“Just think of lovely things,
And your heart will fly on wings,
Forever in Never Never Land.”
- Peter Pan (Carolyn Leigh)
Listen – do you want to know, well, something that’s not really a secret? They’re trying to take this market for a ride. One that will last exactly fifty days.
We’ve been writing in this space about how badly the equity markets want to push higher into the close of the year. What else could explain the ridiculous leap up the last two days of the week? A warning about that Friday gap-up rally: it was the lightest trading day since mid-July. That was when a similar low-volume attempt to set off a technical buy-in was followed by a massive correction (over 20% high-to-low).
But corrections are for July, aren’t they? The 2000-2003 bear market was interrupted by a 20+% year-end rally that began in mid-September of 2001. The market flat-out collapsed almost immediately afterwards, but then (of course) staged another fourth-quarter rally in the fall of 2002. That rally also disappeared immediately with the changing of the year, and the markets couldn’t get going again until springtime, the other important time to buy stocks (and you thought earnings mattered. Silly!).
In case it’s slipped your mind, even the crash of 2008 was interrupted by a fourth-quarter rally. Weeks after the Lehman debacle had caused credit markets to seize up, the economy was falling off a cliff, global trade had come practically to a halt and workers were being dismissed as fast as they could print the notices. Well, some people just don’t understand the power of fundamental analysis, do they? From the low on November 17th of that year, the markets powered ahead by nearly 20% into year-end. Afterwards, of course, the bottom fell out again until – you guessed it – springtime! Here’s a little factoid for you: the 2000-2003 bear finally fled on March 10, 2003. The 2007-2009 sibling left on March 9, 2009. Just a coincidence, we are sure.
We have to confess to a tiny bit of doubt this time around. The current fourth-quarter melt-up is so widely anticipated right now that it’s troubling. That it could still happen, though, is clear. Despite the Street’s long history of punishing universally anticipated trades, the annual rallies of springtime and the fourth quarter have become close to sacred in our increasingly automated trading world.
As for Europe, you may indeed wonder. The Wall Street Journal’s weekend headline ran “Europe Pulls Back From Brink.” But the fact that Greece and Italy are changing prime ministers doesn’t do a single thing to change the real problem: it won’t reduce the ocean of debt by a drop. We’d compare it to relieving the captain of the Titanic after it hit the iceberg. Reassuring for the passengers perhaps, but not for long. The inside continuation headline of the Journal story carefully added, “for Now” to “Pulls back from Brink”.
That Europe hasn’t really fixed anything hasn’t escaped the notice of the Street, but the widely expressed sentiment by hedgies, floor traders and others in recent days is the hope that Europe manages to simply muddle along until the end of the year. Outside the cloistered world of long-only land, where managers live in a bubble, nobody is saying that the EU crisis is overblown, about to go away, or will be easily resolved. Nope, they just want it to stay low and not bother anybody until January 1st.
There are actually a couple of good reasons for the calendar effect. One is that the Street believes in it, and that alone is powerful. In an auction market, what the crowd believes sets prices until something comes along to change everyone’s mind. Another is that as the year winds down to the end, meetings become scarcer, trading books close and vacations begin to pop up. A lack of headlines is exactly the kind of tonic this kind of artificial action needs.
There are some hurdles to cross in the meantime. Italy’s bond auctions could get bumpy again, but the ECB seems to have been back buying in the markets on Friday. There’s a big five-year auction on Monday and US equities are technically overbought – though not hugely so – so another air pocket like last Thursday still lurks. Yet a headline or two about Greece or Italy approving another austerity plan could set off another big rally. The measures may be worse than pointless, but that’s next year’s problem.
A couple more EU meetings loom in early December, admittedly tricky, but markets could easily be in a forgiving mood and perfectly amenable to waving through a pile of vague ambiguities that would get ridiculed at other times. There is also the deadline of November 23rd, which has become nearly invisible behind Europe’s mess. It’s the date for the budget super-committee recommendations, and it could be prove to be a deadly ambush. However, don’t underestimate the market’s ability to look the other way. What the Street wants most of all this time is another postponement of difficult choices, and Congress might well oblige them. The holidays are here, let’s not quarrel, eh? Leave all of that until January.
In sum, equity investors – at least those who care about annual returns – and traders are being asked to skate a across a thin sheet of ice that is about seven weeks wide. The prudent investment action is to stay where you are until Europe has its final denouement. If the ice breaks, it will get really, really ugly. Against that is the business case: being prudent could mean falling behind in the performance tables, falling behind in fees, falling behind in bonuses. Or as Peter Pan said,
“And if it means I must prepare,
To shoulder burdens with a worried air,
I’ll never grow up, never grow up, never grow up.”
The Economic Beat
In a quiet week for data, the weekly jobs claims number received the most attention for its “second” number in a row below 400,000. It wasn’t really the second week in a row, because the previous week was revised back up to 400,000 from a previously announced 397,000. But it looks good on the tape.
