For Whom the Fed Tolls


“The Fed is my shepherd, I shall not weep.” – Anonymous trader

Last week was a neat recapitulation of 2012, a reminder that in the last year or two, the stock market has had little to do with investing in company earnings, and nearly everything to do with central bank action.

When Europe announced recession-level GDP data for the fourth quarter the prior week, stocks didn’t really care. One of the more popular European ETFs, Vanguard’s VGK, dipped for a brief couple of days and by Monday it was all forgotten. The S&P 500 didn’t react at all – Europe is so far away. As for weak January retail sales, industrial production and Wal-Mart’s (WMT) inadvertent leak about a weak February start, it was all quickly water under the bridge. The calendar trade ruled, and the real intrigue was over when the Dow Jones Industrial Average and the S&P would hit their all-time highs.

When the FOMC minutes were released on Wednesday, suddenly the world looked different. The idea that the Fed might close a couple of money gates, even part of the way, made managers shudder and the unemotional black boxes signal for the sell button. After a two-percent drop in two days, the Wall Street Journal discovered that the payroll tax had gone up seven weeks earlier. “Payroll Tax Whacks Spending,” read Friday’s front-page headline.

Were you from another planet, or even worse, a student of serious economics, you might been further worried about the fate of the market on Friday morning after a fresh slate of weak data and the European Commission’s conclusion that the eurozone would stay in recession in 2013. The latest PMI data had missed estimates across the board and but for Germany, were all in contractionary territory.

In a reproof to those who were speculating on Thursday that the Fed was ready to get tough with the markets – a novel theory, it must be said – the Fed’s cavalry arrived Friday morning, accompanied by a panoply of articles. St. Louis Fed President James Bullard, who is supposed to be a hawk, went on CNBC early Friday morning to reassure markets that Fed policy is going to “stay very easy for a long time.” Federal Reserve officials Rosengren and Powell also were quick to defend accommodation, and San Francisco Fed President John Williams (who did not write the score for “Star Wars”) gave a speech Thursday in which he said that that “strong monetary stimulus is essential.

Have no fear, markets, the Fed is here. Thus reassured, the Dow rose over 100 points Friday, aided mightily by the closing of the European markets, which gave the indices a second wind. Not that they were sellers either, as European markets rose across the board with the comforting prospect of another year of recession assured. I wrote on Seeking Alpha that were any sort of greater pullback to develop, I fully expect the ECB and Fed to bring forth soothing words and promises at their March meetings.

Some strategists have been bailing, with one of the recent converts being Dennis Gartman. Marc Faber was brought out with his usual warnings, but he made a good point when he observed that everyone is saying “sell bonds and buy equities,” and that it’s never good when everyone is thinking the same way.

Other warnings and lists of warnings proliferated in the wake of the two-day decline. One of the ironies of it all was that many were based on the notion that the economy really isn’t doing that great, despite its rave reviews as late as last week, while the FOMC minutes discussion of reducing asset purchases was presumably based upon the notion that the economy is doing well.

My sense is that it will still be difficult to derail the march to an April high. The market could chop a while, certainly, but all that is necessary is for ECB president Mario Draghi to say the right thing on March 7th, or for the Fed to reaffirm its commitment at its March meeting to its $85 billion program and markets will start moving right back up again. The two-day pullback and rebound may have shaken some hands, and we could still test the 1490-1500 band on the S&P again, but the move could just as easily build a base. It’s going to take harder news or tougher central bank words to stop the markets’ move upwards.

The question of whether the markets should be moving higher is something else entirely. The fundamentals do not appear to improving, but so long the herd is convinced that easy money is here to stay and that one must be in equities, stock prices will reflect that conviction. I don’t like to repeat myself from column to column, but “deservin’s got nuthin to do with it” (sic), in the words of “Unforgiven’s” William Munny (Clint Eastwood).

If you want an echo of 2007 behavior, it can be found in the Texas Instruments (TXN) story of a major dividend/buyback hike. The company’s plan is to invest 20%-25% of revenue into buying stock and dividends, and only 4% on capital expenditures. Now that’s investing for the future.

The Economic Beat

The week’s biggest report wasn’t data at all, of course, but the FOMC minutes. The rest of the week’s data consisted of negative surprises, with the exception of the Markit “flash” purchasing manager index (PMI) number. It was released with a value of 55.2, a bit lower than January’s 56.1. It would be nice if the 55.2 was true, but the January number was well ahead of the ISM (the traditional PMI measure) result of 53.1, itself a low number for January.

