“All the kids in the marketplace say – walk like an Egyptian.” – The Bangles, Walk Like an Egyptian
Market open, market up. It’s really become that simple now. Nearly every day last week the futures market pointed to a weaker start for equities. They were promptly bought shortly after the opening bell. Any reason in particular? Of course. There is always a good, solid reason, delivered by good, solid, earnest fund managers.
The number one reason is that the market is going higher and higher, and everyone says it’s going to keep going higher, so why not get there now? Price makes right, as the traders say.
We had the chance to watch an interview with Harvey Miller last week, bankruptcy lawyer extraordinaire and shepherd of the Lehman Brothers and General Motors (GM) bankruptcies. One of his observations was the rueful one that “there is no institutional memory,” adding that pools of money are acting as if 2008 never happened. Risk analysis is being pushed to the side again in favor of return-on-capital schemes.
We have seen melt-ups like the current one before, and cannot ever remember one coming to a good ending. The problem is that the timing of the ending is unknown, and so traders willingly ride the wave as far as it will go. The longer it goes on, the more righteous it gets, and so the more a parade of pundits will file in front of the cameras and across the pages to assure us that it all makes sense and there is no reason that the market won’t keep going up for as far as the eye can see.
There is always a reasonable narrative to support valuations. Always. There is always the late-stage caveat that oh sure, a five percent (or so) correction is possible any time, but that doesn’t mean we’re not in a bull market (and so, of course, the dip should be bought). This is a cover story for staying fully invested, the real purpose of which isn’t making life better for investors, but staying near the top of the performance tables.
In our current situation, one of the most common arguments trotted out is that the forward price-earnings multiple of 13.5 or so is quite reasonable. It sure sounds reasonable. It’s also based on the economy growing at the same rate for the next four quarters – which it never does – and on earnings growth, at its highest in 55 years, not reverting to the mean, which it always does. Turn in your hymnbooks to page 134, as we sing, “Never, always, this time is different.”
It also presupposes that China’s obvious attempts to rein in its financial bubble are just so much fine-tuning, not to mention another reason to buy copper. Copper, you see, is going up because of anticipated Chinese demand, and the Chinese wouldn’t be raising interest rates every other week if demand weren’t so robust, would they? Stands to reason.
Nothing will go wrong in Europe, either. We’ve already had that scare and it’s okay. The European Central Bank is taking care of it. Except that in the end they can’t, because there are too many bad debts to deal with, even in Spain.
It’s a familiar pattern. An event comes along that signals difficulty ahead, and the markets wobble. After a brief interlude, the notion that a crash isn’t imminent calms the crowd and a relief rally ensues.
There will be several more such signals along the way, and each failure to take the market down has the odd effect of convincing the market that it cannot be taken down. What happens in theory is that one is being given plenty of chances to get out. What happens in practice is that people pull their cars over to the side of the road to buy dips, as they did during the tech bubble.
The U.S. economy is growing. It isn’t growing at the warm-and-fuzzy rate being assumed. It likely grew at about a 2.5% annual rate last quarter in real terms, not the 3.2% that everyone repeats in a soothing mantra. The BEA (Bureau of Economic Analysis) somehow had the GDP deflator falling to a rate of 0.3%, when every other measure of inflation was running between 1 and 1.2%. A year or so later, the final estimate is likely to indeed be at about 1.0%, but those revisions are still far, far away.
So we keep dismissing unemployment as weather-related, or just plain wrong. We’ll dismiss the decline in retail sales reported for January next week as being weather-related. But we won’t dismiss the goofy GDP print, or the fact that earnings growth will revert to the mean, or the fact that the global economy is going to slow by the summer, because the market is going up every day, and the market can’t be wrong. Right? Think about it, when was the last time the stock market really got it wrong?
Some of this is understandable. Federal Reserve Chairman Ben Bernanke has to sound hopeful when he goes up to Capital Hill, where a motley assortment of financially ignorant Crusty the Clowns lay in wait for a chance to make headlines back home, with tirades whose basis in common sense is as empty as their grasp of the subject. It’s the battle of the sound bites.
And it isn’t as if the economy is about to go into a black hole, either. The S&P is sitting on buckets of cash. The mass migration towards mobile Internet access is driving a big secular growth story in some corners of the tech world. Most of it represents spending shifts rather than the tech pie getting bigger, but it’s perfectly natural to dwell on the winners.
But the money river that has poured into commodities and reignited the resource economies is about to change course. Small business is as gloomy as ever, and remember they are the ones that do most of the hiring – most big-company hiring takes place overseas.
Without the recovery in the auto industry – which was able to come up with its own credit (thanks to the Fed), and doesn’t dare move its domestic production overseas – US manufacturing data would be much weaker than it’s been. That growth rate is going to level off soon, because we aren’t going to return to the production rates of five years ago for a long time to come. The bounce has been great, but it’s getting ready to level off.
