“April is the cruellest month.” – T.S. Eliot, The Wasteland
Maybe the trick to investing is to just sit in cash until the usual quarter- and year-end grab-and-lift sessions. Why bother with silly things like balance sheets? Program your black box to discover that if it’s this day of the year, and rates are not tightening, and there are fewer than three uses of the word “crisis’ in the Wall Street Journal, then buy stocks because prices outperform by 1.36% more than 81.2% of the time, or something like that, with the added virtue of having decimal precision. Valuation is for squares.
Or is it? We came across a thoughtful and well-written opinion piece in the Journal last week entitled “All about the Benjamins” (clever title, as “Benjamins” is also slang for $100 bills or just money in general, thanks to the portrait of Benjamin Franklin on the hundred-note).
The author, Mark Spitznagel, pointed out the dichotomy between the valuation-sensitive approach (first formalized by Benjamin Dodd) and the liquidity-momentum approach, which he ties to Fed Chairman Ben Bernanke and characterizes as a take on the efficient-market theory – prices are always right, so if they are rising they are telling you that things are getting better and you should buy more, and if you buy more then prices will rise and things will get better (no, this isn’t called a con game on Wall Street. It’s called a “virtuous circle”).
Looking at the quarter just past, you’d have to side with the momentum crowd. The Dow put on its best first quarter since 1998, rising 6.4%. The press didn’t fail to fawn on this significant achievement, with nary a mention that nearly all of it came from a furious rally over eight of the last eleven trading days of the quarter (the other three days are being investigated).
The problem, as Mr. Spitznagel pointed out, is that history has repeatedly show that stock market valuations don’t always pan out – for example (our own, not Mr. Spitznagel’s) in the year 1998, prices suffered the Long-Term Capital fiasco after their bonny start, and a very painful correction. Of course, the Fed stepped up shortly afterwards with added liquidity, interest-rate cuts and a bail-out, sending prices into a virtuous-circle orgy that ended in a well-known bubble and collapse.
Perhaps the market believes that fortune is on its side, such that if the overdue correction occurs, it will simply bring on QE-3, the third round of quantitative easing. Several Fed governors have been discouraging such notions of late, going so far as to give voice to the occasional cough of doubt about the necessity of finishing QE-2. Such is the usual way of the Fed to signal future policy, and we think that is the intention.
Still, it isn’t clear how firm the chairman himself is on the impossibility of QE-3. If first-quarter GDP should turn out to be as tepid as some fear, and the market sinks in disappointment at a combination of diffident corporate guidance this month and the latest economic trend (we think manufacturing is in a growth slowdown, despite the rosy ISM surveys), then the Fed may feel differently.
We would rather not see the Fed act. It really needs to keep a few arrows left in its quiver – a more genuine emergency than a growth slowdown and stock-market whinging could arise. But there’s more – the commercial credit markets are clearly behaving stupidly again. More easing would give too much ammunition to the Fed’s crackpot-theorist political opponents.
Perhaps most importantly, the equity markets have to learn to stand on their own and the banks need to be convinced to make money from lending again, rather than conjuring up massive fees from obscure magic tricks with derivatives that may or may not blow up when liquidity contracts. We regret to say, however, that as of this writing the chairman has not called for our counsel.
Looking ahead, the coming week is a light one, which usually favors the upward trend. We’re also into the month of April, and the market has rallied every April since 2002 (though it has occasionally flubbed it in the last week or so). If oil rises “only” a dollar or two next week, and nothing really terrible comes out of North Africa, Japan or Europe, then the trend could continue.
Although retail investors appear to have pulled some money out of stock funds upon recouping their losses from the February-March pullback, there may be more money coming in from tax-season contributions. The market will certainly be acting as if there is until proven otherwise. We’ve a week to go before earnings season kicks off with Alcoa (AA) on Monday the 11th. So far, companies have tried the trick of giving guidance “ex-Japan” because “it’s too early to say what might happen,” but that routine will get stale quickly over the next few weeks.
We have to wonder, though, how honest management will be. Massive chunks of executive compensation are tied to stock prices, a concept that was supposed to align the interests of senior management with shareholders. In a way it has, because management has gone to great lengths to keep prices high, ranging from borrowing money at the bank to buy shares back (a real waste of capital, despite the fact that it keeps fund managers happy) to excluding massive amounts of expense from its “non-GAAP” earnings to outright cooking the books.
The threat of litigation remains as a deterrent to deception, but it isn’t always needed. The market is quite capable of making the excuses necessary to keep the trend alive. Not forever, certainly, but long enough for the professionals to discreetly turn over their shares to the investing public. “The trend is your friend,” goes the well-known Wall Street saying, but few hear the kicker – “until the end.”
The Economic Beat
On the one hand, the jobs report was the best jobs number this year, and it produced the lowest unemployment rate (8.8%) since April of 2009. On the other hand, as jobs reports go, it’s still mediocre. The number of new jobs is still below the average from 1948-2000 (so report the experts at the Liscio report, which we highly recommend).
