“Never do today what you can put off until tomorrow.” – attributed to Aaron Burr
It was confirmation time last week. Two manufacturing surveys confirmed that the sector is in a slowdown. The Europeans confirmed that they had to be pushed to the wall before yanking out some sort of stopgap (an announcement could come Monday). Homebuilders confirmed that housing is still moribund, at least so far as the single-family home is concerned.
As for the stock market, it made its expected dip to the 200-day moving average on the S&P and leveled out, finishing with a slight uptick on hopes that the weekend will bring some sort of bailout package for Greece. The most likely scenario is that everyone agrees to kick the proverbial can down the road again, leading the markets to rally even if everyone knows that it’s all a sham. So long as it’s tomorrow’s problem, put it off until then – it’s always a cozier feeling to be buying stuff going up.
The markets are still oversold, so even a pretend deal takes the worry off the table for a little while and offers a chance to start burning all the put contracts purchased last week. Prices are only short-term oversold, though, and there is plenty of scope for a follow-on move back down to 1250 and perhaps 1220 on the S&P. Especially if they muck it up in Europe-land – we don’t expect that they will, but there are no promises.
Keep in mind that this is not about bailing out the Greek economy anymore, if indeed it ever was. It’s about protecting the European banking system. It was no coincidence that within days of Moody’s downgrading three leading French banks on their exposure to Greece, French President Nicholas Sarkozy pressed German chancellor Angela Merkel to back down from German conditions. The French banks are heavily exposed, the German banks are heavily exposed, the European Central Bank (ECB) itself is heavily exposed, to the tune of some 85 billion or so euros (published estimates range from 70 to 200 billion).
Some kind of technical default would mean a painful amount of recapitalization for all of the above, and it would not be the easiest of times for the governments or the banks to come up with fresh funding. There is also a growing awareness of the ultimate problem, namely that there is too much debt for the countries to pay off in any reasonable amount of time. The lender countries want draconian austerity agreements to satisfy domestic politics, but the domestic needs of the borrower countries would eventually put those agreements back.
They are all playing a dangerous game. The EMU believes it holds the cards – they have the money, after all – and wants concrete Greek guarantees on more self-inflicted mortification. The Greeks are pretty shrewd dealers, though – ask anyone who’s traded with a Greek ship-owner – and know that the EMU has just as much to lose with a refusal to roll the bonds over. We could see history made this year in Greece – emergency fiscal union agreed to on the brink of systemic meltdown, or a partial breakup of the eurozone, or in the case of a “voluntary private rollover” plan, the foundation for a remake of “The Grand Illusion.”
The finance ministers may agree one thing, the bondholders another, Trichet yet another, but the bodies politic may end up rejecting them all. It isn’t for nothing that the euro has been called the leading cause of death for the political careers of European leaders.
Risk premia have been rising in the credit-default and bond markets. The U.S. has made no tangible progress yet on its own debt ceiling deadline, though the belief that some kind of muddle-through is inevitable is widespread in our markets. For a good read of all the balls in the air at this time, check out our quarterly report at our website, or read Financial Times columnist Jillian Tett’s latest at FT.com (the link is also available on the home page of our website).
We’ll repeat last week’s admonition: it’s a good time to be in cash and on vacation. In the case of the latter, though, we’ll add Tett’s suggestion: better bring the smartphone, because you’re going to need it (she actually said “Blackberry” rather than smartphone, but after seeing Research in Motion’s (RIMM) results on Thursday, we’re not sure how many beachgoers are still carrying them).
Doubtless we will hear much from the ECB this week, and we are scheduled to hear more from the Fed policy committee and Chairman Bernanke on Wednesday. We might be able to get around the air pockets, but prudence still says to buckle up. Somebody might slip trying to kick one of those cans.
Congratulations to the 2011 Stanley Cup champions (ice hockey), the Boston Bruins!
The Economic Beat
The news of the week was in the manufacturing sector, where two stunning reports showed sharp contraction from the previous month, instead of the modest rebounds penciled in by the consensus. The reports were surveys, not production data, but based on the previous month’s experience production is likely show a small loss for June.
The first of the reports was the New York Fed’s manufacturing survey on Wednesday. The consensus called for a modest pickup from about 12 to 14 (zero is neutral), but the result of minus 7.8 shook the markets and sparked a sell-off. New orders and shipments plummeted, delivery times and workweeks fell while unfilled orders and inventories stalled. It was the first negative reading since December.
