“Men may construe things after their fashion, clean from the purpose of the things themselves.” – William Shakespeare, Julius Caesar
The annual first-quarter myth of an improving economy is being widely disseminated again by the media, and last week’s rise in the market will be cited as proof. Why the market rose on Friday is difficult to defend, except that it was Friday and the calendar still says, “buy.”
It was also helped along by Thursday’s European Central Bank (ECB) meeting, central bank meetings in the US and Europe being buying events nowadays. In the US, one buys up to the time of the announcement and starts to sell within a day or so, while with the ECB, the rally usually begins after the announcement. In the current case, it was divined that as the ECB did not say it would abandon the periphery, it will support it. The put is still in, Spanish bond yields rose, and European equity prices rallied.
The economic data is discussed in more detail below, but perhaps the most important point is that the economy is having very little impact on the stock market. I often make the point that the tape makes the news, so one should expect a Pollyanna-ish tilt with the markets up 6% already this year.
But the real point is that the stock market engines aren’t terribly concerned with either the economy or corporate earnings. The former is still running at around 2% growth. Maybe it’ll be 1.5% this year and 2.5% next year, or maybe it won’t be. So long as the bottom isn’t falling out, that’s enough. Interest rates are zero. The critical factors are the central banks (i.e., the Fed and the ECB), and the calendar.
Most of all, it’s the two central banks. So long as they profess a willingness to be unlimited, or do “whatever it takes,” or have the put in one form or another to prevent system failure, the masters of the universe feel inclined to let their trading programs run. As I pointed out in my Seeking Alpha column, at this time of year that means buying stocks. The news isn’t required to be good, for the tape can take care of that. It just has to not be calamitous.
Admittedly, this isn’t the stuff of efficient markets, but that theory hasn’t worked brilliantly anyway outside of journalia. If I were writing an article for the Financial Analyst’s Journal – which by the way, is a fine publication that I actually read – I would have to produce a bunch of statistical data in support of a construct arguing why rational investors are unable to arbitrage the difference between real earnings growth and rising stock market prices, or perhaps write a similarly incomprehensible piece on why rising equity premia are justified by a blend of earnings yield, long-run earnings expectations, the inflation rate and the number of equity stock managers renting summer houses in Tuscany.
However, here I can write more plainly and tell you in simple terms that there is nothing to stand in the way of the buy-the-calendar horde. Certainly not equity fund managers, who would rather not give up Tuscany to summer on Coney Island. If they weren’t willing to stand up and say the market is too expensive in 1999, when it was insanely overvalued, they aren’t going to do it ever. Besides, these days equity managers drone on and on about how cheap the market is on projected earnings (that the market isn’t going to earn, but that’s tomorrow’s problem and it may not matter anyway).
It certainly isn’t going to be the retail public throwing a spanner into the works. If something dramatic were to stampede them into selling, it would be another story, but the public tends to follow the leader and likes to chase last year’s returns. Right now that’s the stock market.
Ergo, equity prices will probably continue to rise throughout the quarter, because exhaustive analysis of trading data indicate that in the absence of certain fiscal crisis factors, stocks rise in the first quarter, so the programs auto-correlate themselves and buy away (yes, this does raise systemic risk). I do expect a pullback soon due to a combination of factors – the weather, the impending sequester, another rising week leaving the market overextended again, and the monthly options expiration. Unless the sequester goes really badly, however, it probably won’t be more than a pullback.
There are one or two other situations that could pop up and hit the risk-off button with an audible bang, like a large-scale Middle East conflict or Cyprus deciding to take the honest route and admit it’s bankrupt, thereby provoking another twenty-three EU crisis meetings. Next week’s retail sales data could be a lemon too (see below), but adjustment factors and auto sales will probably keep it in line.
Absent the geopolitical events, however – which are still worth insuring against – your main preoccupation should probably be deciding what to bail into when stocks swoon in mid-spring, and what to invest in after they bottom in late spring. You won’t need the Financial Analyst’s Journal for that – just avoid the siren song of the business media.
Above all else, do NOT do the capitulation buy trade that the public seems currently bent on. Financial newsletter writers are running at maximum bull speed, while corporate insiders are bailing on stocks by the bucketload. You don’t need brighter warning lights than that.
The Economic Beat
It was a light week for data, and what little there was fell victim to the market’s glow. In an article whose headline about a “scant pickup in economic growth” seem to suggest a subdued 2013, the Wall Street Journal wrote confidently instead of 2.4% GDP projections and the “most recent strength sign of strength in the job market,” because claims “decreased by 5,000.”
