Avalon's MarketWeek

Summer Sunshine


“Summer will end soon enough, and childhood as well.” George R.R. Martin, A Song of Ice and Fire

Yes, markets rose again last week, thanks to the usual Friday afternoon push (at lunchtime Friday, the major averages were about flat on the week). This has occasioned a fresh burst of commentary from both sides of the aisle (the bull-bear aisle, not the left-right political edition on full view last week and next), with bulls taking something of the lead in uttering the louder hosannas.

As I reminded readers last week, the tape makes the news. The rosy glow about the economy is probably about to end, mostly because the rally is about to end. The rally wasn’t based on earnings or the economy, except to the extent that neither appears to be too negative (earnings are about to decline for the S&P 500 for the fifth quarter in a row and appear to be headed for a sixth). It had more to do with technical aspects that got quite a wind from the Brexit vote, oddly enough. That is an enduring feature of the stock market – when something bad happens that occasions a few days of selling, if the news doesn’t quickly prove to be fatal, prices will rebound with a short-squeezing vengeance.

The timing was fortuitous. The options calendar was put-tilted for the July expiration, favoring a dealer-fueled buy rally (making those puts expire worthless). The stock market nearly always rallies into earnings season, particularly those that come along in spring and summer. Then it sells off after earnings season, with the violence of the sell-off varying with both the season and the nature of the adjacent rally.

Right in the brunt of the Brexit sell-off, I wrote that the real Brexit effects were likely to take time to be felt in concrete economic terms, unless some hedge fund with a horribly wrongly leveraged position had managed to blow itself up (though such an event doesn’t appear likely at this point, it could still happen). That outlook holds. Some effects have already been felt in London – falling luxury home prices, the suspension of redemptions at some real estate-related funds – but it will take time for the full effects to course through the UK economy, and then the global one. I wouldn’t expect significant data numbers to appear before September, UK confidence surveys notwithstanding.

But, you may wonder, isn’t the economy clicking on all cylinders? No it isn’t, not at all, though the stock market is certainly promoting the illusion of it. A weaker-than expected May (almost zero job additions, weak retail sales, etc. etc.) had the effect of flattering seasonally adjusted month-over-month headline data for June. The reality of job growth is that is slowed sharply in the second quarter. The reality of retail sales growth is that year-over-year June sales growth was the weakest in six years. I keep reading about how great June sales were and how the consumer was hitting it out of the park in the second quarter, but it’s all a bunch of relative nonsense. Many analysts came out of the first quarter quite fearful that the recession screw might turn imminently, and so feared the worst from the monthly numbers in June. When they didn’t get them, they forgot all about the bad May news (and the bad May downward revisions) and started strutting around the chicken coop again. The best rallies always come when the Street has been holding its breath for something bad.

Quarterly retail sales growth for the second quarter of 2016 (Q2 2016) currently stands at 2.1%, compared to the weather-hampered 1.9% growth rate of Q2 2015. Q2 may well be revised downward, given that most of the retail sales revisions this year have been in that direction. The average since 1993 for the second quarter is more than twice that at 4.5% – in fact, the last two second quarters have had the weakest growth rates since 2009, and were well below any other year in the recovery. 2015 had a weather excuse, this year had none, but the seasonally adjusted initial June estimate beat expectations (thanks in the main to the downward May revision) and stock prices went up, so things must be great, right? Of course they are.

Weekly jobless claims beat expectations last week also. More hosannas followed, though nobody that I saw noted that claims were actually up 2% over the same week in 2015. It wasn’t the first week to comp negative this year, either. That’s how the business cycle really begins to end, not with employment falling off a Lehman-style, banner-headline cliff, but with growth numbers getting weaker and weaker and declines slowly spreading from one sector to another. The really bad news always comes in the later stages – Lehman didn’t fail until the tenth month of the last recession. Even so, most seem to be fixated on waiting for just that type of event again.

The calendar no longer favors the stock market, not until the latter part of August. Prices finished out last week with some of the highest overbought readings in a year. Expect a pullback soon, to be followed in due time by surprising and astonishing bits of news that will show that gosh darn it, growth isn’t as good as the June/July choir made it out to be. However did that happen?

The Economic Beat

Last week was quiet on the economic front, with mostly housing-related news on the agenda. Apart from the soaring costs of living in cities or other desirable areas, however – and that tends to happen in the late-mature stage of every business cycle – housing isn’t commanding much attention these days.

The homebuilder index in June shifted from 60 to 59, a trivial change to what is a strong level. Starts rose somewhat, but the sector’s growth, while still good (+7.1% for the first half of 2016 vs. 2015) has eased from last year’s pace of +10.8% . Activity is still far below the levels of the pre-bust decades. Last year was dominated by multi-family housing, but this year single-family has taken the lead and at +13.1% y/y is running well ahead of last year’s pace. In short, housing is doing relatively well but the sector just ain’t what it used to be.

In that vein, the growth in sales of existing homes slowed a bit, taking the year-on-year rate down to a modest (but still reasonable) 3%. Supply has tightened and the year-on-year growth rate in the average price is a respectable 4.7%, leading the national realtor’s association to fret over the sustainability of sales at high prices. Still, the 5.57mm rate (SAAR) is a post-recession high, while the FIFA (government agency) existing-home price index eased from +5.9% to +5.6% y/y.

Manufacturing surveys were somewhat at odds, with the Philadelphia Fed activity index following up last week’s decline in the New York index with its own decline to (-2.9). New order activity was positive, however, at +11.8. The Markit purchasing manager index rose a point to 52.9. Next week will see Dallas report on Monday, followed by Richmond on Tuesday, Kansas City on Thursday and Chicago on Friday. Speaking of Chicago, the Chicago Fed indicated that May was a little worse than previously estimated in the U.S. (its national activity index was revised to -0.56 from -0.51) but that June rebounded – maybe – to +0.16, pulling the 3-month average back up to a still-anemic (-0.12). I say “maybe” because the index is prone to big revisions in either direction.

Next week also brings the all-important Fed meeting (Wednesday), followed in due time by the all-important release of the Fed minutes. The Fed isn’t going to do anything, but everybody will still argue about how much they are leaning to doing nothing as opposed to doing something. The FOMC (monetary policy committee) will surely have seen the first estimate of second-quarter GDP, due on Friday. Consensus is for a gain of about 2.5%, and anything above that will be hailed as a major victory. Most likely the Fed will try to say something mildly menacing rate-wise to head off markets already too complacent, while not genuinely leaning in any direction but the neutral one.

Housing finishes the month with new-home sales and the Case-Shiller price index on Tuesday and pending-home sales on Wednesday. The real reports to watch next week are durable goods on Wednesday and international goods trade on Thursday, not for their one-month changes (which will get the lion’s share of attention) but for their year-on-year rates of change.

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