A Confederacy of Dunces


“Against stupidity, the gods themselves contend in vain.” – Friedrich Schiller

Last week’s three-ring circus was predictable enough: another extend-and-pretend for Europe (this time they really, really mean it), another Washington World of Wrestling match, another week of the business press slapping their heads in feigned astonishment that most companies beat estimates yet again. Oh, and did we mention that Europe really, really means it this time?

Europe has come up with more liquidity for a solvency problem. In brief, the EFSF (European Financial Stability Facility – the resemblance to something for the aged and infirm is completely unintentional and utterly appropriate) has more latitude to buy bonds, guarantee bonds, and throw money around. Funding of same, a bit murky. Greece has longer to pay off its debt, interest rates are cut, and there will be just a little tiny haircut in the private sector (those of you familiar with Monty Python may recall Mr. Creosote’s “one, wafer-thin mint”).

Naturally, the ad-hoc commission of European poobahs assembled for the occasion stated very firmly that only Greece would get such a deal and they absolutely are firm about this, no exceptions, this is strictly a one-off, our decision is final and would somebody please tell the prime ministers of Ireland and Portugal to wait for us behind the tent. We don’t want to lose the deposits on our vacation bookings, so please be so kind as to go away until the fall.

The problem remains that Greece, Ireland and Portugal still owe too much money to pay back. So does the private banking sector in Spain. The proposed austerity budgets and union-wide deficit targets of 3%, the latter with a 2013 deadline, will sink the continent like a stone if adhered to. Perhaps they are all planning massive Ebay listings. In Mandarin and Cantonese.

Europe’s position is quite like our own. Too much debt, can’t figure out how to bite the bullet. They have Germany and the True Finns to deal with (“not one more cent for those lazy southerners!”), we have the Tea Party and their cowering servants (“not one more cent for those job-killing parasites!”).

Europe needs to sit down and figure out a realistic debt-restructuring program without waiting for countries to be on the brink of default. So do we. Our Tea Party and their ideological opposites are completely entitled to their views, but the budget battle needs to be fought at budget time, not at Treasury-default time. A tussle over riding shotgun may be a fun, age-old tradition, but not on the highway at high speed. The debt ceiling isn’t the appropriate venue for this struggle, a fact that seems lost on many.

We are all of us hoping for the proverbial 11th hour rescue, but the clock is ticking late. It was lucky for the markets that Speaker Boehner’s latest flight in the face of “job-killing tax increases” came after the close on Friday, giving us the weekend to recover and raise false hopes if nothing else (presuming the stage-fights to be played out on Sunday morning political television are fought with stage blood, and not the real thing).

We have some sympathy for the Speaker’s position, for tax increases in the budget-ceiling resolution would certainly be a job-killer – for the Speaker and every other Republican who dares to vote for them. They would all be lynched in the next primary, every last one of them (nobody in the GOP has forgotten what happened in the last election or to George Bush senior).

It’s an odd position for the party to find itself in – on the one hand, a group of zealots who won’t vote for any increase in the debt ceiling, are perfectly willing to see the US default and don’t care if they are re-elected. To paraphrase Shrek’s Lord Farquaad, others may die, but that is a sacrifice they are willing to make.

On the other hand, mainstream Republicans don’t want default (they certainly have been getting an earful about not doing so from the business world) but do want to be re-elected. So Boehner has gone off to see Senate colleagues about an alternative approach, either one that raises the debt ceiling without any budget, or the McConnell plan of raising the ceiling while allowing the Republicans to vote against themselves. Where is Will Rogers when we need him?

The Democrats are also stymied, though to a lesser extent. They are not at all willing to accept default, but neither are they willing to vote the ideologically opposite Tea Party position of cuts-only (one supposes that if they were, they wouldn’t be Democrats). As political consultants, we would guess that the Republicans have more to lose from default (and we suspect that the leadership thinks so too), but knowing you will live a minute longer is of little comfort to those a mile from the blast center.

Our hope – and the best thing for the markets – is that the ceiling gets passed without any budget resolution. Then the economic slowdown would have a much better chance of regaining some life before the end of the year. However, it must be said that we also hoped that the government would arrange for Lehman to be taken over in an orderly manner, the way it would with any bank that was failing. Instead, the fatuous desire to “teach ‘em a lesson” outweighed common sense. Our reference to Shrek feels quite appropriate, as ogres and jackasses are in abundance these days in Washington (lest we seem unfair, they are heartily represented in the media as well).

As fot the equity markets, well, traders are still determined to have an earnings party, but it hasn’t been the one they were hoping for (the July version never seems as brawny as April – perhaps it’s the summer heat). There have been plenty of telling examples of too much inventory and guidance suddenly becoming misty to opaque, but we’ll cite the Caterpillar (CAT) earnings miss as representative (n.b. – we are short the stock).

The key takeaway was that management said Chinese demand is slowing. Not a lot, it’s all still good, but slowing. That kind of cyclical hiccup is a refrain we have heard too many times in the past, and the next verse is invariably one of the slowdown being more than originally thought or hoped.

That said, so long as the debt ceiling gets raised, we expect one more try for 1375 on the S&P 500. Volume is still light, making prices easy to work, managers are still afraid to sell, and many are curious to see if the end-of-month price-fixing game will be played again next week (Friday is the last trading day of July).

Of course, if the debt ceiling doesn’t get raised, all bets are off and it’s everyone for themself. If the miss lasts a day or so, the immediate damage should be minimal but the reputational and ratings damage could be long-lasting. However, we worry that some may opt for waiting to see if the markets start crashing before acting, in order to give themselves political cover. To Speaker Boehner’s credit, he was reportedly trying to get something do-able on the table before the market opens on Monday. Yet against stupidity – well, see the quote.

