“Behold, where stands th’ usurper’s cursed head. The time is free.” – William Shakespeare, Macbeth
It’s reminiscent of the last two weeks of March, when prices were suddenly sucked higher in a staged rally that helped mark the quarter to a satisfying close. April markets finished with a similar roar, duplicating nearly the entire first-quarter rally in thirty days.
Journalists call people for an explanation of why this is happening, or why gold is at an all-time high, or silver. Mutual fund managers will earnestly explain that the market is still undervalued and prices are only beginning to catch up to the extremely robust earnings. Brokerage-house strategists will throw in the same, though the more independently-minded ones might mention the importance of liquidity. Hedge-fund managers would probably say something unprintable.
The bond market would probably tell you that the equity guys are nuts again. Not the ones trying to put through junk deals, mind you, but the ones doing boring things like dealing in treasuries. The stock market isn’t forward-looking anymore, we heard a credit guy say the other day, and that’s something to worry about. It’s only partly true, though, because the stock market is looking forward to going up the next day.
This market recalls 2007, when a similar pattern prevailed. Markets would open down briefly, because there were usually more bits of disappointing news than good news. After a half-hour or so, the momentum pros would take over again and prices would march forward again. Mutual fund managers wouldn’t sell, because they were afraid of being left behind and anyway, their job is to stay invested. Hedge funds sold, but carefully because they didn’t want to be left behind in the march for performance and the dollars that short-term numbers bring in. The magic word was, “liquidity.”
Now short interest is as low as it’s been since those glorious momentum days of 2007. The market is overwhelmingly complacent again, but the lemming march to the sea may not quite be over. The magic charts, you see, have Treasure Island laying just a bit further away, somewhere around the 1400 meridian.
We could get there, but it would be better if we didn’t quite yet. The best thing that could happen to the equity markets right now is a 2004-type scenario, when the market slowly ground lower for a couple of quarters after the annual spring rally. It gave the economy a chance to catch up to prices.
That could happen, but it’s less likely than a 2007-style scenario. One reason is that in 2004, good returns were still available in the bond markets, where leveraged credit funds (especially those in mortgages) were producing mouth-watering alternatives to equities. Real estate was also very attractive, or so it seemed. The equity markets had plenty of competition.
These days the only real competition is from the commodity markets. Credit conditions are loose at the institutional level, helping to fuel mergers and acquisitions, buybacks, leveraged buy-outs and the like. The general sense of liquidity is a powerful tailwind for the equity markets, who firmly believe that the central bank(s) will intervene to head off any bad stuff (that the central bank might currently be just about out of bullets doesn’t seem to have infiltrated the equity market’s consciousness yet).
The only two real obstacles to the markets marching higher to a bigger, more damaging correction are commodity prices and the economy. Gold and silver, to name two prominent examples, are providing some competition for money as financial speculators and hedgers overwhelm their markets with cash. So is oil. The beauty of them is that a blow-up in precious metals or energy, unlike credit, is largely harmless to equities and the economy (provided, of course, it doesn’t sink another bank like Barings again).
The stock market could care less if silver crashed, for example, so long as it doesn’t turn out that Bernanke hadn’t been loading up the Fed’s balance sheet with silver calls. A collapse in energy prices could even be welcome. The same is largely true for the soft commodities, such as cotton. However, should oil keep rising ever higher, the stock market won’t be able to last much longer.
In the case of economic data, unmistakable signs of deceleration would check the stock market’s ascent. The problem is that signs are almost never unmistakable until it’s too late. A couple months of lower numbers would start to put the brakes on, and we may well get that. But that usually takes a couple of months, so managers hope to squeeze out another month or two of gains.
May can be a difficult month for equities, as the annual love fest over first quarter earnings subsides (standard practice is that first quarter earnings either beat estimates or promise to make it up in the second half). Given the levels of complacency, we think the current one will try to float higher, possibly with another run in the second half of the month.
