Stop Making Sense


“Who took the money away?” – from “Girlfriend is Better,” Talking Heads

The correction has started, however mild it may yet be, with dip-buyers still swarming around session closes and late morning valleys like so many drones trying to convince the queen of the hive to fly again.

But the psychology has clearly been damaged, if only for a while. Though the Dow Jones streak of trading days without a 3-day pullback just set an all-time record (101 days, thanks in no small measure to the Hewlett-Packard (HPQ) earnings report), the exalted sense of a market entitled to a bump up every day is gone.

The damage was done on Wednesday, first by Fed Chairman Ben Bernanke in the morning and then later that afternoon by the release of the FOMC (monetary policy committee) minutes. Both of them allowed for the possibility of easing back on the pace of Fed bond-buying in the foreseeable future, as opposed to some far-off point on the misty horizon (i.e., anytime after this calendar year). I say kudos to them both, and not simply because I said last week that the market was set to decline.

The spectacle of Wall Streeters complaining that the Fed had bungled its communications – they let the market go down! – causing a grand total decline of about two percent from its initial lunatic peak on Wednesday morning was really one of the more fantastical sights the last two days. The real problem was that the trade had locked in on the notion that decision time had ended – the Fed would goose the markets forever, so all you do is buy, a silly idea from the start.

The message from the Fed wasn’t so much that a letup in stimulus is imminent over the next few months, as it was to get the markets not to act as if they could go from mini-bubble to bubble on the “guarantee” of eternal stimulus. That was a bit of folly that needed to be punctured for the good of the market – parabolic price rises always end badly. Always.

I even heard the “Goldilocks” term dropped last week in connection with the economy, probably in an effort to contain the damage from the Fed. That term had been on ice since 2008. Not to be left out, Cumberland perma-bull David Kotok announced on Wednesday that the correction was a buy point – at a time when we had barely lost a percent (Kotok also declared last year that there would be no seasonal swoon come Many, about which he was also a tiny bit off).

You may have also read that banking giant HSBC estimated a below-50 purchasing manager index (PMI) for China Wednesday night, the bank’s report being more trusted than the official version. The combination of the two led to a knockdown punch for the Japanese markets, where equities had risen over 80% (!) since November in a very 1999-style performance. A little over 7% was shaved off of that in one session.

Yet the history of excess is that it never ends when the handwriting is on the wall. A few early-birds leave, but the typical pattern is that a period of rough sailing is followed by the startling revelation that the world hasn’t ended yet. Human nature is such that investors will listen forever to predictions that the trend will never end, but discount predictions of a reversal if they don’t come true immediately. The first wobble is nearly always followed by triumphant new highs down the road, ironically providing the last best exit point at a time nobody believes it.

There are two weeks remaining until the May jobs report. If it’s a dud, or below estimates, markets are apt to continue having trouble finding their footing until the next Fed meeting in mid-June. There’s a meeting of the European Central Bank the day before the jobs report, but I wouldn’t expect any more action from them yet. Any more reversal of the short-yen trade would be welcome news for Germany and the dispensers of the euro.

If the jobs report is a “Goldilocks” enabler, or a little above estimates but not too much, the rally could get fresh legs. A strong report could present problems. One doesn’t look likely from any of the survey data so far, but initial releases are often wide of the mark and we could find ourselves looking at a lot more leisure and hospitality workers, at least on paper. Most of the market’s rise this year can be attributed to the herd group-think that unlimited stimulus makes stocks the betting favorite. It certainly isn’t earnings. A strong jobs report would revive fears of the Fed letting up on the gas.

In any case, this as-yet quite small correction is unlikely to have run its course, and the overall rally is unlikely to be over either. A test of the S&P 50-day moving average is a reasonable short-term outcome, and new highs later in the year are also a reasonable intermediate scenario. The trouble signs are slowly growing, but as I wrote throughout 2007, it takes more than that. Dangers, heights, calculations, all of these can be ignored for longer than any notion of good sense. You need to run a lot of actual bodies over the cliff before the herd begins to get the idea that a change in direction might be called for.