In any case, we may be hearing the guns of August next month, as all the evidence points to another limp quarter, and we won’t be hearing about much else after earnings subside. We suspect that by sometime next year, the majority will be wondering once again just what people were thinking at the crucial moment. The answer will be the same: they weren’t.

The Economic Beat

Housing didn’t exactly dominate in an earnings-led week, but it was the sector that had the most reports and did exert some influence on market action. The week started with plenty of snake oil being offered by either con men or morons (possibly both), posing as Wall Street strategists. They were trying to palm off a little homebuilding sentiment tick as some kind of fundamental sea change.

The homebuilders’ sentiment index has been knocking around between 10 and 20 for over three years (50 is neutral). Most of the time it’s between 15 and 17, occasionally throwing out a 19 or 13 that could easily be due to nothing more than an extra latte or two (or a missed one). Last month’s result of 13 has been the lower bound of the range for a couple of years now, so a rebound was certain. Would it be 14 or 15? It was 15. We follow the publicly traded homebuilders closely, and they do not hope to increase production this year. They’re buying land and banking it for another day, not processing more build orders.

Housing starts did increase more than consensus in June, but you can put that on the consensus. A catch-up from May weather wasn’t factored in by our wise men (most of whom would much rather be too low than too high). Part of the jump was due to May being revised substantially downward, and another piece of the jump is likely to get revised out next month. But if you really want to believe there’s a change in housing, take a look at this chart from the Econoday website. It makes it plain that starts, like the homebuilder sentiment index, have been dragging on the bottom for more than two years.

The starts “beat” hit an oversold market that was already in rally mode, partly on a rebound off the 50-day moving average on the S&P, partly on news that Europe had rejected German suggestions to redraw maps of the Mediterranean that would have put Greece and Italy in northern Africa. It was the kind of morning when we would have gotten a buying surge from a report that the amount of cheesecake sold at Mindy’s Deli was above expectations.

Lord knows we could use good news out of the sector, but regrettably housing will have to wait longer, as the existing home sales report made plain the next day. No weather catch-up there, as the sales rate fell again for the fourth month in a row and is at its lowest rate since the first half of 2009, when we were still (officially) in a recession. Credit remains historically tight, unemployment high, wage growth below inflation and home prices are likely to fall another 5-10% nationally.

Or so says Zillow (Z) CEO Spencer Rascoff, who ought to know a thing or two about pricing – not only does his web-based real estate listing site claim a database of more than 100 million homes, it managed to price above its suggested range last week and promptly doubled on its first day of trading. All that despite the minor handicap that it doesn’t make money (profits are so yesterday).

The business press, which seems to act a little greener every year, bit on the housing starts story and bit on the Philadelphia Fed survey “good news” as well. One well-known news site promptly declared the Philly survey proof that the soft patch is over. Did any of them read the report, or notice that the number was below consensus? The trading reaction, though, made it clear that whatever the consensus may have been (it was 5), traders feared another negative number, so the actual result of 3.2 was greeted with great joy.

Not so by the Philadelphia Fed, however, which for its part wrote that “responses to the Business Outlook Survey suggest that regional manufacturing activity remained weak in July” (our emphasis). The bank went on to note that activity and new orders were flat in June after contracting in May. Backlogs and prices fell, a sign of softening demand, though shipments were mildly positive.

Leading indicators rose a bit more than expected, by 0.3%, thanks again to the yield curve and – this time – an increase in the money supply. However, the coincident-to-lagging ratio (a favored leading leader) fell and the bulk of the increase is due to the yield curve (has anyone noticed that the yield curve is negative in China?). Weekly claims were revised up from last week (again), were higher than expected (again), and the four-week moving average fell again from the previous week, though since the latter is revised up every week it never moves.

Next week has another heavy calendar of earnings and drama, being the last week before the potential Big Chill. Highlights on the calendar include Texas Instruments (TXN) on Monday; 3M (MMM), BP, Ford (F), and Amazon (AMZN) on Tuesday; Boeing (BA) and Conoco Phillips (COP) on Wednesday, Dupont (DD), Exxon Mobil (XOM) and Potash (POT) (a trader favorite) on Thursday; Friday brings Chevron (CVX) and Merck (MRK). It’s also a week filled with chip stocks, so we should get a good look at this economically sensitive sector.

There is a goodly slate of economic news as well, the most prominent scheduled release being the first estimate of second-quarter GDP on Friday (notices of default could steal a headline or two). In January, GDP estimates ranged from 3.5%-4.0%, and 3.0% was still the default number as late as April. The current consensus has fallen to 1.9%, the same anemic rate as the first quarter. It has become fashionable of late to attribute the year’s tepidness as being partly due to collective anxiety over our looming default; one wonders what the event itself would bring. Do we really need to find out?

Housing rounds out its slate of monthly data with Case-Shiller data on May home pricing on Tuesday (federal data last week showed a monthly increase of 0.4%), followed shortly afterwards by June new home sales. The very cautious consensus for the latter is for no change in the annual sales rate, while pending home sales are due on Thursday. Despite the evidence that recent increases in pending sales have failed to translate into any strength in closings, the market keeps celebrating them.

Manufacturing is pretty well represented during the week, with durable goods for June on Wednesday and a string of regional surveys that includes the Richmond and Kansas City Fed reports along with the Chicago Purchasing Manager’s Index (PMI). The Beige Book compendium of regional activity, usually good for a rally (“they used the growth word again!”) comes out Wednesday afternoon. Two consumer surveys are due, with the influential Conference Board confidence report on Tuesday and sentiment measured by the University of Michigan out on Friday. Perhaps the unusually low numbers will stir our Dunce Captains to action, but we fear a goodly number are willing to risk us going down with the ship.

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