Waiting for Direction


“There shall in that time be rumors of things going astray, and there shall be a great confusion as to where things really are” – Monty Python, The Life of Brian

This week was the calm before the storm, so to speak. though it’s hard to say at this point which way the weather will break. In a very typical pattern for the third week of July, equities crab-walked their way through an episode of light trading that left the indices with mixed results as traders positioned for the week ahead.

There were two bits of interesting behavior that tell you how indecisive the market is – its lack of warmth over a positive surprise in new home sales (traders seemed more concerned about the decline in mortgage-purchase applications), and the market behavior on Thursday and Friday, when initial waves of selling took the S&P down to short-term support levels, then saw it rebound smartly. The final flourish was a flurry at the Friday close that seemed very much designed to push things into positive short-term technical territory and perhaps put a little air under the market to protect the month, in case things turn out badly next Wednesday.

Both rebounds started around 11AM, which some people tend to attribute to the presence of the Fed buying in the market. I didn’t check the New York Fed schedule this week (it handles the buying), because my feeling is that this type of tape-pushing usually happens around that time of morning, when volume is very light and European markets are getting ready to close. I’ve always thought this type of thing to be most prevalent in the waning innings of a bull market, when a few buyers can make some coin by ramping up prices when the majority of holders may be getting anxious about valuations, but are too afraid to sell and risk getting left behind in the performance derby.

There was a time when traders held their breath waiting for the Apple (AAPL) results – it was last year. There was also a time when they held it for Amazon (AMZN) results, though that was nearly a decade ago. The two of them combined this week to power the Nasdaq higher, Apple by beating estimates with a decline in profits, Amazon by beating nothing with a net loss. That’s something to think about.

I noticed a few other high-flyers behaving in similar ways, and I want to pass on a word of caution. It’s not atypical for such names to put on a big in-your-face move up after earnings that are designed to squeeze the maximum pain out of surprised and/or outraged shorts. But these little rallies don’t last, and more often than not are a harbinger of an episode of market weakness. You could do worse than shorting a couple of them as protection going into next month.

Next week has a huge slate of events (see The Economic Beat, below), including a Fed meeting, a European Central Bank (ECB) meeting, the jobs report, a first look at second-quarter GDP, the changing of the month and the beginning of the heart of vacation season for the financial sector and Europe in general.

I really can’t tell you how it will turn out, though August does tend to start with weakness and then rebound in the second half of the month. Global markets are hanging on the words of the Fed these days, and its somewhat back-and-forth behavior of late makes the next announcement even more of a guessing game than usual. I would think that the Fed would want to lean towards circumspection next week, partly so as not to leave the markets in turmoil as August begins, partly to wait until the September meeting when it has a bigger slate (press conference, updated outlooks, two more jobs reports under its belt).

But guessing the next move of what seems to be a divided FOMC has been counter-intuitive for me of late, to the point that I’ve been getting increasingly tempted to select the most rational course and then go with the opposite. For what it’s worth, the recently issued annual report from the Bank of International Settlements, often called the central bank for central bankers, directly addressed the limitations of monetary policy in a way that seemed to be exhorting the Fed to take its finger off the trigger.

I don’t like this global market obsession with the Fed, particularly not at this stage in the cycle. It’s the kind of thing that precedes good-sized corrections, if not outright bear markets. If it’s any consolation, such changes in course usually take longer to come to fruition than the two months we’ve had since Chairman Bernanke first frightened traders with the taper specter. The downside is that the time lapse tends to lull investors back into complacency at a time when they should be more vigilant than ever. We’ll see what next week brings.

The Economic Beat

When the best report of the week is the consumer sentiment number, that should tell you something. Usually it’s a sign that we’re near a turning point for the worse, because sentiment usually lags changes in the real economy by a wide margin. But like the price action I talked about above, there is no good way of knowing when the turning point is coming. The time is usually measured in months, but there’s nothing hard and fast about it.

It’s also not immediately visible to most. There were signals in 2007 that we had passed the turning point, with perhaps the most prominent being the failure of two Bear Stearns mortgage-credit funds in the summer, but the economic data was mixed right up until the recession began. Employment, for example, is not always a good leading indicator, usually peaking after a downturn has begun and continuing to decline in the initial stages of recovery.

There weren’t any alarms being sounded this week. The data was uneven, with no bombs and a couple of pluses, but that could be a signal in itself four-plus years into a recovery. Declines don’t begin with everything falling part at once – that kind of action usually comes much later (e.g., the fall of 2008).

