Osama Been Gotten

“Justice has been done.” – President Barack Obama

Here we are only a week out of April – the market’s favorite month – and the tenor has noticeably changed. This isn’t unusual behavior, and in fact seems to have gotten more pronounced in recent years as more and more trading dollars have come under the sway of one type or another of quantitative approach. April is the time when equities rally in celebration of “beating” estimates and guidance that is carefully calibrated to be beaten, and the usual show of raising guidance is greeted with the usual show of astonished delight.

Even for the companies that come up short, the calendar is still on their side – there is plenty of time of left in the year to make it up, and nearly all of them talk of their plans to do so in the latter part of the year. More will fail than succeed, but one cannot reasonably expect management to be throwing in the towel so early in the year. It doesn’t hurt either that the market is typically in a forgiving mood, partly because every up April only reinforces the conviction to be long again the following April.

All of this year’s gain in the indices has come from two suction updrafts: the last half of March (marking up the quarter), and the last half of April (marking up the best month). Now the situation has changed – May is known to be a down month, and there is no need to be supporting prices anymore. Since there is always some disquieting news somewhere in the world, it can rush to the forefront to get the blame as prices sink.

Typically, the initial profit-taking is followed by a rebound to catch those who got short too quickly, while giving others a chance to get out (and retail investors a chance to get in). Then the market will plunge again. It doesn’t always work that way, but that’s the standard script of our modern market. Had bin Laden been nailed in April, it might very well have provoked a 200-point surge in the Dow.

It may sound crazy, but there is a bit of natural rhythm to it. The economy and earnings almost never have every light blinking green at the same time (and when they do, valuations will more than reflect it). The somewhat contrived euphoria of April is like the early stage of a spring romance, when every blemish finds an excuse; May brings the next stage, when every quality is given a more searching look and there is trepidation. Things may fundamentally be very much the same with all the blemishes unchanged, but the perspective is different.

Certainly some of last week’s news provided reason for nervousness. In particular, there was the Wednesday-Thursday tandem of a sharp deceleration in the ISM non-manufacturing survey index followed by an even larger jump in weekly claims Thursday morning. The latter report poured buckets of gasoline on the fire that the silver market correction – sparked by an increase in margin requirements, in turn brought on by froth and record highs – had started in the commodity markets.

Crude oil futures took a beating and completed a near-20% correction from high to low in the space of about a week. It really wasn’t so much a repudiation of commodities as it was the inevitable result of yet another momentum trade finding itself with the whole world standing on one side of the boat.

Even so, the optimists were just readying stories about how great the fall in oil prices might be for the economy when the jobs report came along and messed everything up again. Although the Dow was up about fifty points on the day, it closed near the lows. The private payroll number of some 260,000 additions was the best monthly number in years, yet in some ways the worst of all worlds.

Traders, you see, were just starting to gear up for the thought of another bout of quantitative easing (QE-3), inspired by the combo of the weak ISM number and elevated jobless claims, when the jobs report blew that idea out of the water. We would not have at all been surprised to see a result of say, only 50,000, inspire a much bigger rally in the stock market. That would have meant an economy still growing, yet weakly enough to invite more Fed easing. Risk on, dude!

Not only did QE-3 get taken out, though, the rest of the report was ambiguous. The establishment survey was much better than expected, at positive 244,000 (consensus about 200k), but the household survey showed a loss of 190,000. The latter report gets much bigger revisions and is a less reliable number than the former, but is usually thought to be a better leading indicator. Some of the key details were on the tepid side, too, belying the good-looking headline and the Wall Street Journal’s Murdochian insistence that all was boffo (see the Economic Beat, below).

The commodity traders were sorely stung, but the even more overcrowded short-dollar trade felt the worst of the pain. If that wasn’t enough reason for caution (the inverse correlation between the dollar and stock prices during the last year is nearly perfect), when equities began to rally Friday morning, oil prices started to leap up right with them. Given that traders were just gearing up to start blathering about the positive benefits of falling oil prices, the obvious message that equities can’t rally without taking oil prices along with them was rather disconcerting, even if traders can forget it again in a day or two.

Monday may be different, but there is no doubt that the market was a little unnerved by the big “risk-off” reversal. Given the very light economic outlook until Thursday, though, prices may move higher for a few days as strategist cook up reasons to love the jobs report while the commodity and dollar trades are due for some sort of technical rebound, however brief. Cisco (CSCO) reports next week and could be a market-mover.

