Trade Winds


“Rough winds do shake the darling buds of May” – William Shakespeare (Sonnet 18)

Yes, the market did actually slip for two weeks in a row, for the first time since November, which is when just about every other streak has started in recent years. It wasn’t very damaging overall, though, thanks to the I-dare-you-to-stop-me parabolic rally in the first half of the month, set off by a European Central Bank (ECB) rate cut and a surprise jobs report.

The latter wasn’t even strong, being just on the underside of mediocre, but the ADP report two days earlier had braced participants for a 40K shortfall of the consensus estimate. When traders got an 11K beat instead (with upward revisions!) it started a bit of lunacy that had the veterans shaking their heads by week two. Madness reached a peak the morning of the 22nd, when Fed chairman Ben Bernanke gave a dovish speech that had the horns blowing full-throated again.

Then Bernanke and other Fed members began to hypothesize the possibility of a reduction in bond purchases in the near future, as opposed to some unimaginably distant date. The fever broke. The fears were perhaps not really rational, but then neither was the fever, and the S&P 500 has corrected a bit more than three percent since that wild morning of the 22nd. On a closing basis, though, the market has only lost about 2% since that day, giving it the first positive May since 2009 (about +2%) and a seven-month winning streak that few would have believed back in the waning days of 2012, especially after all the reductions in earnings estimates.

Most professional traders and investors are aware of the “sell in May and go away” cliché that reflects that May through October are typically the worst six months for equities every year, with June and September being the historically weakest. One consequence was a fairly serious dash for the exits in the last trading hour of the month on Friday.

Despite heavily boosted results from consumer mood surveys, though, the economy has a bit of a problem. It isn’t doing nearly as well as its press clippings, bounding equity prices or slipping bond prices would have you believe. The last have been dragged down by some serious trading issues that sprang out of the Fed’s seeming change of heart, with lots of tangled shorts and damaged derivative players oozing blood. But bond prices aren’t fleeing growth, they’re fleeing the possibility of the anomaly – the big Fed buyer – taking a break from the market.

It probably won’t happen soon. The Fed doesn’t want stock prices inflating into a silly bubble just because it’s trying to help employment. But the economy isn’t so strong either, and there are little whiffs of deflation in the air – just whiffs, mind you, but enough to not be missed by the Fed. The Pimco bond mavens tweeted yesterday that they are back in the game buying longer-dated Treasuries (5-10 years) and predicting there would be no purchase “tapering” or hike in the Fed funds rate anytime soon.

A lot more of the market’s near-term direction should be filled in over the coming week, with much influential data on tap, including above all the May jobs report. Following that, there’s a hiatus until the FOMC announcement the 19th. The market has been all momentum and flow-driven, and those two events will decide the direction.

The Economic Beat

Probably the most significant report of the week was the one most overlooked by the media, undoubtedly because it wasn’t uplifting. The April personal income & spending report disappointed on both categories, with income only up 0.1% and disposable income down by the same amount. Spending was expected to be flat, but instead declined by 0.2% on top of a downward revision to March (from +0.2% to +0.1%).

I’ve been starting to feel the first tendrils of deflation worry creeping up the vine of late, and the income and spending report didn’t help matters. The year-on-year price index for spending was only +0.7%. Granted that some of that was due to very high gasoline prices that weakened a bit (we’re so lucky to have all that shale oil) before rebounding, the category that excludes food and energy was up only 1%.

That’s an imbalance. With the Federal Reserve bank adding $85 billion to the system in the intervening seven months and a stock market up 15% (and around 30% from last June’s lows), something is askew. The “core” PCE (price index) was up 0.1%, partly reflecting gasoline again, and will probably get a tenth or two boost from gasoline next month. Even so, that is a very low level. The odds of the Fed dialing back probably receded with this release, though the odds of the Fed talking about slowing purchases will likely depend upon the behavior of the stock market.

There isn’t deflation in housing prices, clearly, with some areas of the country experiencing a bit of a feeding frenzy. Yet credit is still a problem, and the Fed-inspired surge in mortgage rates has knocked down purchase applications for several weeks in a row. Pending home sales were up only +0.3%. That translates into a probable near-zero change in the next existing-home sales release.

Overall, the last twelve months of Fed action seemed to have resulted in a concentrated burst of activity at the high end of the wealth and income range – the stock market and upper-end real estate – but the broader effect seems quite mild. First quarter GDP, which was lowered to a 2.4% estimate, wasn’t much of a rebound from the fourth quarter and the trailing 4-quarter change in nominal GDP slowed to 3.4%. By comparison, 2010 nominal GDP was at 3.8% and 2011-2012 were at 4.0%. That certainly supports the Pimco tweet.

