“The wise man does at once what the fool does finally.” – Niccolo Machiavelli
So what about that great rally – is it time to launch all the cannons and charge full speed ahead, or something else? “Heartened investors snap up risk assets,” suggested the Financial Times. Not so much for Dow Jones, whose Wall Street Journal cited skeptical traders and whose “Marketbeat” columnist, Mark Gongloff, reported the short squeeze that the rest of the Street certainly knew about. Its sister weekly Barron’s trading reporters were also dubious about whether anything had really changed, and the silly idea that the Chinese will buy Italian debt (fat chance) didn’t hold up well under scrutiny of China’s own difficulties.
On the other hand, an NPR news story at Friday mid-day actually made us laugh out loud when the readers told us that traders were “buoyed by better-than-expected consumer sentiment numbers.” Someone was had on that one.
We’d say Barron’s got it right when they noted that the European central bank move to inject liquidity into their banking system – with our own Fed in there pitching – had traders rushing to ride a wave of QE-3 bets that the Fed will do something similarly big (preferably bigger) at its extended two-day meeting next week (Tuesday and Wednesday).
That Fed view was really the key. Thursday’s U.S. economic data was so ugly that without the eurozone banking move, markets would have faced big losses. But with that policy move – Fed backed, above all – the ugly data was suddenly and paradoxically bullish: now our own Fed has to do something really big. Looking ahead to the data next week only adds to the excitement: the next two economic releases before the Fed statement Wednesday afternoon are housing starts and existing home sales, and you know those are going to stink. Bad news is good news, so better get on board now or you’ll miss another go at last fall’s rally.
Will the Fed do something big? Many, if not most traders had no such conviction at all about such a move, nor if it would do any real good; what they were sure of was that accommodation was the trade du jour and Europe was out of the way for a couple of days. There’s good reason to be skeptical, because what we really need are positive changes from Congress rather than more morphine shots from the central bank. Unfortunately, that less-than-august body is presently divided amongst surgeons, witch doctors and faith healers, with the latter two holding the edge (in Europe, the ostrich party has the clear majority).
Skeptical or not, in a trader’s market, everybody runs to the same side of the boat at once (traders, that is – most long-term managers are simply doing nothing but crossing their fingers and trying to manage fund outflows). If investors were really heartened, you wouldn’t have seen gold, silver and the long bond also rallying on Friday.
What saved Friday’s bacon wasn’t consumer confidence, either – the markets sold off to their lows afterwards. But once Europe closed and traders there had closed out positions from their big two-day rally, our markets turned on a dime. Options dealers had free rein to start wiping out the value of the massive amounts of puts bought in the preceding weeks. It’s not the kind of thing that traders like to tell the cameras and microphones, though.
Well, a trade is a trade and for now it’s the traders that wag the dog. But come we now to a couple of twin conundrums, one domestic and the other European, and don’t think traders have forgotten them. On the U.S. side, the market didn’t rally on either an improving economy or earnings (analysts were busily taking down 2012 estimates last week), but on the possibility of Fed medicine – whether or not it works, it could mean a rally of some duration.
That’s the bull case (though the Fed could very well disappoint, too, and that would get ugly). But while a rally could restore some measure of confidence, and even take advantage of some inevitable inventory rebuild as the year draws to an end, the problem is that a market that is higher in November means another budget-ceiling deadlock in December (House speaker Boehner began laying out the gravesite last week when he announced that any tax increase whatsoever was out of the question, and that cuts would have to come exclusively from social spending). No panic on the Street equals no compromise in D.C.
Maybe the equity markets won’t be higher, though, because the European twin may crack first. The setup is similar: stable or sideways markets over there mean the various parties will be content to rest on parochialism, prejudice and bromides. There will be no progress toward addressing the only real net benefit solution: write down and forgive most of the debt, recapitalize the banks in question.
