Watching and Waiting


“Plus ca change, plus c’est la meme chose.” – French proverb (the more things change, the more they stay the same)

One of the things that strikes me about the modern market is the growing repetition of it all, a phenomenon I put down in part to the growing share of trading by algorithms. The first quarter is the buying season, and the indices tend to repeat year-ago behavior with remarkable consistency.

I’ve been writing in recent weeks about this calendar-repetition trade. My remarks have in turn been repeated in a number of places, and doubtless others have noticed independently as well. It’s become one of the topics of the month.

Let me present you with some fresh evidence, because this crowding around the seasonality explains more than anything much of the recent price behavior and what might be expected in the near future. It can be easy to get bogged down in the minutia or sheer volume of arguments about the nature of the economy, the central banks, and various attempted rationalizations of behavior that in the short run is anything but, except on the most superficial levels. Or when accidents strike.

Out of curiosity, I reviewed some columns I wrote in the spring of 2011. The March 25th column was entitled “March Madness” and could just as easily have been written today as then. The problems I cited were “European debt, growth slowdown, Japan, slowing China, the end of QE2” and remarked that the market is “perfectly capable of ignoring them so long as there is liquidity.” The only that is different is that the Fed pulled the rug out from underneath itself and, along with the European Central Bank, has overtly agreed to write a blank check for as long as necessary.

I’ll return to that point, but first note that on a price basis, the S&P 500 index is up 9.2% through Friday, March 22nd. The 2012 version was up 9.6% through March 23rd. I would attribute the small difference to the lack of an additional Fed easing program on the horizon to bet on. Indeed, every spring for ten years in a row has seen a big double-digit rally, even including the crash year of 2008. Each time, Wall Street strategists and economists predict that the economy will accelerate in the second half of the year and talk of 3%-plus real growth for the following year, and each year it doesn’t materialize. In April 2011 I wrote my fifth consecutive springtime column called “Hope Floats” and I’ll be writing one again shortly. I don’t know how I missed it last year.

All of the market rise and then some in recent years can be attributed to the first quarter rally and the end-of-year mark-‘em-up rally that takes place between Thanksgiving and Christmas. Sell in May and go away, indeed.

As regular readers know, I am one of the voices positing an imminent correction (but not before the end of the month, not unless the EU boots it). Those voices have become so numerous of late that it’s become something of a parlor game to pick the week – will it be early April? Late April? The calendar trade favors a breakdown between the third week of April and the end of the first week of May, so that’s where I sit in this calendar-driven year.

When ECB President Mario Draghi made his celebrated “”whatever it takes” claim, I noted that the bank’s announcement didn’t create a single new job, nor was it at all obvious that it ever would. The main thing it did was to divert the money river back into equities and buy some time for the eurozone to address its problems, which it has so magnificently failed to do that the current period will provide doctorate material for economics majors for decades to come.

The European situation is remarkably similar to two or three years ago. Germany’s membership in the eurozone means that it continues to enjoy an artificially low exchange rate that supports its export-driven economy. Meantime, it lectures its southern neighbors and fellow zone members on the need for more austerity, a process which has continuously driven down their economies into deeper misery, with the promise that someday it will all be made right.

Every six months or so, one of the members teeters, and some sort of minimal plaster is slapped onto the problem. The various EU leaders then proclaim that the crisis is history, everyone but Germany sinks deeper and deeper, and I keep writing that unless and until there is a eurozone-wide debt restructuring, the zone will remain a deadweight around the neck of the global economy.

One might say it’s irrelevant – “don’t fight the Fed,” and I agree up to a point. That point has been reached. Now the market is simply running on its own autopilot. Like a plane that has fuel but no pilot, it will simply keep going until it crashes. First-quarter earnings will act as a mild damper, but earnings aren’t all that important. The Street knows how to ensure that two-thirds of companies beat estimates with remarkable regularity. And I really don’t know when the payback comes. The second-quarter correction could be anywhere from ten to twenty percent, but my guess is that the markets will find some liquidity reason or reasons to trade back up again into the fall.

The market held up on Friday on hopes that the Cyprus situation will be resolved. I hope and expect it will be, but I thought that about Lehman Brothers too. Instead the politicians decided it was time to get tough in September 2008, partly because the administration had become partial to laissez-faire zealots who thought free-market justice was in order.

Now Brussels and Berlin both see a chance to “clean up” Cyprus and its unsightly financial system, with its immoral Russian money. There are right ways and wrong ways to fix things, and shoving them off tall buildings with fingers crossed isn’t one of the right ways. As we go to press, futures markets are having yet another “Europe didn’t destroy itself this week” rally. Fates preserve us.

