Uncle Ben’s Spice


“Overall, the economy seems likely to expand at a moderate pace over coming quarters.” – FOMC (Federal Open Market Committee), January 24, 2007

It’s a truism on the Street that the last players to show up at the game are the public ones – namely, the retail public, and the pension public. Both essentially join in for the same reason, namely that they are tired of watching everyone else make all the money.

This tells the Street trader two things: one, that it is getting late in the game and it’s time to mark out a line that includes coat, money, and the fire escape. Two, however, is that after drudging for hours with the other lean and mean professionals, there’s finally a chance to skin some soft and tender.

In view of the money that’s fleeing the money and bond markets and rushing into stocks – after equities have rallied nearly 100% from their low two years ago next month – it would appear that Soft & Tender Time has arrived, and it’s time to break out one’s favorite spice rubs and bibs.

You may be surprised to see us imply that pension money is some of the dumb money, because big institutions are usually thought of otherwise. Indeed, many pension funds have sophisticated teams. But the asset allocation process is beset with human fear and greed, and the mindset of both public and private funds is beset by changing currents of what is and isn’t acceptable.

And the most unacceptable place to be in the investment world isn’t the one of losing money. You can lose big buckets, as most did in the fourth quarter of 2008, so long as everybody else is. No, the Really Bad Place is watching your neighbor make more money than you. Lots more money than you.

It was only six months ago that the market was down nearly double-digits on the year and pessimism infused the investment community. Since then, the equity markets have rallied by nearly 30%. Every week we read that the market has rallied something like nine of the last ten weeks, and nine of the last ten days, and nine of the last ten minutes, and what feels like just about every time but the time you were in it.

By golly, people want their fair share. Forget all that stuff we said a few weeks/months/days ago about the world being dangerous and not taking too many risks with my portfolio. The markets are taking off without me!

Such is the mindset that precedes the fall, and don’t think that the trading community is unaware of it. Many do lose their heads, of course, and will, but for now what the trading world sees is a momentum market whose end is unknowable. The more or less pat belief right now is that so long as the Fed is firmly behind the market, there’s no point in thinking too much about everything.

Just keep putting down more chips and keep cashing them in until further notice. The talk of an imminent small correction is a big plus, too. It gives the market a wall of worry to climb, and an illusion of sobriety to the whole thing. The sense of entitlement and virtue that has a bid in at every morning’s open and is beginning to run rampant in the financial media is the sign of bad things to come, yes. There will be payback.

But the experienced trader also knows that before the payback, comes the party. You might look at a 20-year chart of the stock market and shake your head at the two bubbles, but the trader looks at them and drools over the bubble-money to be made first. Good for investors, no, good for capitalism, no. Good for hot money? Some of them, yes.

More will lose than win, and they all know that, but also think they know it will be the others that get caught. And all along the way, they will blame the Fed. That’s right. They really don’t approve of what the Fed is doing, but are left with no choice but to chase risk and pocket all that money. Against their will, as it were.

As soon as Chairman Bernanke started speaking last Thursday, making it plain that the Fed backs a rising stock market, the wise-guy money started flowing back into the risk-on trades. Our morning investment is stuffed now with nothing but how to pick the best growth stocks, so you may want to start thinking about getting out of them. Nothing else has changed, except for the sense of entitlement and conviction getting a little bigger every week.

That dovetails with one other observation. Last August, the prediction that we heard the most was that there would be some kind of market crash in the fall. We didn’t believe it, and said so at the time. Crashes come from a height, we said, and the market isn’t high. It’s a lot higher now, isn’t it? And the one thing we hear the most is that this rally is for real.

The Economic Beat

Unemployment is getting better – the unemployment rate is “only” 9%. Unemployment isn’t getting better – the economy only added 36,000 jobs last month. That’s not enough to bring down the employment rate, which fell four-tenths of a percent. Uh, wait, didn’t you say – just throw the whole report out, suggested Moodys.com economist Mark Zandi.

The markets tentatively voted in favor of the report on Friday, and are ready to keep voting in favor of it if events will let them. They will cling to the “9.0%” and ignore the rest. To be fair, if markets had been stuck in a slide, it might have been the reverse. Wall Street hates to give up a momentum trade.

The unemployment rate didn’t actually fall four-tenths of a percent from December to January. It might be better to say that what really happened is that the Labor Department decided that it hadn’t been 9.4% either. Kind of.

It really is a confusing report when the department says that there were around 400,000 fewer jobs last year than it thought, and hardly any jobs were created this month, but unemployment got much better. Oh, but you shouldn’t compare this year to last year (yes, they really said that – all of it).