That may offend a certain Calvinist sensibility, as well as every politician’s dictum that his or her home ground gets more benefits than it pays for. But neither the offense nor the costs are anything compared to the bloodletting that will follow a course of continued belief in the fantasy that Greece and the other periphery countries can cut their way to prosperity. Each additional austerity step immediately dooms the latest revenue target by further crushing the economic activity that generates it.
Nor can contagion can be contained by the mere utterance of fine words from a small circle of technocrats from the best schools and families (c.f. the sub-prime crisis, the Asian currency crisis, the collapse of the British pound, the Great Depression, World Wars I and II).
Treasury Secretary Tim Geithner had the best of intentions on his European trip last week, but went about it completely wrong, because the last thing any self-respecting European politician will do is appear to take any advice at all from their inferior (though admittedly bigger) brothers and sisters across the pond. He was wrong to urge them to unity, action and stimulus: had he the wit to exhort them to do absolutely nothing but raise interest rates and above all pass greater austerity measures, a stimulus bill would have been on the floor of every European parliament before his plane could touch down again in Washington.
That is the enduring paradox we are confronted with here (again) in the fall of 2011, asserted here before: without action, we are doomed to disaster, but only disaster will get us to act. The irony this time is that it’s not the so-called slacker generation doing nothing, but the ones of their parents and grandparents.
The Economic Beat
For us, the release of the week was a tie between the August retail sales report and the weekly claims numbers. Sales fit in with the pattern of other data following the budget mess and the market meltdown, registering no gain from July when a mild increase was anticipated. Excluding autos, sales gained a tenth of a percent, but July was revised downward by two-tenths. Evidence that the consumer is on pause might be seen in the online category, which only increased by 0.5% (consumers have been doing more online business because of high gas prices) and was revised downward to a 0.3% increase in July – barely keeping up with inflation.
It’s significant that consumer spending paused, but so is the fact that weekly claims rose more than expected again, for about the sixth week in a row now. The latest estimate was an uncomfortable 428,000, definitely the wrong direction. There is some consolation, though, for those who fear Armageddon – claims are still better than they were this time of year in 2008-2010. The ship is not yet lost.
The manufacturing surveys from New York and Philadelphia might have caused a sell-off any other week, given the weakness: the Big Apple’s Fed reported a decline to (–8.82) from Julys (-7.72), while Philadelphia checked in with (-15.0) versus (-30.7) for its previous result. The latter was incorrectly reported on at least one news channel as being an improvement from July, but it isn’t. The surveys measure monthly changes, so a minus reading on top of another minus reading represents further deterioration (though the rate of change, or second derivative, is slowing).
The Fed’s surveys suffer from the same defect as consumer confidence surveys – neither correlate very well with real activity. Despite the horrible Philadelphia reading last month, industrial production still rose by 0.1%, and capacity utilization ticked up by the same amount. The slowdown is real, but it doesn’t have to turn into a recession.
Inflation raised some eyebrows during the week – although the Producer Price Index (PPI) showed no change, the Consumer Price Index (CPI) rose by 0.4% to post a 3.8% year-on-year change. Core inflation rose by 0.2% and is at 2.0% year-on-year. The pressure exerted by housing costs, though, is due to the rental market being squeezed by people losing their homes or unable to meet today’s stringent purchase requirements, rather than some change in desirability.
Import-export price increases are still running at double-digit year-ago levels, but the year-on-year rates fell along with monthly import prices. That was mostly oil-related, and would disappear on any rally in the stock market.
As for that consumer sentiment report, well, it was still at very low levels. 57.8 did beat the consensus for 56, but not the whisper number of 60 and was forgotten by lunchtime.
Next week the focus is on the Fed and the two-day meeting Tuesday and Wednesday. There is a raft of housing data too – the homebuilder sentiment index Monday, housing starts on Tuesday, existing home sales Wednesday and price data on Thursday. That said, housing can’t really surprise much to the downside this year and extra weakness might be perceived as bullishly provoking the Fed. Overseas, everyone’s eyes are on CDS spreads and what the Germans might get up to – or not. The Fed will need to do something special to justify the market’s hopes.