The Markit flash is also at odds with two of the latest regional Fed manufacturing surveys from New York and Philadelphia, of which the latter is the older and more influential. Last week’s New York reading of 10 was the lowest February result since 2009, and the Philadelphia result was actually negative at (-12.5). The unadjusted result was negative too (-2.9), also unusual, though not quite at recessionary levels. The Philadelphia Fed revised its seasonal adjustment factors again, which is to be applauded, in an attempt to smooth out the bias towards inflated first-quarter data and overly bleak summertime numbers.

A possible explanation of the divergence between Markit and the regionals is that the parts of manufacturing that have been doing relatively well – farming, automotive and energy-related – are concentrated in the middle of the country (although not so much for Caterpillar (CAT), which just reported weak North American sales for the latest three months). The Eastern regions may be feeling the European downturn more than their interior brethren. Some good clues may come next week, with the Dallas Fed survey on Monday, January durable goods on Wednesday and the Chicago PMI on Thursday. The last Dallas result was a surprise positive with a good production value (+12.9). The Chicago number also looked good, but was due almost entirely to seasonal adjustments.

Speaking of seasonal adjustments factors, the Labor department seems to continue to struggle with theirs. Headline claims data has been swinging back and forth in 2013, with many weekly swings of 20,000 – 40,000. Some of it may be due to weather and holidays, but the biggest source of variation has been in the adjustment factors themselves (calculated in advance, in case you didn’t know). Next week’s factor declines again, meaning that we should see another increase towards the 370,000 level in the headline release.

Of bigger concern is the steady flattening out in claims, which have slowly been receding back towards 2012 levels for the last few months. A partial explanation may be that the very warm winter last year meant that claims were lower than usual and so the comparison is difficult. However, the year-on-year improvement was steady until late in the year, so it may be more realistic to attribute it to the GDP number of (-0.1)% in the fourth quarter. The first revision of that print is due on Thursday, and the consensus going into the weekend stands at +0.5%. Much of the increase may come from a deceptive revision downward in imports – it’s not an indication of strength.

The last of the latest round of housing figures are coming out next week, starting with new home sales on Tuesday. Going by this week’s news, they are set to decline. Perhaps the best tell is that the homebuilder sentiment index declined to 46 in its latest reading. It wasn’t a big decline from the previous 48, but it’s a good indicator of where starts and new home sales are going. The former came in lower than expected at an 890,000 rate, though the single-family component was steady.

Interestingly enough, the Western region showed increases in starts and permits, yet was the only region to show a decline in the latest existing home sales report. Lack of supply was widely cited as holding down the latter, but that lack is doubtless due to would-be sellers hoping that prices will come back more first. The anecdotal evidence is that the California market is red-hot again.

Credit is still tight, and will remain so until there is a sustained upward move in prices that can frighten banks into worrying that they are missing the boat. Another restraint on lending is the by-now nearly universal conviction that rates are going to go up, making banks reluctant to make loans for anything that they can’t sell to Fannie and Freddie. Mortgage-purchase applications have been falling in recent weeks, which doesn’t bode well for the pending home sales index on Wednesday.

One good piece of news ought to come Monday with the Chicago Fed national activity index. It’ll just be a fluke of the calendar and Sandy, but it will still get some excitement value as the 3-month average should finally poke its head back above zero. This will be due to October falling out of the calculation, to be replaced by the big post-Sandy November result of +0.27. December came in at +0.2, so even with a modestly negative January result and a potential downward revision to December, the average will still be positive. The parade follows later that morning.

The latest inflation data was reported during the week, and raised some questions for the wonky. The year-on-year producer change in prices (PPI) was 1.4%, 1.8% excluding food and energy. The related change in consumer prices (CPI) was 1.6%, 1.9% excluding food and energy, with the January monthly increase at +0.3%. If yearly inflation is running at 1.8%-2.0%, then where did the BEA come up with an 0.6% annual rate for its fourth-quarter calculation of real GDP? Maybe real GDP really was that low.

If January inflation was +0.3%, what does that say about the retail sales increase of +0.1%, which is not price adjusted? It implies that seasonally adjusted sales declined, which is what you might expect from the higher payroll tax and, according to Wal-Mart, a delay in tax refund checks. The latter may provide a delayed lift when they come in, but it’s temporary. The payroll tax is here to stay.

The week will finish up with a bang. Besides Friday being the first day of the month, it will provide the latest ISM manufacturing reading, along with personal income and spending, construction spending, and February auto sales. We’ll have to wait until the following week for the jobs report (though a slip-up can never be excluded).

There’s also the little matter of the sequester scheduled to go into effect that day. Despite the recent increase in rhetoric, especially from the White House, there doesn’t seem to be any of the sense of urgency that the fiscal cliff had. It appears that there are enough members of both parties willing to take some sort of stand and see what happens, that it probably will happen.

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