As you may know, the unemployment report has two parts, a survey of households and a survey of companies (establishments). The two headline numbers, jobs created and unemployment rate, come from the two different parts. While they manage to match up fairly well over time – after revisions – on a monthly basis, the reports can and do differ dramatically.

The household survey, quite volatile with big number swings, is used to estimate the unemployment rate. It didn’t add very many jobs (a little more than 100,000) but shrank the labor force by 400,000, so the unemployment rate went down. A bogus improvement? No, the department says that when its new population controls – instituted for the January report but not applied to previous months – are removed, new jobs would have increased by 589,000 (the labor force up too, but only by 162,000).

So jobs really did go up? Maybe. Some. When there is a discrepancy this big between household and establishment, it’s usually the household survey that takes the brunt of the revisions. The establishment side reported a number of only 36,000, though clearly weather must have had some impact on the construction and transportation trades.

Yet some analysts were skeptical about laying too much of the shortfall (consensus was around 150,000) at the weatherman’s door. Claims are still too high. We compared last week’s unadjusted total of about 460,000 to the last twenty years of such claims, and the current data is near the bottom of the pile.

The only periods that last week looks good against are from 2009 and 2010. For the third month in a row, the jobs number has been well below expectations, and for the third month in a row, it’s being dismissed as flawed. Well, it’s a lagging indicator.

The workweek data didn’t change much, no sign of pressure there. There was some excitement about the increase in hourly earnings, but we suspect that mix played a big role, with 62,000 goods-producing jobs being added at the same time as many temp jobs being lost. That will pull the average up.

Manufacturing turned in a good month. It was echoed in the ISM manufacturing report, which turned in one of its better results, an index value of 60.8 for a seven-year high. Employment jumped in the ISM reading too, also to a seven-year high. The trouble is, as we’ve been saying, is that manufacturing has shrunk so in the U.S. Seven years ago, that kind of ISM reading might have produced 100,000 new jobs last month, rather than the (estimated) 49,000.

The ISM non-manufacturing survey also turned in a rare result, with a reading of 59.4. Its employment index also jumped, a result that actually highlights the limitations of the ISM reports. Even with revisions, it is most likely that services hiring decelerated significantly last month, rather than accelerated (the establishment survey estimated new December service jobs at 146,000 and January at only 32,000).

The latest ISM results are good, but nowhere near as precise as those one-place-after-the-decimal-point results imply. Whether business or employment or orders have improved by one unit or fifty, they get the same weight (“higher”); the surveys are usually filled out by lower-level employees who are in turn susceptible to headline influence. The manufacturing numbers tend to run better at the beginning of the year, and aren’t consistent indicators of stock market performance.

They are more like political polls, with some bias by who is responding and what was on television that day. Polls are useful, though. We can see that manufacturing is certainly in a good mood. Factory orders ticked up in December, despite an improbable drop in civilian aircraft and parts (-99.5%!). It should get revised higher. Looking at the price increases on everybody’s lips, we’ll be very surprised if January doesn’t turn in another decent result.

In sum, production is enjoying a pretty good moment right now, and we would surmise that the renewal is coming in three-part harmony: motor vehicles, aerospace, and export machinery for resource economies. It could keep humming for a bit longer, but it looks to us as if consumer spending had a holiday surge and then subsided.

We’ll get a feel for whether the payroll tax cut has the University of Michigan’s lot feeling any better – it’s preliminary sentiment report for February next Friday is practically the only one on the dock for the entire week.

Although the same-store January sales results reported on Thursday were better than expected, some things to remember are the survivor bias – most chains that struggle with sales growth drop out. Another is that they are year-on-year comparisons, but the December-January comparisons are going to look much less favorable. That will get blamed on the weather too, but the consumer-spending piece of this quarter’s GDP is probably off to a slow start. The January retail sales report due out the week after next will be problematic, but no worries there – weather, remember?

Construction spending was down in December, and November was revised down as well. We’re getting into heavy seasonal-adjustment territory now anyway, so we wouldn’t get too excited by some inevitable back-and-forth volatility. We’re likely to see multi-dwelling (apartments) spending continue to do well, but not much else.

International trade is apt to be volatile, what with all the currency moaning and groaning. Europe is still struggling and commodity prices are all over the map. The December data is due on Friday, along with consumer sentiment. That’s about it for monthly reports, except for the consumer credit report on Monday afternoon.

But there are some earnings of interest, in particular Cisco (CSCO) on Wednesday after the close. There’s also Disney (DSY) on Tuesday and Coca-Cola (KO) Wednesday morning, but Cisco will be the one to watch. Unless it’s the Middle East.

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