More than a third of the new jobs total of 216,000 were jobs at the bottom of the income pole – health care, leisure and hospitality. The growth in manufacturing jobs slowed in half to an addition of 17,000 – another indication that that sector’s growth rate is slowing. Add in temp jobs and more than half the total was not at the top of the quality scale. Still, jobs is jobs.
In terms of how well the labor force is doing, average weekly hours were unchanged, average hourly and weekly earnings were unchanged, and the weekly payroll index rose slightly. No pressure there – in fact, it suggests that real disposable income fell in March for the average worker, as it did in February. Things are improving in the labor market, but slowly.
Other encouraging signs came from the Monster Employment index, rising smartly for the second month in a row, and the Challenger layoffs report, which concluded the quarter with the fewest number of first-quarter layoffs since 1995. Anecdotal evidence was positive, with Manpower’s (MAN) CEO Jeffrey Joerres averring on CNBC that employer optimism had definitely improved (though he cautioned that the recovery would be gradual rather than a breakthrough).
All of that is encouraging, and we do believe that the jobs are coming back. Even financial services added 6,000 jobs last month (estimated), for the first time in a long time. However, it has to be kept in perspective. The participation rate (willing workers as a percentage of the total population) is still lower than it was a year ago, as is the employment-population ratio (percentage of Americans who actually have a job).
The participation rate really ought to have been moving up some time ago; this is an anemic recovery. The apparent improvement in the unemployment rate rests heavily on the millions of discouraged workers no longer counted as being in the labor force. While last month’s labor force finally ticked up, if March 2011 had the same participation rate as March 2007, the unemployment rate would be 11.5%. Those people are still out there: the civilian population is estimated to have grown by about 8 million since then, yet the civilian labor force (people counted as working or willing to work) is nearly identical.
That would partially explain the drop in consumer confidence, as measured by the Conference Board. It fell from 72.0 to 63.4, which is an unusually large drop. The rapid increase in gasoline prices and drop in the stock market (at the time of the survey) weighed on confidence (not to mention the crises in Libya and Japan), but there was also deterioration in the current and future outlooks on employment. Inflation expectations also rose. And while weekly jobless claims have been inching down over the last six months (despite a small bump last week), the levels remain too high for a non-recessionary period.
Certainly the recent march of crises on the front page may have had an outsized impact that could be quite transitory, but the number isn’t the stuff of recoveries. There was a time the stock market would have reacted sharply, but the current one was still being driven by quarter-end markup. The personal income and spending report for February showed part of the problem: personal income rose 0.3%, but the PCE (inflation) measure rose by 0.4%, meaning real personal income was down.
The report also showed that goods-producing and manufacturing payrolls contracted, another small clue that growth in the sector is decelerating (despite the purchasing-manager surveys) and possibly a contributor to the drop in confidence. The large improvement in service payrolls was probably driven by bonus payments, and there is also some inference from state data that some of those payments were staggered into March.
Pending home sales for February rose 2.1%, pointing to an improvement in home sales for March. Mortgage-purchase applications were also higher in March, so we should indeed see a month-to-month improvement. Keep it in perspective – February’s sales data were so abysmal that some improvement is almost inevitable, and the year-on-year data are still going to show declines. The activity levels are still quite weak, with prices on a months-long slide according to both federal data and the new release of Case-Shiller data (down 0.9% in January).
Manufacturing seems to be the bright spot, with the Chicago PMI and the national ISM (purchasing manager groups both of them, and we really wish they would all use the same acronym) manufacturing surveys recording strong numbers. Chicago reported another skyscraping result in the seventies, at 70.6, and the national number for March was also at a very high 61.2; both numbers were essentially unchanged from the previous months.
However, some caveats: these levels tend to immediately precede a slowdown, as they are rarely sustainable for long. The surveys are only that, and don’t measure depth of activity (and are often filled out in two minutes by lower-level subordinates). One bit that caught most people’s eyes was the measures of price increases, with over 85% reporting higher prices, the highest reading since the oil bubble of the summer of 2008. That wasn’t good for the economy, as we recall. All eighteen of the manufacturing sectors reported paying higher prices, and while over thirty commodities were reported to have risen in price, only three (including cocoa powder) reported being in short supply.
Construction spending was reported to have fallen by (-1.4)% in February, coming on top of a big downward revision to January (-1.8%). That is going to be a drag on first-quarter GDP results, as will the drop in factory orders (down by 0.1% in February). GDP estimates have been quietly coming down in the last two weeks, with January outlooks of three to four percent growth being reduced to two to three percent – and in the case of Bank of America-Merrill Lynch, all the way down to 1.5%. Hmm, decelerating growth, rising stock market. Is that the way it’s supposed to work?
Maybe it will for next week. The calendar is quite light, and that usually translates into a continuation of the previous week’s trend for the stock market, meaning up in this case. There are some interesting data points for wonks – consumer credit on Thursday, wholesale trade data on Friday, same-store April sales (the sample is now quite small).
But the main interest will come Tuesday, with the ISM non-manufacturing survey for March and the latest installment of Fed (FOMC) minutes. Given the stage to themselves, the two reports might get a bit more interest than usual. Then there’s Friday and the budget deadline, definitely a binary outcome (either a big mess or a big non-event) and the European Central Bank’s rate decision on Thursday. It might get interesting.