The Economic Beat

The economy has so far gotten off to a positive, yet weaker start in 2013 than it did in 2012. Manufacturing indices are running weaker, trade is weaker, employment growth (real, not headline) is weaker. Only housing has had a genuinely better start, and a great deal of that is being fed by investment money pouring into the sector.

I don’t want to dismiss the investment-fed bump in housing as insignificant. Cyclical recoveries are usually characterized by pools of investment money coming in to snap up bargains once it is satisfied that the worst is over, and that money helps launch the next up cycle. The improving tenor of the headlines and the removal of much of the distressed inventory from the marketplace have helped gin up some urgency in buyers.

So, for example, existing home sales increased to a 4.98 million rate in February, with an 11.6% increase in median price (partly a mix issue, as the sales are not like-for-like) and a 6.5% price increase in federal agency-sponsored home transactions. Not a surprise to the market, and even slightly below consensus.

In addition, February housing starts showed a respectable increase, though the data is highly adjusted and subject to much revision. It was counterintuitive, for example, that the Northeast and Midwest showed large increases while laboring through a cold and snowy month, while the West and South declined. The latter may be partly why homebuilder sentiment declined from the previous month to 44, instead of rising as expected (50 is neutral).

However, credit is still quite limited in housing and there is no reason to expect that to dramatically change this year. It will heal over time, as all credit cycles do, but it will probably take longer than people think, especially given the respectable chance of another credit event coming along in the global markets that would cause banks to hunker down again.

The issue for the investor is more delicate. Housing isn’t going to make a big enough contribution this year to pull the economy above 4% nominal growth, and there is even some inference that GDP could fall back below that figure. However, what matters to current prices isn’t the reality but the belief, and many traders are happy to bet on crowd succumbing to the belief for a long enough time to make some decent profit. It’s something of a conundrum, because these types of trading credos tend to end abruptly and unpredictably.

Recent weekly claims data pose something of a puzzle. After a three-month period of very little year-on-year improvement, the data seem to have resumed a pattern of showing respectable decreases. However, it isn’t nationwide. The bulk of the difference is coming out of California, which often sends in estimates and has reported huge swings in recent weeks. It’s hard to know what to make of it.

Data out of Illinois and Michigan has been sharply better as well, and it’s tempting to attribute this at least in part to the auto industry, a large employer in the area. It hasn’t shown up yet in national estimates, though, and on the state level we’re still waiting for January data. Weather may also be at least partly responsible for slowing down the filing process – Texas and Florida data, for example, haven’t participated in the recent improvement.

Pennsylvania data didn’t show much improvement either, nor did the Philadelphia Fed manufacturing survey. It did manage to squeak out a positive result versus the negative estimate, as I predicted a week ago, but the result of +2.0 was considerably weaker than the year-ago figure of +12.5.

Retail sales have been moving up as we approach Easter, though the Bloomberg Consumer Comfort index declined. The Leading Indicators came in on schedule with a 0.4% gain, while the coincident and lagging indicators weakened somewhat.

There was of course an FOMC meeting too, and the obligatory rally followed by the obligatory sell-off. The Fed staff lowered its forecast for this year, as expected, though the outlook for the unemployment rate improved mildly (it’s a long-held tenet here that you should not put any money on Fed forecasts). I realize that Fed chairpeople are constrained in what they can say, lest they frighten the horses, but I wasn’t cheered by the chairman’s light dismissal of Cyprus, or his putting the declining participation rate down to demographics.

German business sentiment unexpectedly fell, but it will fall a lot harder next week if something goes wrong with Cyprus, now the main event on next week’s calendar. It’s a heavy calendar too, starting with the Chicago Fed national activity index and the Dallas Fed manufacturing survey on Monday, durable goods and the Richmond Fed on Tuesday, and the Chicago PMI and Richmond Fed on Thursday. That’s a lot of manufacturing survey.

There is housing data too, with new home sales and Case-Shiller data on Tuesday, and pending home sales on Wednesday.

Another revision of fourth quarter GDP comes Thursday morning and the market will most likely trade it, though it really isn’t meaningful by now. Corporate profit data will come that morning as well.

The oddball day is Friday. Personal income and spending data for February will be released, along with another consumer sentiment survey, but the US stock market is closed (European markets get their turn the following Monday). The banks will be open in the US that day. Whether they will be open in Cyprus, I cannot say.

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