“The climate must be perfect all the year.” – Richard Burton, Camelot
Stocks kept their rally shoes on last week, and on the second attempt traders managed to close the S&P 500 above 1500. It was largely for the sake of its own momentum, as equity traders and prices are wont to do.
The Russell 2000 also managed to clear its magic round number of 900, leaving the Dow looking up at 14,000 as the last major enchanted tree to climb (some cynics might wonder if $400 for Apple’s stock price (AAPL) should be included). The MDY, or mid-cap ETF, closed Friday just short of $200 ($199.64), so perhaps it will join the other faeries Monday morning.
A disconnect between the real economy and the stock market isn’t new, nor is the phenomenon of the latter casting a rosy glow over the former when the latter is rising. The new year usually starts out with a wave of calendar enthusiasm – in 2011, markets were still riding the “sugar high” of QE-2 from August 2010. In 2012, markets rode the wave of the post-Thanksgiving rebound and the inflated data of one of the warmest winters ever, in the warmest year on record, to post the warmest first quarter for prices on record.
Now we are riding the first quarter wave again, this time launched by the last-minute aversion of the fiscal cliff, cheered on by the usual gang of suspect narratives, and sustained by behavioral trading programs programmed to buy the first quarter until proven guilty, with high-frequency trading programs (HFT) front-running everything. Keep in mind an enduring truth of every momentum wave – no matter the direction – that any and all news will get sucked into the vortex of the wave and recast in its image. The routine shall become dramatic, and the dramatic shall be trivialized as necessary.
A good case in point is the over-the-top fanfare over some European banks repaying €137 billion (around $180 billion) from the European Central Bank’s (ECB) LTRO (long-term repurchase operation) program – paying it back early! Naturally, European financial ministers sat up and crowed, and naturally, trading programs reflexively bought the euro. Europe’s banking system is healed!
Reality is a bit different. What it really reflects is that one, many of the banks involved are losing money on the program by borrowing at 0.75% and depositing it at their central bank for nothing. Two, they’re not lending out money, or they wouldn’t be repaying it. Three, there’s still the little matter of the rest of the €1 trillion program, and four, they can always get more money from the ECB, as the following chart from the Wall Street Journal shows
The ECB said that the loans will add 0.7%-0.8% to the region’s GDP – if the banks lend it out, which they aren’t doing. In the meantime, the UK’s economy is in trouble again, riot police are at work in Athens, and well, I could go on for some time, but I won’t. All that matters to investors is that sovereign yields are low because the ECB says they’ll backstop them under certain conditions, and in a yield-starved world buyers aren’t inclined to test the promise.
2013 will be the third year in a row that starts off with excited (some might say inane, but that might sound disloyal) talk of a robust US recovery that is on the verge of reaching “escape velocity.” It won’t be true this year any more than it was last year, but for many market participants that point isn’t relevant. The hard part isn’t seeing that the economy isn’t really going anywhere, nor even keeping a straight face when asserting on television that grand things lay ahead. The real trick is to guess which week in late April or early May that the jig is up again and jump off the wagon.
Markets are quite overextended now – the S&P is up for eight days in a row for the first time since 2004 – so expect some pullback in the coming days. The next two pivot points on the calendar are the jobs report on Friday and the middle of February. Notice that I didn’t say anything about earnings – they don’t matter right now, so long as no one is predicting bankruptcy.
Consider the case of Flextronics (FLEX), a nice canary-in-the-coal mine kind of cyclical bellwether. The stock of the contract electronics manufacturer is in the dumps right now, because business isn’t so good. Said company management on Thursday, “maybe the macro environment will improve as the SIA forecast for 2013 indicates a 4.5% growth, but we have no visibility of that rebound existing in our base business today.” I counted forty instances of “weak” and “weakness” in the conference call, with about half of them in the context of “weak macro.” That matters little compared to the magic of Fibonacci levels (i.e., 1510 on the S&P 500).
The jobs report could send the market anywhere. I am already suspicious of the seasonal adjustment process used in recent jobless claims (see below), but there’s more than that. If the market was so bold as to keep rising into the jobs report, it would probably sell off on a really good number, or one that was below consensus. The latter is for obvious reasons, but if the market is still overextended, someone will whisper that the Fed is going to pull the plug soon and it will be a good excuse to take profits.
If, on the other hand, markets have pulled back as they should, then the jobs report could give the rally another kick-start towards the magical 1510 level and keep the faeries dancing until mid-February. It wouldn’t make sense, but the magic of the markets has never required logic, especially in the brave new Camelot of financial leverage and central bank magical money.
The Economic Beat
The number of the week was again weekly jobless claims, and it left me as baffled as the previous week’s release. I wrote the gory details up in Seeking Alpha yesterday, but the cheat sheet is that for the second week in a row, claims were higher than the year-earlier period, yet reported as substantially lower. It isn’t typical and with the exception of Sandy, I can’t recall it happening at all in 2012. Time will tell, but I am skeptical of the adjusted numbers. The bigger issue is what effect, if any, it has on the January jobs report released next Friday. One twist is that next week’s seasonal adjustment number is lower this time than the year-ago week, which could lead to a big spike in claims (n.b. – the week is past the cutoff for the jobs report).
