“And I ain’t seen the sunshine, since I don’t know when, I’m stuck in Folsom Prison, and time keeps draggin’ on.” – Johnny Cash, Folsom Prison Blues
There really isn’t much new to add this week that is different from last week. The Fitch credit-ratings service downgraded Greece – what a surprise. Suddenly-former IMF chief Dominique Strauss-Kahn is still in trouble, though out of the slammer. Christine Lagarde is still the leading candidate to replace him, and Greek short-term bonds are still yielding over 20%.
On the domestic front, all the evidence pointed to a manufacturing slowdown, though the markets are unsure as to whether it’s a Japan-related blip or something deeper. Retailing stocks reported disappointing earnings, in large part due to overestimating demand and finding themselves in a competitive battle to mark down excess inventory. The risk-on button was lifted again on worries about all of the above, and crude oil finished the week with another pummeling.
It’s May, a month that for some time now has been a time to pull back from April exuberance, protect some profits, fret over whether the April peaks are sustainable. A typically choppy month marked by angst-driven pullbacks and sharp reversals, yet rarely massive declines.
The week should start off with the same worries, as the Socialist party in Spain is getting a bigger hammering in elections than silver did a couple of weeks ago. That will heighten anxiety about the euro and the debt of the PIGS countries as doubts grow about their willingness to accept more jail time in exchange for German bail money. It doesn’t help that there is no IMF chief around to get people to make nice to each other (latest theory: Strauss-Kahn fell asleep watching “Maid in Manhattan,” woke up watching “Pretty Woman,” and well, just got it all confused).
While the ruling parties in Ireland, Greece and Spain are getting thrashed for agreeing to draconian German conditions in exchange for help, the German ruling party is getting thrashed for offering any help at all. It may be fertile ground for a comic sketch, but it isn’t promising for holders of peripheral country debt.
Asian markets were tumbling as we went to press on fears of a general global slowdown, debt contagion, the end of QE-2 and the rumor that Pakistan would accept Strauss-Kahn as a prisoner. All in all, a gloomy mood.
Yet May is known for its reversals too, and the market is ripening for one. While we firmly believe that the European debt situation will have a messy and quite possibly calamitous ending, one must allow for the possibility of another extend-and-pretend that permits a ripsaw reversal first. It’s getting old, true, and it’s difficult to handicap the tipping point in advance, but markets as a rule tend not to abandon hope until all else has failed. They ought to be able to patch together one more dead parrot and pass it off as the real thing.
While US investor sentiment is anxious about the short term, it’s clear that bullish sentiment still prevails. What else could explain LinkedIn-mania (LNKD)? Here’s a company trading at 40 times sales and 600 times last year’s earnings, while not expecting to have any this year. People try to draw comparisons to Netscape and Google (GOOG), so we’ll highlight some of the differences and similarities.
Netscape was the first publicly traded pure play on the World Wide Web (the “www” that most websites begin with) and like LinkedIn, wasn’t profitable. It was also a growth story in a growth-starved world, much like the one we are in. Another similarity is that Netscape never did make much money and was soon a distant rival in the browser wars. LinkedIn won’t make much money either, unless someone suddenly discovers that Facebook causes cancer.
One of the principal reasons businesses like LinkedIn is that the site is functional as opposed to entertaining. It isn’t nearly as popular as Facebook, the company that investors wish they were really buying. It doesn’t suck up your employees’ time – far from it – and will be lucky to be the Yahoo of the social networking business. In the short term that doesn’t matter, because people aren’t investing in LinkedIn’s traded shares, they’re just making racing bets. On the first day of trading volume was four times the float, meaning that the tradable shares changed hands roughly two times in one day. A long-term investment.
Google was an expensive IPO, but also the clear market leader with years of rapidly growing earnings. LinkedIn is indeed much closer to Netscape, with the difference this time being that people aren’t going to believe that social networking will have infinite growth the way they did about Internet websites and telecom gear. People will be willing to bet on it short term, and it’s a dangerous short in spite of its valuation, but the day Facebook comes public will mean the beginning of the end for LinkedIn’s valuation.
That said, LinkedIn is clearly a symbol of our growth-starved times and the desire for GAAP stocks. Nothing to do with accounting principles, mind you, but Growth At Any Price. Investment banks are going to try very hard to keep the market going while they dump as much social networking shares onto the public as they can (or cloud, the other buzzword).
The end of the month is approaching, which could help spark a little rally, and Groupon hasn’t priced yet. That alone might keep the market from any really serious damage, even with June (a difficult month) looming on the horizon. The warning signs are multiplying, true, and there are growing reasons to take all your chips off the table and go. Yet the market could top 1400 first, and that alone will keep all the Chuck Princes at the dance.
U.S. bond markets will close early (2 PM) next Friday in anticipation of America’s Memorial Day holiday weekend, the traditional kickoff to the summer season. Stock market volume will probably disappear on Friday as traders get a headstart on weekend traffic. All US markets and banks will be closed on Monday the 30th. In keeping with the spirit, MarketWeek will appear in its holiday-shortened form.
The Economic Beat
The two most surprising reports of the week were the Philadelphia Fed’s manufacturing survey for May and the April Industrial Production report. The Philadelphia news had been tipped by a sharp downturn in the New York Fed’s May survey released on Monday, showing a drop from 21.7 to 11.9 (neutral is zero, so 11.9 is still decent expansion). The New York report did have some redeeming features though, such as increases in unfilled orders and delivery times, as well as futures expectations (a good coincident indicator, though useless as a predictor). Price pressure remained strong.