The housing news was mixed, but the market’s reaction to it seemed less about the numbers than about the fear of tapering. The existing home sales report showed a decline in the rate from May and was below consensus, but it still represented a 15% increase from a year ago. The report noted a year-on-year decline in first-time-buyers, however, from 32% to 29%, and while that’s really not much of a swing, the report went on to complain (again) about tight credit conditions and the fact that first-time buyers should be closer to 40%. That led to homebuilder stocks selling off, even though the report doesn’t measure new-home sales.

The latter report did beat estimates and was decent in a relative sense, being the best June since 2008 and otherwise the worst since 1983. If you want to be a bull, you can legitimately say that there’s still an awful lot of upside left for new homes. If you want to be a bear, you can legitimately observe that housing is playing a much smaller role in this recovery than in the past. The recent declines in mortgage-purchase applications seem to preoccupy the taper-fearing market more. A question that remains to be answered is whether or not the recent surge in rates will lead to a possibly transient surge in buying as people attempt to “get in before it’s too late.”

New orders in June for durable goods were mixed. The headline number of +4.2% easily beat consensus, thanks to a big surge in airplane orders, but the ex-transportation increase was zero. New orders for business capital goods were positive for a third month in a row, though they eased back to 0.7%. It may have been the first time since February that the 12-month growth rate wasn’t negative – it too was zero. Next Friday’s factory orders report will bring a revision.

The Chicago Fed’s national activity index improved a bit in June, though both the current month and the three-month moving average stayed negative, where they’ve been for eleven of the last fifteen months, including the last four. That doesn’t bode well for second-quarter GDP. The recession line is thought to be (-0.70) for the moving average, and the closest the index has come was last August, when it was at (-0.50). It was at (-0.49) again in October, partly pulled down by Hurricane Sandy, which in turn gave way to an activity rebound that lasted until February. It currently stands at (-0.26).

On the manufacturing side, the Richmond Fed survey showed a surprise drop to (-11), down from plus 8, while the Kansas City index did the opposite in going from (-5) to +6. It may be an issue of seasonal factors, as both the New York and Philadelphia surveys had reports that were neutral to down, but seasonally adjusted to strong positives. The July PMI “flash” number from Markit Economics increased to 53.2 from 52.8. The Markit index has usually run two or three points higher than the more-established national ISM figure, due out next Thursday.

A good possibility is that we are in for some misleading evidence about the current strength of the economy. GDP for the second quarter is currently estimated to be 1% or less (annualized). Suppose, for example, it does come in at 0.8% – then an increase in the third quarter back to the first quarter run-rate of 1.8% would leave four-quarter nominal GDP at a recovery low, yet result in seemingly improved data for a couple of months thanks to activity that was less down than usual. That could set equities up for a negative surprise.

With two weeks to go in July, the two weekly retail sales reports are running at odds again, usually meaning another average month for ex-auto ex-gas sales. This week’s burst of cool, wet weather in much of the northern part of the country could hold back monthly sales.

Next week’s calendar is loaded. The top three events come on Wednesday and Friday, with the all-important FOMC (Fed) announcement on Wednesday afternoon. It comes about six hours after the third-most important report, the first estimate of second-quarter GDP. ADP payrolls and the Chicago PMI also come out that morning, and on top of everything else it’s the last trading day of the month. Here’s another rule of thumb that you may find useful – when a day has that many releases, the market usually doesn’t move much in either direction as traders and programs try to digest all the data. It need hardly be said that anything remotely surprising from the Fed would trump that rule and everything else.

The week gets off with a bang on Monday morning with the pending home sales report (which doesn’t measure new-home sales activity). Traders will be looking for more clues on whether the recent interest rate back-up held back sales or stampeded buyers. The following morning will bring the Case-Shiller housing data; the latest federal mortgage-based data showed no change in the year-on-year rate of 7.3%. It will be followed an hour later by the consumer confidence report, which should show an increase if it follows the University of Michigan sentiment trend.

Wednesday rates to be the day of the week, but the employment situation release on Friday could always be a surprise. The four-week average of unadjusted claims hit a five-month high during the cutoff week for the report, and the adjusted continuing claims number was also at a five-month high the week prior, so things could get interesting. The report will be accompanied by June personal income and spending, which may be slightly revised from the GDP release on Wednesday that also breaks it out.

In between on Thursday, the first of August (already?) we’ll get the latest announcement from the ECB, and that will come on the heels of PMI results from some of the EU’s biggest economies: Germany, France, the UK and Italy. The ISM manufacturing survey and June construction data will follow later in the morning as July auto sales begin to roll in.

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