Avalon's MarketWeek

Hope Floats, Vol. IX


“Blessed is he that expects nothing, for he shall never be disappointed.” – Benjamin Franklin, Poor Richard’s Almanack

In the spring of 2007, I wrote the first MarketWeek column, entitled “Hope Floats.” The name was both a nod to the 1998 Sandra Bullock movie (not so old at the time), and a comment on hope in the stock market. Hope in this case for the stock market means the annual springtime rally, regardless of how bad things might be, and the market’s knack for hoping that something, somehow will come along and let the good times keep going (or every eight years or so, get them started again).

That pop last week in equity prices was well, ominous. Not that the market went up for no apparent reason, or perhaps no good reasons. Prices moving higher on goofy action and/or sentiment is as old as the hills, and most of the time doesn’t mean anything deeper than the fact that the market is open and the zombie apocalypse has yet to arrive.

In good years, good either for fundamental reasons (the economy or earnings are doing better) or for momentum reasons (the market is still in the early stages of a fresh, can’t-miss narrative), stocks would typically have been under selling pressure last week. The usual suspects for the pressure include tax selling in front of the April 15th filing deadline, natural pullbacks from the usual first quarter rally, worries that earnings might not be as good as hoped, and last but not least, the knowledge that stocks do usually sell off in the first half of April before rallying strongly in the second half.

Unfortunately, there are fewer capital gains to go around this year. The market was up in 2014, true, but in mid-October it fell to flat on the year, scaring many off to the sidelines. There was no first-quarter rally to speak of, and one of the main sources of confidence during the week was that the market was fully prepared for a negative earnings season that would not be as bad as predicted. Well yeah, earnings are pretty much always better than expected (the built-in quarterly cushion of about 300 basis points that I have been talking about in print for over a year is now being frequently mentioned on CNBC).

It seems that part of the bull case is that the reversal of April form this year is because the market already sold off on earnings worries in the first quarter, and so is naturally doing the opposite thing in the first half of April. Thus, the market is already looking past this quarter’s so-called “earnings recession” and looking ahead to the rest of the year. That seems like standard stuff, another example of the “look across the valley” syndrome that tries to explain that the stock market cleverly looks past the near term, and isn’t just dominated by a bunch of greedy pigs afraid that others will sniff out the next trade first.

The stock market wasn’t looking across the valley last week, however. It rose because of the now-global conviction trade that investing is as easy as watching central bank liquidity conditions. The United States is responsible: although the Federal Reserve’s own studies have shown that its quantitative easing (QE) programs have added a quarter-point or less to annual GDP, they plainly added to stock market gains, partly due to the enhanced liquidity, and partly due to enhanced conviction levels that the Fed would not let the stock market fail. Somehow.

So now Chinese markets are in bubbles because the economic news is weak, thus authorities will have to resort to more stimulus – buy stocks! Money is pouring into European securities as well, with US money managers singing the praises of European stocks for various reasons, and the real underlying motive of chasing after the European Central Bank’s (ECB) newly instituted QE. Stocks rose in the U.S. last week precisely because the IMF was warning that global growth was low and the economic data – wholesale trade, import and export prices, the Fed’s “Labor Market Conditions Index” – was weak. Or in other words, the Fed can’t move yet, China and Europe have to keep pumping money and all roads lead to TINA (There Is No Alternative to equities).

I’ve seen this movie before: it comes in the waning part of just about every bull market in the last forty years. The gist of the plot is that we can forget about the waning of the business cycle, because it means that the Fed will have to act to save us, and so you should keep buying stocks. And the Fed will act, not quite as it always has, because its follies in clinging to ZIRP and thinking it can fine-tune the economy have left it with much less room to maneuver. But it will act. And the business cycle will end anyway, just as it always has, because central banks can’t stop it.

At the end of the week, General Electric (GE) announced it was selling its credit and real estate businesses. Press coverage was mostly of the end-of-an-era sort, with some wondering how GE could be so naive as to be selling its real estate to those shrewd folks at Blackstone (BX). I’m not so sure. GE is basically going to take the money and plow it into buying stock and paying dividends, hardly a ringing endorsement for economic demand. It just might be that CEO Jeff Immelt thinks he’s cashing out of these businesses at peak valuations. As for Blackstone – whose management has a controlling interest, and doesn’t have to answer to any activists – if you think they would never pay up at the end of the cycle, you’re dead wrong. The group bought $39 billion of property from Sam Zell in a single deal in 2007. Not the greatest timing, but keep in mind that it gets a big stream of fee cash in both deals, with the latter supposedly having some rebate provisions. It makes you think.