The Philadelphia report showed a steeper drop (a robust 18.5 to a barely positive 3.9), declines across the board and the completion of a two-month plunge from a lofty 43.4. Readers may recall that we observed at the time that such high numbers presage a pullback – one can only stuff so much into the channel before it starts getting clogged. The unusual speed of the decline suggests just such indigestion, and let’s not forget Japan-related supply issues, so the number may well recover shortly. Yet the Philly report is probably second to the national ISM report as the most widely watched such survey on the Street, so it took some more wind out of the stock market sails.
For its part, the industrial production report rarely lights up the Street, but it is watched and it was a surprise. The consensus estimate had been for a growthy 0.4%; not only was the preliminary estimate a very non-growthy zero point zero, but to add insult to injury, the last few months were also revised downward nearly across the board, including total output, manufacturing, and capacity utilization. For those worried about a slowing of growth, no need to look further. Second quarter GDP estimates will certainly be coming down (again).
In an odd sort of way, that could provide a buying opportunity for the market. Fears of a slowdown and/or correction could keep prices in a downwardly pressured range for the May-June time frame, always a tricky period for stocks anyway. Yet GDP often seems to run out of step with corporate earnings, due to where companies are in the business cycle. As the cycle peaks, only small amounts of growth in GDP will keep producing apparently robust earnings gains. When leverage begins to flatten out due to the inevitable catch-up in costs, earnings start to break down despite an economy that seems to be doing fine.
The typical S&P 500 company has a good chance of surpassing earnings estimates for the current quarter. Most are not hiring, keeping control of costs, and emerging market demand abroad is still enjoying the benefit of elevated commodity prices, the recent pullback notwithstanding. Earnings estimates are carefully constructed to be beaten anyway, so we could see quarterly results ignite the market for one last defiant, in-your-face summer rally before payback time arrives. A lot of black-box trading programs will be primed to make just such a run – they are the marginal buyers, not the traditional mutual or pension fund.
The other bulk of the news last week was in housing. Since the bar for news there is practically on the ground, it didn’t spark any selloffs, but the dreary tidings were certainly of no help to a market having trouble finding things to celebrate. To begin with, the homebuilder sentiment index remains mired in the basement, with the only silver lining being that it remained unchanged, sparing us a lot of idiotic prophecy over a meaningless one- or two-point monthly variation.
Homebuilder sentiment came out on Monday, and tipped off the next day’s release of April housing starts. Starts were well short of estimates and declined from March, along with newbuilding permits. The only relief came from some upward revisions to the earlier month, and we wouldn’t be surprised to see April similarly revised higher, as it’s been the trend recently for this series. The homebuilder sentiment number does not get revised, though, and its continued residence in the cellar is more revealing than the odd revision. Don’t look for good news in next week’s new home sales report (Tuesday).
It was all topped off by a disappointing result for April existing home sales on Thursday, also short of expectations, also a decline in volume, though prices rose by two to three percent. That’s misleading, though, because it’s not a like-for-like comparison. What it really showed is that inventory at the very bottom is getting cleaned out over time – all-cash transactions (bottom-fishing) dropped four percent from a record 35% to 31%, slightly exceeding the gain in median price. The National Association of Realtors complained repeatedly about excessively tight credit in the report, and they are likely to continue to do so through the balance of the year.
The release of the FOMC (Fed) minutes showed the central bank fretting over its balancing act of how to begin ending its current expansionist policy without jeopardizing a recovery that isn’t providing much in the way of victory parades. There was no surprise that the Fed will continue its expected policy of not buying any more Treasury bonds after the current program ends next month. The Fed will also stop reinvesting principal payments on agency securities (Fannie-Freddie, mostly) and Treasuries, constituting a modest form of indirect tightening. The committee reserved the right to change its mind if things get bad. The lack of surprise and the usual we-stand-ready assurances were all that was necessary for the customary post-minutes rally.
Next week will round out most of the remaining housing news with new home sales on Tuesday, federal price data on Wednesday (Case-Shiller data fall into the following week this time) and pending home sales on Friday. The good news about all of them is that there is no good news expected.
Probably the report of the week will be the April durable goods report on Wednesday, where the bar is set even lower than for housing. With a consensus of minus 3.0%, there’s a chance the number could top estimates. If it comes in with bad surprises, it will rattle an already-nervous market, perhaps all the way down to the next technical support level. A clue will come from the Richmond Fed’s manufacturing survey the day before.
The second estimate of GDP for the first quarter comes on Thursday and expectations are it will clear the magic 2% number this time (originally 1.8%). Business investment and inventory accumulation were revised higher (something retailers are regretting), but so were imports. It will probably come down to the price deflator. A print starting with a 2 will certainly cheer the market up a bit, backward-looking as it may be. For our money, the Chicago Fed’s National Activity Index on Monday is probably a better indicator.
Jobless claims will be of interest too, as last week’s drop to the low 400,000s seems to indicate that the burst of layoffs that followed quarter-end and Japan-related auto production issues is subsiding. A break back below 400k, combined with a GDP revision to two-plus percent and a handy chart point could well spur the market on. It might not say very much about whether employment is really improving, however.
Besides the pending home sales report, Friday will close with April personal income and spending and the last installment of consumer sentiment for the month. The earnings calendar is relatively quiet, with tech and cloud-related stock NetApp (NTAP) on Wednesday and luxury retailers Ralph Lauren (RL) and Tiffany’s (TIF) Wednesday and Thursday respectively. The market will be looking at the latter two closely to see if high-end spending is still holding up in the wake of last week’s disappointing retailer results. With Chinese bubble spending still going strong, we think sales will have been okay.