It’s fuzzy, because things such as the timing of the European debt implosion or the deflation of the Chinese property bubble are difficult to pin down. They will come, but it could be next week or next year. Not that we need either to get a correction, but either event would certainly trigger one. Left to themselves, though, our lemmings will continue their march to the sea.
The Economic Beat
In another market in another time, last week’s housing news might have dampened some spirits. But not when the quarterly beat-the-estimates game is being played in April. Besides, the fact that housing sucks is already well known, and the Street is very good at ignoring known problems. Prices usually only correct on surprises. The surprise may have been in plain view for many months, true, but like many a smitten lover, the Street is very good at not seeing the blemishes it doesn’t want to see. Especially in springtime.
The best you could say about last week’s housing data is that it wasn’t as bad as February – mostly. March new-home sales bounced off their historic post-WWII low, though not by that much. Due to the weather, February is usually the annual low point and March a rebound month, so there’s a lot of seasonal adjustment of low-volume data. Current levels are so low that any improvement looks big on a percentage basis, but sales were still quite close to the record low.
Average prices for new homes fell again, and the number of homes for sale also fell to a new low, a sign of the pressure that builders face from foreclosures and distressed inventory. However, a public relations break is in store, as comparisons will start to get easy again in May, providing an opportunity to hype the “important recovery.” It will all be thanks to last year’s severe plunge following the expiration of the tax credit, but we have to wait one more month yet (sales peaked in April).
Catching a break in home prices will be more difficult, at least on a year-on-year comparison. Case-Shiller showed another monthly decline in February (-1.1%), but that should start to reverse in March with the normal seasonal pickup in demand. The year-on-year comparisons, though, are probably going to stay negative for some months to come, particularly given the difficult credit environment.
Pending home sales showed an improvement in March, but take it also with a large grain of salt. The February sales rate was a bottom, and many current deals will fail to get financing. The best thing one can say about this year is that we will slowly, slowly keep burning off excess inventory. Much of it is being bought by investors, as mortgage-purchase applications sank back to February levels.
What the market really had eyes for was the March durable goods report. The current flavor on the Street being things industrial and luxury, the increase of 2.5% was heartily greeted, and the accompanying revision of February from minus 0.6% to plus 0.7% was icing on the cake. Business capital goods jumped 3.7%.
However, the increase was not across the board. Aircraft and especially defense figured heavily in the increase, as well as vehicles. It appears that autos are slowing, partly due to Japan, and aircraft data is very lumpy, so we could see a reverse in the April data. The rebound in business capital goods came after a bigger drop in January and a sideways move in February, so on balance the quarter is probably still down from the fourth quarter of 2010. However, the direction of revision suggests a potential positive bump next month, which would add to the revision of the first-quarter GDP estimate.
GDP could certainly use the help, because the initial estimate of the first quarter was that it did not glitter. It didn’t even glow. The result of 1.8% was between the lines, though, because it was neither the “upside surprise” of two-plus percent that the market was hoping for, nor the 1.5% low-ball number that some market strategists had put up recently as a conveniently easy hurdle (got to keep that rally going, folks, and every “beat” helps).
It wasn’t as much of slowdown as it seems, though, and could get revised to a friendlier number. To begin with, the price deflator – which is subtracted from nominal GDP to give us the headline “real” GDP – for the last four quarters was 2.0, 2.0, 0.3, and 1.9. Does anyone really believe the 0.3 anomaly for the fourth quarter of 2010?
Putting the rate at a more realistic, yet still sharply disconnected 1.0% – the price index for domestic purchases in the fourth quarter was 1.1%, so it’s consistent – would give us a fourth quarter GDP of 2.4%. That would make the line score for the last three quarters 2.6%, 2.4%, and a probable 2.0% when the revisions are over.
However, there is little disputing that underlying demand eased in the first quarter. Real PCE eased from 4.0% to 2.7%, and real final sales plummeted from 6.7% to 0.8% in the first, although the result is skewed by an inventory run-off and subsequent restock. Spending in the lower income brackets is probably flat and wage growth in March grew at a modest 0.3%, so at this point we are probably dependent upon what the top-tier income brackets do with what’s left of their bonuses.