This week’s total of 390,000, while benefiting from a generous seasonal adjustment, should survive the revision, which typically have run in the 3,000-5,000 range. Wall Street seemed quite pleased with this data point and heavily pushed it on the media (and doubtless down to their retail brokerages) as another strong point in the recovery. As we are highly interested ourselves in whether the employment picture is improving, we decided to have a look at all the claims data since the year 2000 to see how last week stacks up historically.
Compared to the 2008-2010 years, claims have been running better all year. Since the first half of that period is classified as a recession, one would naturally expect 2011 to be better. Going back earlier, the November 5, 2011 week most closely resembles the matching week in November of 2003. The non-seasonally adjusted (NSA) number for the November 8, 2003 week was 397,387, very close to last week’s NSA datum of 398,753. The size of the current labor force is approximately 126.2 million, while the size then was 126.4 million. In numeric terms, this is quite a close match.
Also in favor of the comparison is that the end of 2003 also resembles the end of 2011 in that both periods come about two years after official NBER-dated recession endpoints: November 2001 in the first case, and June 2009 in the latter.
The comparison is encouraging from one perspective, in that claims did continue to slowly improve after November 2003. It also took until 2006 for them to finally drop below the 300,000 level, and even then it was only for a few months. Still, any move downward would be welcome.
However, a big difference between now and then is in the size of our production sectors. In October of 2003, the goods-producing sector was estimated to have about 22.2 million workers (the number doesn’t include benchmark revisions), of which approximately 14.6 million were in manufacturing and 7.1 million were in construction. By comparison, last month’s estimate was that only 18.4 million workers are in goods production, including 11.8 million in manufacturing (about 20% less) and 5.8 million in construction (all figures not seasonally adjusted). Some of the difference is due to productivity, some to the flattened housing and commercial construction sectors, and some jobs have left the country.
Goods production is generally the most cyclically sensitive sector. Leaving out weather-related problems, it’s usually the first to pick up workers and the first to lose them. What concerns us is how much of the current improvement might be due to a smaller production sector rather than an improving hiring climate. When set against the fact that nearly half of October’s jobs increase was in the health care and leisure-hospitality sectors, it raises the possibility that the claims improvement is due more to sectors such as production having gotten about as lean as they can get.
Consider that the goods-producing workforce rose by only 1.7% from October 2010 to October 2011, according to BLS (NSA) statistics, and that manufacturing employment has flat-lined for several months now. In addition, total non-farm payrolls have risen by only 1.1% in the last twelve months (also NSA). These increases barely keep up with the official increase in the population (0.7%, seasonally adjusted). The implication is that the recovery is over, at least so far as employment is concerned. To put it in economic terms, we may have reached equilibrium. Claims may simply continue to vacillate in the current range for some time to come.
Some help is on the way: the number of new homes for sale sets a new post-war low every month, and the falling dollar and rising overseas (read: Asian) inflation is starting to bring some jobs back. Eventually homebuilding has to recover, and narrowing wage differentials will rebalance some of the production losses. However, the momentum in both areas could easily be frozen by either a European recession or a European currency meltdown, at least one of which appears inevitable.
Turning back to the other data, wholesale inventories fell in September, suggesting a downward revision to 3rd quarter GDP. That might possibly be offset by a rebuild in the fourth quarter, but recent port traffic data hasn’t suggested it; the rebuild may wait a bit longer. Consumer sentiment edged up a bit, doubtless due to the historic October stock rally. Mortgage-purchase applications have marched steadily higher the last few weeks, surely inspired by historically low rates. However, credit availability is also historically low and the purchase level remains quite low overall.
The more interesting data may have been from overseas last week. European data continues to weaken, while China announced lower inflation data. We believe that China is laying the groundwork for an eventual monetary easing, mainly to head off the eventual property crash. It won’t work and never has, but the markets will first rally furiously in the hopes that it will: they do it every time.
Next week a flood tide of data returns. In manufacturing, we will see the latest regional Fed surveys from New York (Tuesday) and Philadelphia (Thursday), with the national industrial production data for October coming in between on Wednesday. In inflation, the October Producer Price Index (PPI) is due Tuesday and the Consumer Price Index (CPI) Wednesday. Housing shows up with the homebuilder sentiment index Wednesday and October housing starts on Thursday.
We’ll also get October retail sales on Tuesday. That’s going to make Tuesday a very busy day, what with the PPI, the New York Fed survey, and preliminary GDP estimates for Germany, France and the EU in advance of our own data. Given Europe’s place in the headlines these days, they will likely matter.
The earnings calendar isn’t especially heavy next week, but it is interesting with many retailers reporting along with some high-profile tech names. Keep an eye on Lowe’s (LOW) before Monday’s open, Wal-Mart (WMT) and Home Depot (HD) Tuesday morning (it just gets busier and busier), Target (TGT) and NetApp (NTAP) Wednesday, and Sears (SHLD) and Salesforce.com (CRM) on Thursday.