The Economic Beat

The week was bookended by two interesting reports, one from the Chicago Fed, and one from the Department of Commerce. The first report gave us the regional bank’s National Activity Index, as good a measure as any of how the economy is doing. It’s April measure came in at (-0.53) vs. (-0.23) in March, keeping the 3-month average (CFNAI-MA3) submerged just below the waterline at (-0.04).

source: Chicago Federal Reserve Bank

As you can see, it’s been generally trendless since the fall of 2009, with some occasional peaks and valleys, leading to cries that either the economy is back or call in the Fed. Right now the moving average is downward sloping, which isn’t promising for second-quarter GDP. Only one month of the quarter, April, is in the books, but the latest manufacturing surveys aren’t showing much and the last two weeks of jobless claims data has been above the April average.

Friday’s durable goods report for April did show a rebound bigger than estimated (3.3%), along with a downward revision to March. It’s a volatile series on a monthly basis, and perhaps the most useful nugget in the report is that new orders for business investment spending are up a mere 1.8% through the first four months, which isn’t much higher than the inflation rate. Shipments are only up 1.2%, about flat in real terms.

The main areas of strength in durables is coming from aircraft, which is in the middle of a replacement cycle driven by demands for fuel efficiency, and motor vehicles. The latter is somewhat more reliable, because aircraft orders are often switched off in a downturn and not restarted or accepted for delivery for many months afterwards. Obviously auto sales slow in a crisis as well, but aren’t as likely to have shipments go to zero.

The biggest drivers in auto sales continue to be the availability of credit, in turn driven by a healthy securitization market, and the elevated average age of the American auto fleet. Cars are old. A third driver this year is the demand for pickup trucks from the rebounding housing market.

That market, however, is still constrained by tight credit. An indication of that came in the latest new home sales data, which showed a drop in every category below $300,000 and an increase in every category over $400,000. The builders are talking up rising costs and holding the line on profits versus going for higher sales numbers, but I suspect that the lower end of the market is getting more credit-constrained. Most of the financing in this area has come from the builders themselves and the FHA, and the lower end of the economic spectrum is participating much less in the recovery (Bill Gross tweeted Friday that Washington “juices Wall Street with easy money & placates the 99 with food stamps and disability benefits”).

The average price for a new home rose to about $331,000, a record, and the annual rate rose to 454,000. Media and Wall Street types tend to crow over these numbers as if the word is on fire and homebuilding is going to fix the entire US economy (and by extension, the globe). But that rate is still the lowest since the 1960s, making an awfully small engine for a population that has doubled in size. There is clearly very much a mix issue going on, and I suspect that these data resemble the Depression more than any other decade.

The median price for an existing home rose to $192,800, “the highest level of the recovery,” but the last Case-Shiller report showed the median price is still down 29% from 2006. That is probably why the National Association of Realtors (who put out the existing home report) are still complaining of limited inventory (Econoday wrote that supply “poured into the market in April,” so they’re not quite on the same page). A very large 30% of sales are still all-cash, and 20% are by investors.

It’s part of a general trend lately in retail commerce overall to target the higher end customer, not just in housing, because the lower end (which these days might be the bottom 90%) customer is struggling, as the latest results from Target (TGT), Wal-Mart (WMT) and even the teen retailers showed this week. Cold March weather surely played a role in retail sales, but April weather was good enough. When people are holding the line on teenage spending, that’s a careful consumer.

The agriculturally-focused Kansas City Fed region crept back into positive territory with a reading of 2, though the readings on backlogs and employment continued to decline. Like the durable goods report, the regional readings are falling into a pattern of overall very minimal growth, but not outright deceleration. Next week will feature regional reports from Dallas and Richmond on Tuesday, and the more influential Chicago report on Friday. I should expect that Chicago is due for a bit of a rebound, on restocking grounds alone.

A new Case-Shiller report will also come out on Tuesday, which has a bit heavier schedule than usual due to the Memorial Day holiday. The Consumer Confidence report comes out the same day.

But the rest of the goodies are towards the end of the week. Another first-quarter GDP revision comes out Thursday (the corporate profit revision is probably more useful), along with the weekly claims data. It still looks to me like California keeps throwing off the latter.

The biggest reports are on Friday, with April personal income and spending and the Chicago PMI. PMI data from EU countries come out on Thursday. It irritated me no end this past Thursday to see the Bloomberg crawler constantly announcing that European PMI indicators “rose,” when they did no such thing. They all declined, including Germany, but not as steeply as the month before. These are diffusion readings, so they have to flatten out to neutral (50) eventually, even if the continent is depopulated.

All US markets are closed Monday, May 27th, for Memorial Day.

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