“Oh, then, I see Queen Mab hath been with you.” – Mercutio, in William Shakespeare’s Romeo and Juliet
What is that stuff they keep sprinkling at the end of every month? The first thing you need to know is that prices did not rally last week because the world is now safe from Greek contagion. After a couple of aborted attempts last week (noted here in MarketWeek, and promised to be tried again), operators managed to get out the magic dust for another paint-the-tape rally the last four days. It’s the fourth month in a row that this little magic spell has worked, with the rallies getting shorter and shorter. Without them, the situation would look very different.
We don’t mean to dismiss events overseas. Had the Greek parliament actually turned down the European Central Bank (ECB) offer, markets would have fallen. They also would have fallen had a meteor wiped out the central United States, but the lack of the meteor landing was not a reason either for the rally. Traders expected neither disaster and got no surprise. Indeed, the rally was already two sessions old before the actual vote came around. Market strategists passed out notes on how to profit from the short squeeze.
The second thing you need to know is that the market is now overbought after its contrived low-volume rally. Putting fresh money to work here would be quite dangerous – the upside from here is about five percent, tops, while the downside is ten-to-twenty. That’s not to say traders or black boxes will exit the market, though, because they’re not investing in stocks anyway. They just rent them for a couple of days at a time. It’s the mutual fund holders that would get left holding the bag.
The ECB did indeed inhale some more dust and kick the can down the road yet again. A liquidity crunch has been postponed again, but nothing has happened with the more important solvency issue. Greece is still unable to pay back its debt. More knee-buckling stages are still to come with the latest bailout deal, but we don’t think the existing government will choose default. The Greek people, on the other hand, are another story and in time are likely to reject their chains.
The only genuine exit for Greece is to write down debts. Amnesty would be a good idea all around, with at least some partial debt forgiveness. Although there have been some creative financing solutions thrown around of late, they all leave in place the same mountain of debt. Greece will eventually buckle under it and the accompany recession. Recessions facilitate payback? Someday, we are told.
The problem with debt forgiveness is that inevitably, Ireland, Portugal and even Spain would demand the same thing. Oddly enough, this is probably the best solution and we could even come to it some day. All the other alternatives would have to be exhausted first, though, and the intervening passage would not be a scenic one.
The ISM manufacturing number that you may have read about if over the weekend (“Soft Patch Over! Economy recovers!” etc.) was a lot weaker than it looked – we were surprised it was up at all (see below). PMI indices in Germany and China fell.
Here’s what will happen in July: the likely scenario is that markets will fade again into the middle of the month. Then an earnings rally will ensue, despite the fact that about 200% of traders expect earnings to be good (it’s the only thing that kept last month’s correction from getting out of hand). Afterwards it will be “look out below!” The economy is slowing, as the Economic Cycle Research Institute (ECRI) observed during the week – probably for the rest of the year.
The less likely scenario is that last week’s rally lasts all the way into earnings season. Improbable, but stranger things have happened. In that case, there would be no end-of-month rally, because earnings will not possibly be able to support heightened expectations. A bloodbath would follow. Of course, expectations have been ratcheted down feverishly over the last month or so, in order for companies to “beat” them again this month, but this is about as universally expected on the Street as anything can ever be.
Still, one musn’t fight the tape too hard. The market can remain irrational far longer than you can remain solvent, as the great economist (and trader) John Keynes famously observed. The longer it stays crazy, though, the worse the final reckoning. If you’re not a day trader, stay away. If the market should rally another five percent anytime between now and the end of the month, best to get out. You might miss the last day of the party, but you’ll miss the wrecking ball too.
A Happy Fourth of July weekend to our readers, and a reminder that all US markets are closed on Monday the 4th.
The Economic Beat (holiday-shortened)
The news leaned to the negative side, though you wouldn’t know it from the market.
Personal income and spending for May came in slightly below expectations. Spending was unchanged. Income rose 0.3%, but real disposable income by only 0.1% and is virtually flat since January.
Pending home sales rose by 8.2%, which the media guessed as a reason for Tuesday’s rally. What you need to know: the NAR said last week that it would be strong, so it didn’t really surprise anyone. In the last six months, the pending home sales index has fallen from 93.7 to 88.8, while the existing home sales rate has dropped from 5.3 million to 4.8 million. More recovery like this we don’t need. Construction spending fell sharply in May and April was revised downward, also sharply.
Case-Shiller showed prices rose month-on-month by 0.8%, similar to the federal data, but that number isn’t seasonally adjusted for the usual spring bump. The seasonally adjusted year-on-year figure fell to a minus 4.0%, slightly worse than expected.
Consumer confidence fell more than expected to 58.5, pretty close to recession territory. The University of Michigan sentiment measure also fell. The motor vehicle sales rate dipped for the fourth month in a row and came up short of expectations. At least it’s getting due for a bounce.
The Richmond Fed manufacturing survey was about a wash, with a slight positive reading but with backlogs and prices falling, indicating softness. The Dallas survey was negative, but the Kansas City survey was decent, though prices fell there too. The other good reading was the Chicago PMI, but even there prices, backlogs, inventories and employment fell. The ISM number Friday was higher than expected at 53.5, but the underlying details were soft enough that we were surprised at the increase. New orders and production were virtually unchanged; backlogs, exports, imports and prices fell.
The key reports for next week are the ISM non-manufacturing survey on Wednesday and the jobs report on Friday. The range is wide for the latter, with consensus falling in the middle to about 110,000. That would be a good pickup from May, but still anemic. Jobless claims were high all month, including last week. It’ll take a big seasonal adjustment or a lucky sample to print a good number, but that’s not unusual for the first estimate.
The earnings calendar is almost completely empty next week. The ECB and Bank of England issue statements Thursday morning. Monday is a holiday in the US and markets will be closed, giving us an extra day to digest whatever dish the EU ministers order up to try and fix their Greek indigestion. Perhaps they will summon Harry Potter.