Hope Floats, IV


“Nobody ever went broke overestimating the gullibility of the American people.” – P.T. Barnum

This column marks the fourth springtime in a row that we have entitled a column “Hope Floats.” It’s no coincidence that it arrives at this time of the year. Animal spirits run high in the spring, particularly in New York City, where the March and April weather begin to churn out beautiful spring mornings that put a bounce in the step and a boost to the sap. Or is it saps?

We are certainly in the middle of one of the great springtime rallies. The markets have risen five weeks in a row and seven out of the last eight. The commodity markets are soaring, despite bearish supply-demand imbalances, with commodity funds taking in 25% of all domestic stock inflows.

Commodity futures are, of course, one of the best-leveraged bets around these days, making them a natural draw for those looking for the biggest pop. It’s become humorous of late to watch the difference between the analysts who follow commodities for a living, and the remaining free-market Panglosses in the business media.

The analysts snigger when asked if there is any speculation in the markets. The latter, still desperately trying to sell that good old magic, markets-are-always-perfect snake oil off the back of their burnt-up wagons, gravely intone that there is no real evidence that speculators are affecting the price. What about the summer of 2008, when oil hit $150 a barrel, then collapsed to $35 six months later? All supply and demand, don’t you worry.

The springtime effect isn’t all due to the weather, although we believe that it plays a strong role, because another one of the great things about springtime is the calendar effect on the fiscal year. Budgets are generally refilled at this time of the year, so there is usually money to spend, even if much of it is in the form of promises and hints.

That’s particularly true now, when instead of recovering from the shock of a collapse in demand and credit, as they were a year ago at this time, the big industrial companies are luxuriating in the warming glow of balance sheets positively overflowing with buckets of juicy cash, courtesy of a bond-market stuffed to the gills with money desperately looking for something that returns more than twenty-five basis points – and isn’t ready to trust equities again.

Along with the springtime promise of money to be spent, companies also have plenty of time to make their annual numbers. The rest of the year, in fact. Everyone can be hopeful and everyone is confident that more customer dollars are going to flow their way rather than somewhere else. If we could aggregate everybody’s internal projections, it would be clear that the total was a good-sized multiple of the actual money available for spending. But we can’t – and even if we could, the Street would probably find a way to talk past it.

Hence the markets rallied in the spring of 2000, shortly before entering a recession and a two-year bear market. They rallied in the spring of 2001, when we were in the middle of both. 2002 was a relative rally, as equities managed to go sideways in a falling market. They rallied again every spring after that, with the exception of 2005, when they didn’t start to move up until the first half of April (so what was that all about?).

Markets also rallied in the spring of 2003, when shell-shocked investment money largely stayed away from the markets and looked desperately for fixed-income investments that could yield more than the one percent available in the cash markets (sound familiar?). The homebuilding market that had largely escaped the recession unscathed drew attention, and money began to flow more strongly into mortgage-backed securities (MBS). They didn’t yield big numbers, but if you leveraged up, you could squeeze out something north of ten percent.

Markets also rallied in the spring of 2007, when credit-madness peaked. As Larry McDonald recounts in his entertaining yarn about the fall of Lehman Brothers, A Failure of Common Sense, it was clear to the distressed-debt department where he worked that the world had gone mad, so clear that Lehman’s top fixed-income and distressed-debt minds began parachuting out of the company before it was too late. His group – pretty smart money, thought to be the smartest in the firm – thought that the equity markets had gone completely insane. You may want to remember that the next time you bend over to look for a brick to throw, you know, when someone has told you again that old bromide about the stock market being a discounting mechanism. Look for one with a good grip.

Markets rallied last spring of course, but markets also rallied in the spring of 2008. The latter came a year into a recession that Wall Street was in denial about and more than a year (at least) before ending. It was also came immediately in the wake of the downfall of Bear Stearns. Well, of course the danger was over by then, wasn’t it?

It all puts us in mind of the famous Salomon Asch psychology experiments involving three lines on a piece of paper: two of the lines easily appear to be the same length, and as the game is to pick which two are equal, almost everyone gets it right. Life is so easy.

However, Asch found that if he stacked the group with accomplices who would deliberately announce incorrect answers aloud first – and visibly agree with each other – the response accuracy of the genuine participants would go down dramatically. In other words, herding behavior. Did somebody say, “Wall Street?”

Don’t forget the Street’s supporting cast. Not only is CNBC trying its best to talk up the recovery – one expects that, as their ratings go up and down with the market – but the Journal last week was positively rhapsodic on Friday (“Factories Revive Economy,” blared the headline). The latest Economist cover proclaims “Hope at Last” and the Financial Times reported that the American economy is reaching “escape velocity.” It seems to have become downright unpatriotic of late to be cautious, as if caution itself is the problem and not a lack of demand.

However, as our patron saint, John Maynard Keynes, so famously observed (and we do so love to cite), the stock market can remain irrational far longer than you can remain solvent. We expect the markets to rally on the jobs report, because that is what the stock market does; it usually takes a crazy number to spook it. We also expect the springtime rally to continue, because that’s also what the market does.

The steady pace of the current climb has in fact helped, because it keeps the players from getting too edgy. It may be, as economist Dave Rosenberg has suggested, that the market is being largely driven by the same few trading desks, since mutual fund managers are about out of cash and not much money is coming into domestic equities. But nobody seems terribly interested in selling, either. We should keep floating a bit longer – but you may want to start thinking a little bit about not getting caught looking up for too long.

The Economic Beat

The two main numbers of the week, at least from a headline point of view, were the ISM manufacturing report and something else, what was it? Oh yes, there was some report about jobs.

The ISM report was a good one. The month-over-month change was clocked at 59.6, the best reading since July of 2004. New orders climbed above the 60 level (61.5), indeed the only blemishes were a small decline in employment expansion and a drop in backlogs.