The airline industry is the other leg of manufacturing. It’s in a delicate balance. Much of the order book is due to high oil prices. But if oil goes up much more, orders will get postponed. One terrorist incident would have the same effect.
We are as pleased as anyone with Moubarak’s exit, and our congratulations to the people of Egypt. Nobody knows what will happen next, though. Right now a benign ending is priced in, and the trouble we are having is trying to recollect the other benign endings in the Middle East. Please forward suggestions in care of this column.
Conditions are so overbought now that at minimum another wobble like the one brought on by Egypt two Fridays past is imminent. We said recently it was a matter of a week or two, and last week’s light calendar helped facilitate another rally. Now it’s a matter days. Had Cisco (CSCO) printed a great quarter last week, markets would have exploded – buy tech!
However, it didn’t. No problem – a good quarter would have been symbolic of the robust tech industry, but the weak result, well, that must have been symbolic of a Cisco-specific problem. The important thing, dude, is that Internet service will be restored in Egypt. Time to buy cloud stocks!
The Economic Beat
It was about as empty a week as you can get for economic data.
Consumer credit rose, maybe, in December, with the first increase in credit card debt in over two years. We say “maybe” because it’s a number that gets heavily revised, but we suspect that the December number will hold up – people were willing to put on a stretch for Christmas.
Looking at the weekly data, retail sales arrested a slide of four weeks in a row, though it was too late to help January. Mortgage-purchase applications went down and up around the Martin Luther King holiday, and have subsided back to bottom levels. Rising mortgage rates aren’t helping.
Jobless claims declined below 400,000 – or did they? Unadjusted claims held steady at about 436,000, and even Street strategists were suspicious that snowstorms caused more filing delays that will be caught up later. The Department of Labor released its JOLTS study for December (Job Outlook and Labor Turnover Survey), and it found no change in job openings or separations. Obviously they are mistaken, because the strongly improving job market is accepted wisdom on Wall Street now. Silly statisticians.
The trade deficit widened a bit in December, mostly due to oil, but the result was on target and caused little reaction. Exports rose. The deficit was a tad narrower than expected, a positive for the next estimate of fourth-quarter GDP. But inventories may have offset that, as wholesale inventories rose less than estimated in December.
Consumer sentiment continues to crawl up, as measured by the University of Michigan, rising to 75.1. It was higher only last summer, when a weakening stock market and nasty election campaign started taking it back down again. When the can’t-miss stock market finally misfires, it will come back down again.
Next week the economic calendar gets interesting again. The selection is so intriguing that we confess to being stumped over which reports will hold sway over the market. Ordinarily we would say, whichever reports favor the ruling mood on the Street. But the market’s been moving relentlessly up for a long time and earnings season is about done, so maybe it’ll be whichever report gives the best excuse to leg it.
There are four major areas of interest reporting next week: manufacturing, housing, retail sales and inflation. Our bet is on retail sales and inflation to lead the hit parade, but you never know.
Retail sales for January start the week off Tuesday morning at 8:30 sharp. Although sales data picked up last week, the weekly data for January had four straight weeks of declines. It’s hard to see how sales could be positive, but there are always seasonal adjustments and if those fail to come through, we can blame the weather.
Housing checks in on the homebuilding side, with the sentiment index Tuesday morning and January starts reporting on Wednesday. We’re into the lightest time of the year for the industry, so seasonal adjustments are big and one housing development can make a difference.
If rising prices – though not in houaing – live up to expectations, however, they should get center stage. We start with import and export prices on Tuesday (along with retail sales), the Producer Price Index (PPI) on Wednesday and the Consumer Price Index (CPI) on Thursday. The focus will be on the headline data and food and energy prices, with “core” prices taking a back seat. Fed opponents are primed to pounce.
But manufacturing has been running strong, and could smooth over any rough business. The New York Fed manufacturing survey comes out Tuesday, at the same as retail sales and import-export prices. It’s a lot to think about at once, but the bias is towards dwelling on the good and dismissing the rest. The Philadelphia Fed survey is Thursday morning, with the January Industrial Production report in between on Wednesday. We reckon they will all look pretty good.
Rounding out the week, the FOMC minutes come out Wednesday, and Leading Indicators on Thursday. The funny thing about the FOMC minutes, like the FOMC statement, is that equities nearly always rally afterwards, but never right away. Usually prices sink the first five or ten minutes, as if there’s a chill of fear because the minutes didn’t specifically say in bold print, “Buy Equities!” But after a short period, traders find some way of decoding the words that makes them realize that was what the Fed really meant to say, and become happy to oblige.