“Oh, how this spring of love resembleth the uncertain glory of an April day.” – William Shakespeare, The Two Gentlemen of Verona
You’ll have to excuse us if we don’t hearken to the week’s comparison with 1998, the last time the markets had so strong of a quarter. We remember 1998 quite well; it was the year that the markets kept ignoring the growing Asian currency crisis until they couldn’t. The brutal 28% correction that began in midyear wiped out all of the gains; yet there was no mention of it in the many weekend psalms about the market.
It’s true that there is no Long-Term Capital this time around, the infamous leveraged bond fund that froze the credit markets in ‘98, but there is plenty of systemic risk around the globe. The French appear ready to elect a Socialist government at odds with Germany’s Chancellor Merkel, the Greek situation will almost surely end in a bigger default, and the Spanish and Portugese situations continue to worsen. Did we mention Ireland, or the drop in German retail sales? The continent is headed into recession, but like the Asian crisis of yore, we’ll just ignore stuff that’s far away until we can’t.
The US economy isn’t doing badly, of course, though it isn’t growing as much as it was in 1998. It looks like it’s growing about as much as it did last year, despite the fawning in the business press (that also resembles this time a year ago). But the news out of the economy last week was quite mixed, with more downside surprises than to the upside, despite the self-serving tone from Street strategists.
The regular press is easily fooled by this type of stuff, writing up Friday’s rally as due to improving consumer sentiment, as well as other vague notions of the economy “gaining momentum.” What saved the market last week was the rally that began at lunchtime on Thursday straight through to Friday afternoon on the back of the story about the new European firewall fund. When the Chicago PMI and consumer sentiment data came out Friday, prices sold off sharply. Then the European liquidity news floated back in, and the usual group of late-morning buyers came back to work the tape higher into a profitable quarterly close.
We would not be surprised to see the market continue to follow the 2011 script: an initial rally over the first few days of the quarter (nine quarters in a row now), followed by some sort of nervous sell-off, then the final run for the roses from mid-April to early May. The only element missing so far from a repetition of last spring was the traditional February wobble, for which we can thank the warm winter weather.
What might cause a deviation? Oddly enough, more bad news for the markets to rally against. Every frothy rise stays alive not by climbing the wall of worry, but by betting that tomorrow’s news won’t be strong enough to kill it. It is, after all, an auction process, and at times the fever grips the crowd enough that even news that is glaringly bad can be wrapped into something more suitable – for a time.
It’s clear that the situation in China is deteriorating, but what traders are really waiting for is a chance to rally, not to run. The expectation is that the authorities will be forced to ease monetary policy soon, and whether or not such moves can head off a slowdown or hard landing is entirely beside the point. One buys easing moves first and reads the reviews later.
Another move that is looking for traction is the talking down of first-quarter earnings. The murmurs are beginning that growth is no longer required of earnings, or at least not much of it. The rationale behind this revelation is that said growth will come later, so best to be ready for it now. Real earnings growth lies over some distant rainbow that will be called into existence by a series of events that are rather nebulous for the time being; if you’re not sure, just look at the charts. Things will just get better. It’s the spring, after all.
The Economic Beat
The manufacturing surveys from Dallas, Richmond and Chicago last week all showed significant deceleration last week, with the new order index falling in half in Richmond, going to zero in Dallas and slowing sharply in Chicago. Employment slowed in all of the districts but Kansas City. Except for the last district, not a bellwether and largely ignored by markets, all of the surveys were big misses against expectations. So was the durable goods report, which rebounded much less than expected from January’s decline. Pending home sales fell instead of rising as expected. Home prices are still falling, personal income for February was half of expectations (0.2% vs. 0.4%), and disposable income fell again (-0.1%).
“The economy is gaining momentum,” rhapsodized Wall Street economists. If only it were true. The Chicago national activity index contracted in February. Weekly claims seemed to have settled into a new range of about 350,000-365,000 (seasonally adjusted), but are creeping back up over the 360k level in recent weeks. That’s not part of the acceleration script. Consumer confidence retreated slightly in the Conference Board’s monthly survey, but consumer sentiment advanced slightly in the University of Michigan’s monthly revision. The former was quickly forgotten, while the weekend press talked endlessly of the latter.
The parlay that we mentioned last week – a upward revision in fourth-quarter GDP and a durable goods beat – didn’t come to pass, but it wasn’t needed after the latest liquidity play from the EU. Business investment spending did rebound by 1.2% after the January drop, though more was expected.
The February personal income and spending report should tell you a lot about the economy’s true state, though admittedly it could be mined for different views. Spending was higher than expected (+0.8% vs. 0.6% estimate), but that was due entirely to the auto sector. Car sales are indeed increasing, thanks to a combination of an aging fleet (the average is nearly eleven years old), available credit (bank balance sheets are not clogged with bad car loans, and the finance arms of the manufacturers are functioning normally), attractive terms, and better mileage. The unemployment rate among the college-degreed is low (excluding those no longer counted). It’s a good backdrop for car sales.
However, there is no evidence in the report that consumption is taking off. The annual run rate in real personal consumption expenditures – the PCE measure – over the last seven months has ranged from 1.5% to 2.1%, with the February rate clocking in at 1.8% versus the mean of 1.7% over that period. Year-on-year real personal income growth has slid in the last three months from the anemic 0.7%-0.8% rate in the fourth quarter to 0.6% in January and an even more anemic 0.3% in February. Some late-arriving data may take it up a bit, but it’s quite unlikely we would see a revision large enough to get back to fourth quarter rates. As gasoline prices rise in the spring, they add another headwind.
Next week’s jobs report is being talked down already, in an effort to head off any disappointment. The good part is that it’s one of those rare jobs reports that fall on Good Friday, such that the stock market will be closed. The last time this transpired, to the best of our recollection, stocks burst forth with extra vigor on Easter Monday. Notwithstanding the effort to manage expectations, the consensus estimate is for 200,000 heading into the week, but don’t be surprised if it’s talked down before then. We’ll interested to see how the estimate of the raw data compares with historical trends (if you’re curious, March usually adds a bit more than February in actual jobs, and not as much as April).
It’s a busy week in other respects, with the ISM manufacturing report on Monday and the services report on Wednesday. There are the usual first-week of the month sales reports, motor vehicles and same-store sales, and we’ll get delayed reports about February construction spending and factory orders. The latter should closely track last week’s durable goods report.
The FOMC minutes come out on Tuesday, and during frothy periods they are usually good for a rally, regardless of what they say. If the governors sound encouraged, then the economy is roaring and one must buy equities; if they’re worried, then more central bank help is on the way and one must buy equities.
If you think we’re being cheeky, we saw stories last week – from institutional people, mind you – arguing that stock prices should rise regardless of whether or not first quarter earnings disappoint, rise regardless of which way the Supreme Court rules on the health care act, and – no doubt soon – rise regardless of whether or not Iran launches nuclear missiles (clearly that would be good for energy stocks, not to mention defense, health care, and technology, so what’s to worry?).