Indeed, the interval between next Wednesday’s close and Thursday’s open should set the direction for the week. The Cisco report comes after the close on Wednesday, and the bar will be set low for the tech bellwether – it has disappointed for some time now, so anything half-decent might revive its fortunes.

Thursday pre-open will have the latest weekly claims, Producer Price Index (PPI) and retail sales for April. The last should look good both sequentially and year-on-year, due to the late Easter. A bit deceptive, admittedly, but that’s never derailed a good rally. Claims are almost certain to drop, but by how much, and can it beat the estimate? It’s all hard to predict – but then again, it is May.

Our congratulations to President Obama and his team, in particular the special services, for a job well done in ridding the world of Osama bin Laden. Like many in the investment business, we had personal connections to people caught in the twin towers on that evil day.

The Economic Beat

Back to the jobs report and its ambiguous message, notably the bifurcation in the two surveys. The data mavens at the Liscio report inform us that the household survey loss of 190,000 translates into a gain of 40,000 “when adjusted to match the payroll concept.” We don’t know the details of that adjustment and didn’t ask, but taking the result as given, it’s still a substantial slowdown, even if one anticipates another revision upward.

Upward revisions were the other good part of the report, yet perhaps another drag on stock prices (!). The newly revised string of three months of 200,00-plus increases seemed to say “no QE-3” in blinking lights. It’s one of the perversities of the stock market that a big miss might actually have inspired a much bigger rally, in the hopes that more Fed easing was back in the game. That it might not really help the economy would be irrelevant: traders don’t have time for such pusillanimous thinking. Risk would be on, and to paraphrase Keats, that would be all the traders knew and all they needed to know.

The expectation for more easing was lifted by the weekly claims report, which rose a very surprising ten percent to the 479,000 level. For the fourth week in a row, apologists struggled to paint the number as a one-off exception, but four weeks starts to put the burden of proof on the other side. The two most commonly cited special factors were a new emergency program in Oregon and a holiday in New York, but it’s worth noting that neither state figured in the Bureau’s list of the nine states with the highest increases in initial claims.

It was the first week this year that unadjusted weekly claims were higher on a year-on-year comparison (413k vs. 399k), but that inclines us to believe that distortions did indeed play a role. Besides the exceptions noted above, there was the added effect of the late Easter holiday, which may have led to a pent-up burst. Still, that only spreads things out, and we are yet left with an elevated four-week moving average and suspicions about what is going on. It does dovetail with the household survey, where the jump in unemployment was heavily weighted towards those without jobs for less than five weeks.

Other signs of mediocrity included the average workweek being unchanged at 34.3 hours and a drop in temp workers, a category thought to be a leading indicator. Half of the jobs were of the low-paying variety, with many of them seasonal (bars and restaurants, retail stores). The unemployment rate bumped back up to 9.0%, led mostly by the survey loss. The ISM non-manufacturing report also showed a sharp decline in employment practice. Perhaps May will provide a clearer picture, as many economists suggested in the wake of the data.

The Fed’s latest survey of banking senior loan officers indicated increasing demand for commercial and industrial loans, but not for residential mortgages. Declining demand for traditional loans and some tightening on alternative seem to indicate that the pool of eligible borrowers (either a 20% down payment or qualifying for a federal guarantee) is shrinking. Standards on credit card lending eased, perhaps partly responsible for the small increase in card lending.

The ISM manufacturing survey reported a result (60.4) that was slightly better than consensus and better than our own expectations. It was still a slight decline from the previous month, but not a significant one. Factory orders exceeded expectations in March and February was revised upward. There is some anecdotal evidence that firms are stocking up in anticipation of more price increases, but in any case business is good. As to the non-manufacturing number that caused all the trouble, it fell from 57.3 to 52.8; consensus was for about 57. A big miss.

Construction spending surprised to the upside for March (+1.4%), mostly due to a big downward revision to February (-2.4%), so in dollar terms it was about a wash. Domestic manufacturers showed another good month in motor vehicle sales for April; the sector is still humming, led by credit availability.

Turning to next week, things are quiet until Thursday but for import-export prices on Tuesday and the trade deficit on Wednesday, which tend not to excite the markets. As noted above, Thursday will have April retail sales (consensus 0.6%), the PPI (also 0.6%) and business inventories for March. Friday brings the Consumer Price Index (CPI) and the first monthly reading of consumer sentiment by the University of Michigan. We’re not making any predictions, but the markets will be anxious about the price indices, given the strength in food and energy, and if they run hot equity traders won’t like it.

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