seen). The Atlanta Fed current-GDP tracker was estimating 2.4% as of the end of the week, but everyone’s estimates will adjust when the first count of shipments for durable goods in June are released on Monday, along with the month’s new orders.

The month’s housing reports will wrap up next week, with Case-Shiller price data (through May) on Tuesday and pending home sales for July on Wednesday. Regional manufacturing and business surveys include Dallas on Monday, Richmond on Tuesday and Chicago on Friday. Consumer sentiment measures are due on Tuesday (Conference Board) and Friday (University of Michigan).

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