It’s one of the most enduring frauds the business media is able to perpetrate on the public. For years now, the prior week’s total has been revised upward, I would guess around 95% of the time. The usual revision is about 3,000. Last week’s revision was 3,000. And every week, the press takes the apples-and-oranges route, acting as if the decline from the upwardly revised number to the later-to-be-revised number is the real deal. Actual claims rose, of course, as they always do at the end of January.
The more interesting fact is that the 4-week average of unadjusted claims stood at 436,312 on February 2, 2013, and 441,489 on February 4, 2012. The date shift does mean that the figures aren’t exactly comparable. but both periods do include the end of the month and should wash out the effect of the Martin Luther King holiday. The average at February 5, 2011, was 485,280, and indeed the ten percent decline was typical of the entire year. The latest data suggest quite a leveling off in the rate of improvement.
The Congressional Budget Office (CBO) released its forecast for 2013. A year ago, it projected real GDP of 2.0% for 2012, and the preliminary reading is 2.2% (the final reading may be years away). For 2013, it’s forecasting growth of only 1.4% . That’s better than the 1.1% projected a year ago, but quite at odds with the romantic images being spun in the press. The Philadelphia Fed’s leading indicator measure also slipped to 1.4% at the end of December. Maybe they don’t read enough newspapers in government offices.
The CBO also forecast an unemployment rate of 8.0% for 2013. The good news is that they were on the high side for 2012, and the drop in productivity reported for the fourth quarter of 2012 means additional hiring pressure. That said, the trend looks lukewarm to me right now. The improvement in monthly jobless claims has declined sharply, and January 2013 saw a larger contraction in counted establishment payrolls than January 2012. So long as demand remains anemic, it would seem that most big companies are happier to buy stock than to invest in labor and capital.
Factory orders for December were released Monday, and new orders for durable goods were revised downward, along with the business investment category (non-defense capital goods excluding aircraft), which swung from a gain to a loss. It must be the roaring economy at work. The category was weak for the last few months of the year, perhaps reflecting the uncertainty over the fiscal cliff. Yet the initial data for wholesale trade and inventories belie the notion of a big drop. Fourth quarter wholesale sales rose 2.6% (unadjusted), not too bad for the fourth quarter and above last year’s rate. The December inventory-to-sales ratio did rise from a year ago, to 1.245 from 1.189 (unadjusted). It doesn’t suggest that inventories are too lean.
There has been so much talk in the press about pent-up demand being unleashed once the fiscal cliff was avoided that it has been accepted by many as an article of faith. Yet businesses appear to be still reluctant to invest, not surprising in light of the weak demand so frequently referred to in corporate earnings talk. If the historical pattern holds, there won’t be a genuine restock of inventories until the second quarter. If some part of the sequester goes through, it isn’t going to stimulate additional ordering.
The ISM non-manufacturing report came in at 55.2, about consensus, but it wasn’t a great-looking number from my view. It was weak for January, the number of sectors contracting outnumbered those growing, and the increase in the employment indicator was entirely due to seasonal adjustments. The latter still haven’t recovered from the first quarter of 2008 and 2009.
One report I saw expected January retail sales to show a 0.5% gain when the report is released on Tuesday. I expect that the consensus will go lower before then in order to improve the odds of producing a beat, and I also don’t see how a 0.5% number is in the cards given the persistent weakness in the Redbook weekly sales data. The number is seasonally adjusted, though, so anything could happen. The year-on-year improvement in monthly retail sales has been easing for months now, and December’s increase of only 2.45% wasn’t impressive. The small sample of stores still reporting monthly same-store sales had mixed results.
Imports fell sharply in December, leading to a drop in the trade deficit and promising a boost to fourth-quarter GDP. Most commentary blamed the drop on the fiscal cliff and a California dockworker strike, but holiday imports were down months before the strike. Why the drop was unexpected is the larger mystery, as we were reading about the dockworker strike all the way over here on the East coast. Another group not reading the newspapers enough, I imagine.
Let’s see, the Christmas selling season was below plan, Redbook sales reports were weak throughout January, and new orders for business capital goods fell in December. It all could tempt one into thinking that lower demand is responsible for the drop in imports, but that can’t be. The economy is booming. It says so in the Journal.
Monthly Chinese trade rose sharply (over 25% year-on-year), though most of it was due to the calendar effect of having five extra working days and the shifting of the Chinese New Year holiday from January into February. The Chinese PPI (producer price inflation) index continues to be lower than a year ago, which doesn’t support the notion of strong expansion.
Besides next week’s retail sales report, the two other highlights are the New York Fed manufacturing survey and the central bank’s Industrial Production report on Friday. There’s also the Small Business Optimism report on Tuesday. Probably the most important scheduled event on the calendar for the stock market, though, is the expiration of February options. The historical tendency is for stocks to stay supported leading up to expiration and then be vulnerable afterwards – although they avoided that fate in 2012.