That’s the good news, but we will maintain our caution. The ISM only measures monthly changes and doesn’t relate to actual levels of output. For example, while the change may have been the sharpest since July 2004, the levels of industrial and manufacturing production were much stronger back then than today.

So while we are glad that the inventory restock is in swing, the two-quarter bounce that has been predicted since last September doesn’t seem especially robust to us. Furthermore, we don’t see any compelling evidence as of yet that it will be more than a bounce – despite all the back-slapping by Wall Street strategists. The latest regional survey, the Chicago PMI, showed some slowing in March from the previous month.

Then there is the jobs situation. Two weeks earlier, 400,000 was the whisper number and 300,000 a done deal, but a couple of late duds lowered the bar a bit. The ADP payrolls report on Wednesday showed a disappointing drop in private payrolls of 23,000 where a gain was expected, and then the Challenger job-cuts report the next day reported a higher number of layoffs than expected.

The actual number of 162,000 was a mixed bag. It did fall short of expectations for about 200,000, but the earlier negatives had tempered those so it really wasn’t disappointing. Much more than that, it was the first six-digit print on the plus side since about forever, and that alone is something to cheer about. Don’t expect to hear about the shortfall again either, at least not for some time, as we expect that beginning this week the employment recovery will rapidly be on its way to achieving the status – though perhaps only temporary – of cosmic divinity.

The increase in goods-producing jobs was better than expected, while the increase in census jobs was lower. Those two statistics will be shouted repeatedly until the next report in May by bull strategists, delighted at the prospect of adding more census jobs to the next tally. Both January and February totals were also revised higher.

Not all is so good, though. The unemployment rate stayed the same, at 9.7%, and the U-6 rate of under-employment climbed back to 16.9%. The unemployment rates in the unadjusted data did fall a bit, but the percent of the unemployed who are long-term (27 weeks or more) reached an all-time high of 44.1% in a series that goes back to 1948. According to the Liscio report, the chances of a person unemployed in February finding a job in March also hit an all-time low.

Looking things over, something that leaves us uneasy is that the unemployment rates of the last three months for all workers and for all private non-farm workers are the highest since 1983, a year that holds the post-war record. More detailed records are available going back to the year 2000, and the rates of unemployment by every sector are startlingly higher than the 2001-2002 recession. They run about 50-100% higher, in fact. We don’t think this recovery will look like the 1983-1984 one, either, one big difference being that interest rates won’t be going down, since they can’t go any lower than they are now.

You are going to read or hear a great deal of headline nonsense about the recovering employment market over the next month, and nonsense it will be. Weekly claims are moving down at an agonizingly slow rate, and remain at very elevated levels (440,000 in the latest week). Any improvement in continuing claims is outweighed by larger increases in emergency extended claims (and anyone who thinks that the emergency program is keeping people comfortably unemployed – as frequently muttered by the six-figure newsreaders on CNBC – has never tried to live on unemployment checks).

We’ll leave the subject with a quote from the people at the Liscio report, whose livelihood is based on the analysis of state and federal data on employment and tax receipts (and they earn nothing from selling equities): “the March numbers are consistent with a gradually improving labor force, but hardly one bounding back to health. The headline gain was at the 42nd percentile of changes since 1950…how anyone thinks that this news will accelerate the Fed’s tightening schedule is beyond us.”

The latest data on personal income, spending and confidence illustrate the current nature of the recovery rather well. Income was unchanged in February, while consumer spending rose 0.3%. Consumer confidence rose to 52.5 in March, a rebound from February but a number still well below the longer-term average of something in the seventies. Nevertheless, this led to the usual fatuously gleeful remarks about underestimating the American consumer.

Income is unchanged because the economy is weak and net positive hiring is in mostly low-paying fields: average hourly earnings actually declined last month. However, the stock market has been steadily rising, generating a positive wealth effect among the well-heeled and well-to-do, who do account for the lion’s share of wealth and therefore spending. They don’t get extra votes in the confidence survey, hence the rather low number there, but they do at the cash register, ergo the increase in spending. We leave you to work out what might happen when the stock market flattens out, as it inevitably will.

Turning to housing, housing prices fell in January, according to the Case-Shiller index. The adjusted data showed a slight gain, but as Dave Rosenberg pointed out, that is due to overweighting the last three years. At any rate, some firmness should be expected in the next couple of months. Although February data will probably show another decline, the same sort of seasonal adjustments might push them back into positive territory.

March and April should also show some pick-up from the increased activity generated by the impending expiration of the tax credit for homebuyers. Mortgage purchase applications did rise again last week, but take heed: the levels are well below last August and September. We may see a decline to new lows after the tax credit’s putative expiration date.

Factory orders rose in February by 0.6%, above expectations, but the smallest increase in several months. Construction spending fell yet again – it’s really overdue for at least a bounce, and we may get one with the improvement in the weather. New car sales improved in March, but not as much as hoped.

Looking ahead, the day of the week might be Monday. That’s unusual, but it would be typical of equities to rally, given that it’s a) a Monday and b) the first chance to rally on the jobs report. On top of that, the ISM non-manufacturing report is due for March along with the latest report on pending home sales. Most European markets will be closed for Easter Monday.

The rest of the week is fairly light, and that usually means a continuation of the current trend in the stock market, meaning up. The FOMC minutes are released Tuesday afternoon, and there is no reason to expect anything but the usual professionally cautious optimism. There isn’t much else – chain store same-store sales come out on Thursday for March, and should benefit from the Easter effect. Consumer credit comes out Wednesday afternoon; although it’s not typically a market-mover, a surprise number might catch the eye. Wholesale trade data for February come out on Friday.

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