You surely saw the news blaring that Case-Shiller showed a year-on-year increase of 10.3% in existing home sale prices. That compares with the government’s own agency mortgage-based comparison of 7.2%, which excludes foreclosure and short sales data. Seven years on, we’re still well below the 2006 peak, but in areas where there is a lot of investment money poking around, the markets have gotten tight, if not outright rich.

Two numbers that got quite a lot publicity were the sentiment numbers from the Conference Board (“consumer confidence”) and the University of Michigan (“consumer sentiment”).

Sometimes the eagerness to be the first to call out the name of the next tree makes people forget the rest of the forest. What both of the sentiment surveys measure best is where the stock market has been in the last couple of years, or to put it more bluntly, the statement amounts and NAVs in their 401K plans. The surveys also happen to be very good contrarian indicators, invariably peaking just before downturns. Not little one-month corrections, mind you, but prolonged downturns. The silver lining is that although the U Michigan number is at its highest since July of 2007 (cue organ chords), they don’t signal imminent chaos. It means things have arrived at the plateau, without telling you how wide it is or whether there might not be a couple more bumps to climb.

Much was made in the press over the improvement in the job indicators in the confidence survey, with Econoday going so far as to gush that it reflects ‘rising strength in the job market.” This despite the fact that 2013 has so far had slower job growth than 2012 through the first four months, despite the recent pick-up in claims (not huge, but not falling either). It may be extrapolating from private wage and salary growth, which was up 0.03%. Which rounds to zero.

But most egregious was the attempt to center excitement around the 1.1% improvement in the Conference Board’s “jobs are plentiful” category and the 0.8% decline in “jobs are hard to get.” That may sound good, but let’s have some perspective. The percentage of people saying jobs are hard to get, at 36.1%, is three and a half times the 10.8% “plentiful” category. If you ask me, that’s a pretty lousy labor market, especially coming in the fourth year of a recovery. I don’t even want to tell you that jobs are a lagging indicator and ought to be jumping off the page by now. Perhaps the theory is that if people can be panicked into buying houses by stories of rising prices, employers can be panicked into hiring employees before they become scarce. If only.

The regional surveys were mixed, with the Richmond and Dallas manufacturing surveys showing contraction. However, the Chicago PMI rebounded out of negative territory, as I predicted last week, aided by shifting seasonal factors that truly did exaggerate the actual change in underlying activity. As an example, the headline number was reported to have leapt from 49 all the way to 58.7. But the non-adjusted number went from 53.4 to 57.9, about half as much. On top of that, the responder comments were very much lacking in any enthusiasm, reinforcing my recent guess the report was more about restocking than anything else. It seems an easy enough conclusion that we simply live in a low-growth world that only needs to restock every few months. Every time there is one, stock market denizens attempt to seize on it as the new inflection point.

Well, the next few weeks could decide much of the summer. Friday’s jobs report is once again the big kahuna. I wouldn’t dare predict the number, as I thought last month’s report had enough contradictions in it – cutbacks in the workweek, job growth concentrated in part-time and low-paid occupations. The consensus currently stands at 167,000, or about the same as last month’s 165,000.

Is it enough? The advantage of last month’s number was that it surprised to the upside. We could get a similar situation one more time this month if the ADP number comes up well short on Wednesday and then the Labor Department number is over. The market isn’t quite as worried this time about a clunker as last time, partly because some are buying into the notion that a rising tape means a rising economy. That probably leaves it a little more vulnerable to downside surprise. There is also upside surprise risk this time, since a number of 225,000, for example, might frighten the market into thinking the Fed will start slowing asset purchase sooner than expected. That could further hammer a lot of bond and currency trades and lead to some weird results.

A Goldilocks number might be something in the 165,000-190,000 range. Enough to lie that the labor market is growing strongly while simultaneously being too weak to force the Fed’s hand. It all starts with the ADP number on Wednesday.

The week will start off with another high-profile report, the ISM manufacturing report on Monday. Last month confounded guesstimates by being positive after all the regional reports were negative. The latter symptom is still intact, with weaker New York and Philadelphia numbers being offset by the Chicago PMI. The non-manufacturing number comes out Wednesday.

Monday also includes April construction spending, and Tuesday has international trade. But for the jobs report, Wednesday would be the day of the week, with the ADP job number, ISM services, factory orders, and the Beige Book. May auto and chain store sales round out what rates to be a most influential week.

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