Although the nation as a whole was willing to dip into savings and credit to help with Easter and the return of warmer temperatures, that effect will be short-lived and is under considerable pressure from rising energy costs. Real spending as measured by the PCE statistic grew at a modest 0.2% in March.
That leaves us wondering how we are going to get to the midpoint of the Fed’s newly revised projection of 3.1-3.3% GDP growth for 2011. With the 1.8% start, that means that we will have to average 3.6% the rest of the way to get to 3.2%. Only two of the last six quarters have put up numbers above 3.6% (one of them being 3.7%), so it seems like a tall order.
We suspect that the first quarter will get revised up to about 2.0%, so that will help, but so long as the stock market believes that the Fed’s liquidity program protects it from anything bad, oil prices are likely to keep going up too. West Texas oil finished at a 2½ year high on Friday of $113.93, gasoline has risen seven days in a row and is rapidly crossing the psychologically important $4/gallon threshold around the country. This is supposed to translate into GDP accelerating from the first quarter?
Fed Chairman Ben Bernanke opined in his press conference that oil prices will ease soon, perhaps with the thought that the Fed’s withdrawal of stimulus at the end of June will deflate the bubble in commodity prices. Or maybe the one-way trade on selling the dollar will reverse itself. But these things don’t happen in isolation – if the risk trade comes off, allowing oil prices to descend, then equity prices will come down too and that will hit luxury spending, the only non-auto category with any growth.
Emerging-market demand seems set to come off both because they are struggling to contain inflation, and because any burst in the commodity bubble – and there seems to be one brewing – will take down the resource countries with it. In the long run, it will be beneficial, but in the short term bubble bursts do not augment GDP.
Next week brings what could be some serious reality checks. The national ISM surveys are due, with the manufacturing report coming on Monday and the and services report on Wednesday. The consensus estimate for the former is for a slight decline to a still-elevated reading of 59.5, but we’re looking for something a bit lower. The Philadelphia and Richmond surveys both showed sharp deceleration, though the Chicago edition continued to run strong, despite significant drops in both new orders and employment.
The estimate for the services sector is for an unchanged reading. Two things that might help out both readings, though, is if the fear of rising prices provoked some stockpiling on the part of business. The falling dollar ought to be helping export business. Either could stop abruptly.
The April jobs report will of course be the main attraction next week. The consensus guess currently sits at 185,000. That would represent a decline of 30,000 from last month’s total in this “robust” job market. One never knows with the monthly job data, as they are volatile and subject to big revisions. Two big factors that do not point to a good number, though, are weekly claims, which have risen steadily the last three weeks, and consumer confidence.
Both the Conference Board and the consumer sentiment readings were little changed from the preceding ones, although the Conference Board did show some improvement in the assessment of job conditions. Manufacturing is probably continuing to hire, but government rates to be a drag.
Claims data is a bit confusing, rising three weeks in a row, with the four-week average rising solidly above 400k. However, the latest report highlighted many more decreases than increases. Opposite that, the jobs survey period had some big jumps in claims.
We don’t think that the job market is about to tank, but it could well pause in the face of rising energy costs and the pass-on effect; the Producer Price Index has been posting some big numbers and the ISM surveys have shown very high price readings. It’s rash to predict the jobs report, but to us the data seem to suggest a downside surprise.
Rounding out next week’s data will be March construction spending and factory orders, coming on Monday and Tuesday. April car sales data will come on Tuesday, and same-store chain sales Thursday. The usual teasers for the jobs report are on Wednesday, and consumer credit comes near the close on Friday. The international scene could make some waves, with the German PMI coming Monday, and the European Central Bank (ECB) announcement on interest-rate policy Thursday.
The earnings calendar is still heavy, but most of the calendar-quarter heavyweights have reported. Visa (V) will report on Thursday, and analysts will be interested in sales trends.