The Philadelphia report the next day was equally bad, but having been shocked already the markets were largely unfazed by the repeat. It was similar, except the decreases were smaller. Activity was negative, new orders were negative, unfilled orders and delivery times plunged, though shipments managed a slight increase. In both report, pricing pressure dropped dramatically, reflecting the slowdown.
Industrial Production for May slowed also, but still showed a gain of 0.1% from the previous month. Optimists were quick to point to the drop in utility production, but utility production varies all the time and it was nothing unusual. Although the year-on-year change in manufacturing production is 3.7%, according to the Fed, the change since December is 1.0%. That’s an annual rate of about 2.2%. The economy is slowing. It will pick up again later, probably in the fall, as the inventory overhang from the first quarter is worked off. However, it will take more than a small miracle to get GDP to 3% this year.
The retail sales report for May helped rally an oversold market. It wasn’t better than expected, it just wasn’t worse. The headline rate was (–0.2)%, better than the (-0.3)% expected, but it was pulled down by a drop in auto sales related to the Japanese tsunami. Auto sales should resume a more normalized rate by the fall, and the ex-auto rate was the expected 0.3%. The core rate, which excludes gasoline, autos and building materials, was up by 0.2%. As we suggested last month, consumers have shown themselves willing to step up for Christmas and Easter, but are otherwise careful.
Inventories rose a bit in April compared to sales. It isn’t the kind of stuff that sets off a major cycle correction, but some categories are ahead of themselves (if you haven’t heard that semiconductors are in oversupply, you haven’t been reading the financial pages). The supply situation isn’t catastrophic, but it won’t look good for a couple of months.
Prices continued to creep up in May. The Producer Price Index (PPI) rose 0.2%, slightly ahead of consensus (0.1%), while the core rate also rose 0.2%. The Consumer Price Index (CPI) rose 0.2% (consensus was for no change) and the core rate was 0.3%, also ahead of consensus. The year-on-year rate for PPI is just above 7%, while CPI is at 3.4%. Although the regional Fed surveys show price pressures easing, and they should continue to do so during the summer, the combination wasn’t welcome to a jittery market. Oil prices are taking a beating right now, being so closely tied to equity prices, and that will ease pricing pressure in food as well. Look for rates to ease before the end of summer.
Don’t look for much from homebuilding, though. The sentiment index dropped to a new low on the year and the bottom of the 13-17 range it has mostly inhabited since the crash. It was echoed by the housing starts number, which although posting a higher increase than expected was helped by a downward revision. Building permits increased by over 8%, but the strength was in the multi-family market. New home sales are released next week; look for another record low in the number of new homes for sale.
Sentiment has fallen, not surprising given all the headlines. The small-business optimism index fell to 90.9, recession territory, while the consumer sentiment index (University of Michigan) fell to 71.8. If the June slump in prices continues, we could see sentiment drop below 70 again, but a bailout rally is pretty inevitable. Whether it will have legs is another story.
Leading indicators rose sharply, by 0.8%, reversing April’s decline. They will probably decline again in June, as many of the categories look set to decline.
Next week brings one the month’s other major report, the Fed statement and accompanying press conference with Chairman Bernanke (Wednesday). Existing home sales come out the day before, and if the month is weak the markets will practically be demanding a bone from the Fed. Federal home price data is released earlier that morning, which could add to the begging. They probably won’t get anything, though, at least not yet.
The reports might be drowned out by the European finance committee meetings on Sunday and Monday. Another kicking of the can looks certain, which should help markets rebound and so the housing data could get lost. New home sales follow on Thursday.
Thursday also brings the Chicago Fed National Activity Index, worth paying attention to and starting to get some respect on the trading floor. It’ll be joined by weekly claims, which benefited last week from a strong seasonal factor. Layoffs look set to increase after the end of the quarter. The week will end with May durable goods, due to rebound from a drop in April, and the last official revision of first-quarter GDP. Although the number isn’t exactly a forward indicator anymore, a print of 2.0% or more would give markets a big psychological boost. Consensus is for increase of 1.9%.
Earnings will be a tad busier than in the coming week, with bellwether Fedex (FDX) on tap Wednesday and Oracle (ORCL), Micron (MU) and Accenture (ACN) on Thursday.