If historical form holds, the majority of Wall Street and investors will cling to the Fed-as-savior myth until the bitter end. Ergo, although volatility will increase, the stock market will keep trying to go higher – and probably will, too. The summer should mean a pickup in economic activity, though not as good as last year (in large part because the first-quarter decline wasn’t as bad either), and a return to snarky bull bragging and sneering. You can find bulls making the case even now to buy because the negative first quarter puts the Fed on hold on the one hand, but sets us up for another rebound on the other. It’s all very end-stage stuff. Hope will float higher again, and – as traders like to say – the trade will work until it doesn’t.

The Economic Beat

A quiet week for data saw the market focus on two issues – the FOMC minutes and some weakish reports. People see what they want to see in the minutes, I suppose, and I am probably no exception. Though the comments are somewhat censored, I see a divided Fed quibbling over what day might be best to wash the laundry, while the elephant in the room begins to stretch and stroll around. The ever-optimistic staff keeps pretending that the cycle has no ending and that the economy will instead accelerate (as always) over the next two years. The stock market rises because it thinks soft economic data means that the Fed will have to postpone tightening, while the staff writes – no joke – that “Movements in asset prices over the intermeeting period largely seemed to reflect receding concerns about downside risks to the global economic outlook.” Oh well.

At any rate, traders want to see a Fed on hold, and though they had to struggle a bit to get there, that was the provisional conclusion. Fortunately for asset prices, two weak reports coming in after the meeting reinforced the cannot-tighten view.

The first was wholesale sales and inventories. A decline in February wholesale sales of 0.2% (seasonally adjusted, or SA) meant that inventories rose 0.3% (SA) and the inventory-to-sales ratio was at its highest level since June 2009 (SA), or about 10% higher than a year ago. Then Friday saw the release of March import-export prices, with further declines in the year-on-year rates to (-6.7%) for export prices and a whopping (-10.5%) for imports, including a (-0.4%) in the ex-petroleum category. As Econoday put it, “The doves at the Fed can be a little more persuasive following today’s import & export price report.” With the FOMC minutes expressing concerns over the deflationary impact of falling petroleum prices and a rising dollar, the numbers were grist for the can’t-tighten mill.

Although the February labor turnover report (JOLTS) showed a new high in job openings, the hire rate of 2.9 (not SA) was only a fraction higher than the year-ago 2.8, and the Fed’s conditions index fell (as note above) by 0.3. That allowed bulls to simultaneously claim that the labor market is improving (the economy is getting better) even as it is not really improving (the Fed’s index says it has to remain on hold). Yup.

There are areas where the economy looks good, though. The ISM non-manufacturing report was fine, with a reading of 56.5 (consensus 56.7), an expansion-contraction score of 14-4 and generally upbeat comments from respondents. Chain-store reports for retail sales got an Easter boost (look for strength in the March report) and weekly jobless claims remain at cyclical lows.

The market’s reaction to the March retail sales report should be interesting. The consensus is for a gain of 1.0%, reversing a string of recent weak reports (that were actually better than the headline numbers looked). It’s easy enough to imagine the usual suspects charging forth to bellow about the winter being over and the economy entering the second quarter with fresh momentum, not to mention the upgrades to GDP estimates that will surely follow in its wake – assuming that the consensus does hit. Will traders focus on the positive of the rebound, or the negative that maybe the Fed can tighten after all? Many Fed governors are slated to speak in the days following the report.

Wednesday brings March industrial production and the New York Fed manufacturing survey, followed by the Philadelphia Fed survey on Thursday. Both of the surveys have been showing quite modest, below-consensus results in recent months. The latest estimates punted, with consensus predicting the same levels as the last report.

The monthly homebuilding calendar gets started on Wednesday with the sentiment index. followed by March housing starts on Thursday. Inflation data is updated with March producer prices (PPI) on Tuesday and consumer prices (CPI) on Friday. The Fed’s Beige Book will tell us on Wednesday that growth is “modest to moderate,” while the ECB will issue its latest policy views earlier that morning.

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