After the Fall


“Your Cadillac has got a wheel in the ditch, and a wheel on the track.” – Neil Young, Alabama

Two weeks ago, we bluntly made the case that either Europe give up its pointless village square bickering and get serious about putting out the fire, or risk a financial meltdown that would menace the union as a whole, the parts that are its members, and quite possibly the global financial system.

We are not alone in this view, and similar thinking has made the rounds of the front pages of the world. In turn, the equity markets, being naturally optimistic and ready to leap up at any sign of a resolution or central bank magic, thought they saw signs in the heavens and immediately rose up on belief that salvation might be at hand. An improbably sharp rally ensued, amplified by black-box and high frequency trading.

Alas, the magic from heaven did not arrive. The policymakers of the European Union are still riven by local domestic political considerations and unable to do more than talk. The Federal Reserve bank did only what it hinted at doing, the so-called “Operation Twist,” a plan to hold rates down at the long end of the curve. Traders that had bet hopefully on the notion that weak economic data would provoke a bigger reaction from the Fed, perhaps another round of quantitative easing, were disappointed.

Not only that, the Fed observed that downside risks had increased. An improbably sharp sell-off ensued, amplified by black-box and high-frequency trading. In the absence of the quantitative ease, commodity prices began to tumble and margin calls proliferated, causing gold and silver to suffer their sharpest drops in decades.

The net effect of the two-week round trip – or was it one year? – was the indices sagging about two percent lower. The EU decided to have more talks and plan more votes. Republicans threatened the Federal Reserve not to do anything they don’t like, a bit of a first. Partisan lines hardened.

What stands out the most about the economic data from last week and the ones preceding it is that the economy isn’t doing so badly. It isn’t growing robustly either, granted, but the real danger to the economy is the multiple hits that confidence is taking from political gridlock and worries about the financial system.

It’s as if the economy is the classic image of a car stuck on train tracks. The occupants of the car can see the train coming, but it is still a ways off. So instead of jumping out and pushing the car out of the way, they stay in the car quarreling about whether to push it backwards or forwards. Worse, the vital issue of whom to blame for the predicament must be decided first. To paraphrase one’s side-view mirror, trains in the distance may be closer than they appear.

In sum, little has changed. Some fantasies float around – the BRIC countries rescuing the euro, China buying Italian debt – but they aren’t going to happen. The EU needs to pull together and restructure the debt situation. The U.S. needs to give up on the idea of austerity as a cure for recession, but its parties are in a stalemate where neither has enough numbers to prevail yet both have enough to frustrate.

And so we wait. We leave you with a warning: the kind of volatility we’ve been seeing in the stock market usually precedes lower lows. While a resolution in Europe would send stock prices soaring, it seems the West only acts after they fall.

The Economic Beat

Most of the data last week was related to housing, but the sector won’t have much interest for markets until an upswing seems established, which isn’t yet the case.

The obvious mover of the week was of course the Fed policy statement that many had hoped, or at least hedged, would be a rerun of last year. The unwind was painful.

Coming back to housing, the sector still struggles but there was a bit of a mix. The homebuilder sentiment measure edged down to 14, but we don’t consider it significant: it’s still in the same range it’s been in for years, a range of 14-17 with most of the points in the middle and the occasional outlier here and there. The silver lining is that some of the publicly-traded builders have been reporting improving backlogs.

Housing starts and building permits moved a little bit in each direction, but there is little point in trying to extract some sort of trend out of it. Wall Street’s needs notwithstanding, the monthly movements are just noise. Credit conditions remain quite difficult, employment is stuck, the economy is going sideways, so housing is going to remain weak. The only thing that is getting better is that the supply of new homes is extraordinarily small; if and when conditions improve, homebuilders will get quite a bounce off very low levels.

Existing home sales did improve more than expected. Prices were down, but we suspect that this is more of a continuing mix issue, as the federal housing agency price data from the next day showed some improvement in same-home sales. It is more likely that the economic hard times are wearing out the resources of those at the bottom of the economic ladder. There was a pickup in foreclosure and all-cash sales, both of which reflect distressed conditions. It could also be that owners trying to move for non-distress reasons – new job, downsizing, retirement – have started to give up on holding out for their target price. Case-Shiller reports same-home sales data next week.

Employment claims continue to edge ominously higher, but fortunately the movement has been slow. The misreport of the week, as usual, it was reported as “a drop of 9,000” when it was no such thing. The previous week was revised higher, the current week estimate will be revised higher next week, and the drop will turn out to have never happened. That’s how the four-week moving average stays the same or moves higher while the news outlets report a steady diet of “falling” weekly claims.

Leading indicators continue to rise, which is good, though the measure seems ill-suited to abnormal financial times. The Philadelphia Fed coincident economic indicator shows the U.S on track at a steady pace as well, so the economy hasn’t fallen off any cliffs. However, both retail sales and mortgage-purchase applications showed some weakening last week, and the current week headlines aren’t going to help matters.

The Conference Board reports its monthly confidence index on Tuesday, and the question is which week it will reflect. Will it be the improbable market rally of the week before, or the sell-off that preceded it? Perhaps a plague on both houses. At any rate, it isn’t going to matter much. The Street doesn’t expect anything good and the real swing factor is the EU.

There will be a lot of Fed business surveys next week: Dallas (Monday), Richmond (Tuesday) and Kansas City (Thursday), topped off by the Chicago Purchasing Manager’s Index (PMI) on Friday. New August orders for durable goods comes on Wednesday.

The final standalone revision of second-quarter GDP comes on Thursday, but as the news is getting old its impact will be limited. The monthly housing picture is rounded out by new-home sales on Monday and the Case-Shiller report Tuesday. Friday should be the day of the week in domestic matters: besides the aforementioned Chicago PMI, there is also the personal income and spending report for August and another sentiment report, though the latter probably won’t matter.

Given the light earnings and economic calendar, the spotlight should remain on Europe next week. The cognoscenti will be watching the earnings report for Jabil Circuit (JBL), not the most glamorous name in tech yet still considered a bellwether for the sector.

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