Existing home sales were a bit weaker in December than expected, at an annual rate of 4.94 million, down slightly from a downwardly revised 4.99 million in November and about 13% higher than the previous year’s rate. Prices were reported to have moved up, though much of that is surely a mix issue.
The new home sales report inspired quite a bit of festive reporting from most of the press. Although the December number showed a seasonally adjusted decline, all I heard all day was that the rate rose 20% from last year (which was the worst year for new home sales since probably the 1930s, though the records only go back to 1963). You can get some big percentage increases from such low numbers. It was also the best rate since 2009, which at the time was also the worst year since the 1930s, only to be bested by 2010 and 2011. Now the 2012 rate of 367,000 homes is only the third lowest rate since the Depression.
Another was, “forget December weakness, look at that big November revision!” It really wasn’t all that big, a rounded up 2,000 added to the monthly total, well within the margin of error. New home sales data is subject to substantial revisions, and given the warm December weather, I wouldn’t be surprised to see another upward revision later. However, the homebuilder sentiment index last month didn’t budge and remains below the neutral waterline, so I wouldn’t expect anything major.
One news service advised ignoring the estimate miss and focusing on the two-month total. The fourth quarter of 2013 saw 81,000 actual homes sold – a number still subject to revision, clearly – versus 72,000 in July 2012. data. That’s a nice percentage pickup of 12.5%, but keep in mind that the fourth quarter of 2011 was the weakest fourth quarter since records began in 1963.
Housing is recovering, yes, but it’s a slow pace and long-time industry followers have been trying to dial down expectations, largely without success. The mainstream press was positively gushing over the huge increase and glowing over its implications for the economy, though homebuilding is only about 2%-4% of GDP. Pending home sales is next up on Monday.
The Chicago National Fed activity index had an upward revised November, thanks to Hurricane Sandy, and then a sideways reading in December (0.02). The three-month moving average stayed near-unchanged at (-0.11), negative for the tenth month in a row, but with that big November number of +0.27, it would take quite a large negative in January for the moving average not to turn positive, which would doubtless occasion a lot of bombast about a recovering economy.
Is it really recovering? The claims data, right or wrong, should drive up the Chicago result for January. The latest four regional Fed manufacturing surveys – Philadelphia, New York, Richmond and Kansas City, all turned in negative results this month. The Chicago PMI was reportedly revised downwards to a negative reading of 48.9 for December. However, the Markit PMI “flash” PMI was released with an increased reading of 56.1, prompting the Econoday website to advise forgetting all the other regional data. Maybe, but the Markit number is still quite new and has run well ahead of the national ISM number every month but one. The latter comes out next Friday, after the jobs report.
Weekly retail sales data has been running weak all month. The Leading Indicators seemed to report an increase of 0.4% for December, but when factoring out the Hurricane Sandy effect on weekly claims data, it was only up 0.1%. Yet the headlines continue to report over-hyped numbers, driven in part by the over-hyped stock market advance. I don’t usually cite the Bloomberg Consumer Comfort index, but it did fall to a three-month low this week, which seems at odds with the glow coming from the press.
I fear we are doomed to another first-quarter batch of excess optimism, fed by a circle of program buying and erroneously adjusted data. There are glowing reports about the improvement in PMI (purchasing manager) surveys around the globe, when nearly all of them are still negative, just not quite as negative in some areas. The small monthly incremental gains in China coincide with the accession of the new leadership, and the numbers themselves are barely above neutral.
Next week will be either the apogee of the spin, or a dose of reality. December durable goods orders are due on Monday, and a good increase should be expected because of the usual year-end rush to use up budgets along with the possibility that the 50% bonus depreciation tax provision would expire. But will it really be more than a blip? Fittingly enough, Caterpillar (CAT) will report before the opening, and its December monthly results were disappointing. The Dallas Fed manufacturing survey later on Monday and the Chicago purchasing survey on Thursday are the last two regional results before the national number on Friday.
Tuesday brings consumer confidence in the morning and Amazon (AMZN) earnings after the close. Wednesday has the latest Fed meeting and announcement. The committee will no doubt be influenced by the morning’s release of the first estimate for fourth quarter GDP, which is estimated at 1.2% (annualized). The governors will probably want to be cautiously optimistic, which reminds me uncomfortably of 2007, but the GDP number could throw a wrench in their plans.
Thursday brings December personal income and spending, which should be boosted by dividend payouts, and perhaps a sharply higher claims number (easily dismissed, if need be). Friday will add construction spending to the jobs data and the ISM number. Exxon (XOM) and Chevron (CVX) both report earnings that morning.