The Heat Is On


“The heat is on. It’s on the street.” – Forsey-Faltermeyer, The Heat is On (Glenn Frey)

If you’re wondering how much longer the stock market can keep rising in the face of weak earnings (yes, they’ve been anemic so far) or worrisome economic news (though the media tries its best to skip the bad news and concentrate on the good), the standard answer is, “a lot longer than you think.”

That said, though, I think the current move has nearly run out of steam and will probably top out next week. A market that rises four more days out of five in the face of a number of notable earnings misses and generally weak revenue numbers, notably including GE (sales down year-on-year), IBM (ditto), Google (GOOG), Intel (INTC, and sales down year-on-year), Coke (KO, also negative sales) and Microsoft (MSFT) is neither unusual nor long-lived, as a rule. The weight of these things tend to take time to build.

The primary market event of last week was neither earnings nor something as banal as retail sales, but Federal Reserve chairman Ben Bernanke’s failure to talk the taper in two days of Congressional testimony. That was really what the market wanted to (not) hear – Goldman Sachs (GS) observed during its Tuesday earnings call that the firm’s clients are waiting “on the edge of their seats” for the next tidbit from the Fed.

The second-most important market event of last week (short-term) was the tried-and-true breakout trade, as seen in this chart of the S&P 500:

S&P 500 Index – trailing six months

Note the new high at the top-right corner. Traders eat this kind of chart move up – for a couple of days, anyway. The principal order of business at the outset of next week won’t be the direction of the economy, but 1700 on the S&P, only a half-percent away. It’s a round number! And you thought that earnings were important.

They are, but it often takes time for their meaning to become apparent. In the interim, our modern, algorithm-dominated market is busier with more important data, such as analyzing any Fed-speak or derivatives thereof for signs of being looser or tighter, positive and negative words on the ticker, the week of the month, the month of the year, and of course chart patterns. Let those pension fellers worry about earnings.

With S&P 1700 so close, then, equities are bound to keep moving higher next week unless bad reports (and I’m not predicting anything) from new home sales, durable goods, and random Fed governors can stop them. That would take the market into very-overbought territory at just the right time, namely the annual late July-early August fade. If there is no serious news externally, it shouldn’t be more than a few percent, but any meaningful external item can knock the markets hard as we get into August, not least because of light volume and vacationing traders and politicos.

In the meantime, the chart and rotation games should play out for one more week, as traders abandon tech and industrial stocks for health care, energy and financials, large-cap for small-cap, foreign for domestic. And you thought earnings were important.

Europe lingers on in a dreamlike state of paralysis, with Portugal, Spain and Greece continuing to sink, dragged down by austerity and a too-expensive currency with Germany continuing to preach austerity in the face of all evidence until after its election in September. I believe it’s the calm before the storm (despite the latest Barron’s cover) – all of this hot air is going to end in thunder and lightning.

The Economic Beat

In the pantheon of monthly economic events, the retail sales report generally ranks third, behind Federal Reserve announcements and the employment report. Housing reports follow close behind. This past week they all ranked about dead last, with the Philadelphia Fed business survey topping the charts. It was the best result, you see.

Retail sales did not measure up, so the markets ignored them. A monthly gain of 0.8% had been broadly expected, and what came out was a print of +0.4%. To add to the insult, May sales were revised down a tick, and worst of all was that the ex-auto, ex-gasoline number was actually minus 0.1%.

The longer-term trend in retail sales went sideways, as is often the case, but it’s been on a steady decline nonetheless. The chart below tracks the annual change in 12-month sales:

The last two months have run about 3.8%; should it fall to the 3.5% threshold, we’re verging on recession (by the way, this data does include auto sales, currently being credited, along with housing, for saving the economy). The media is having none of it. According to the Econoday website, “consumers….have definitely been flexing their muscles.”

The irony of the last statement was that it came in the context of a sentiment survey, not actual sales data. What should have been the second-most important report, housing starts, was generally ignored because it too was weaker. The stock market rose instead, preferring to focus on Bernanke’s non-taper performance. Starts fell nearly 10% from the previous month, with most of the drop centered in the multi-family sector, though single-family starts also declined. Permits were weaker too, which led to the Leading Indicators for June coming in at 0.0%, well short of the expected 0.3% (no surprise that it too was ignored).

The housing report that wasn’t ignored was the aforementioned homebuilder sentiment survey, which rose to 57 (50 is neutral), the highest level since 2006. The two reports combined were a puzzle, because the direction of the homebuilder sentiment survey is usually a very reliable guide to the direction of starts. Except for this week, apparently. The year-on-year rate for first quarter starts was around 27%-28%, falling to about 20% for the first six months with the June data. So one explanation could be that business picked up in July, although that didn’t show up in June permits, and next month might see a rebound in both starts and permits, bringing the year-on-year rate closer to its earlier levels.

The industrial picture was more mixed. Although June production rebounded 0.3%, the year-on-year rate remained below 2% (1.8%) for the second month in a row. The New York Fed’s survey showed an increase in the headline number to 9.46, though that was all seasonal adjustments – what it really meant was that activity declined less than usual. A similar process produced the surprise result (+19.8) of the Philadelphia Fed survey that was so beloved by the bulls. It too was largely based on adjustments, with the underlying actual data suggesting that activity was sideways to down, but less so than usual.

It’s possible that weather played a role in the June-July data, with some rain and cool weather holding back June and producing a rebound effect in what has been a hot July. In addition, auto manufacturers are running more continuously than they usually do in the summer, when they have typically shut down for a week or two. The July Beige Book report was about the same as June, with perhaps a touch more optimism.

Next week will produce the bulk of the rest of the housing news, with existing home sales on Monday, federal home-price index data on Tuesday, and new home sales on Wednesday. The last report, along with durable goods orders on Thursday, rate to be the two most-watched releases of the week, though with earnings season in full swing now there could be some distractions. The June durable goods estimates will give analysts another chance to sharpen their guess on the initial estimate of second-quarter GDP, which comes out the week after next, on the last day of the month.

There are some lesser regional Fed reports, including Richmond on Tuesday and Kansas City on Thursday, but I will be watching the Chicago Fed’s national activity data on Monday. There’s a heavy earnings calendar, but two companies that will certainly be in focus are Apple (AAPL) on Tuesday and Amazon (AMZN) on Thursday. I would also pay attention to 3M (MMM) on Wednesday for good detail on the broader domestic economy, and follow up with UPS on Thursday.

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