Summer Dip


“For this, for everything, we are out of tune.” – William Wordsworth

The stock market is right on schedule, as it’s been all year. Spring rally, end-of-spring drop. Rally in the latter part of June until the third week of July, early August pullback. Stocks are now short-term oversold, and only await a catalyst to begin the late August rebound.

It could come on Wednesday with the release of the latest FOMC (monetary policy committee) minutes, which the market will scour much like ancient seers poring over the entrails of sacrificial victims in former times. Any hint that the Fed might not lighten up its bond purchases in September – the infamous “tapering” – would be cause for dancing in the streets of Lower Manhattan.

The market’s obsession with Fed policy has long passed the point of bothering with attempts at rational explanation. The difference it may or may not make on the economy is still debated, at times quite hotly, but so far as traders are concerned the point is irrelevant. The Fed buys, we buy; it doesn’t buy, we don’t buy.

It’s probably fair to say that the recent sell-off isn’t really a fear of what might happen to the economy or even liquidity if the Fed cuts back on purchases – after all, St. Louis Fed president James Bullard was implying in a reassuring way this week that any initial cuts steps might be but the littlest of snips – but a recurrence of the violence of late May and early June, when bond yields soared and stock prices plummeted in the wake of Chairman Ben’s initial broach of the dreaded taper topic.

I hope the perversity of the situation isn’t lost on you. One of the few things that can get the attention of a momentum-driven stock market is a decline in employment. A few doses of that and even the tech bubble had to come apart. Yet here we are with the market hoping for a little fade in the jobs data – not too much, mind you, just enough to lead Goldilocks back into the house and get Bernanke to put off the day of reckoning.

Sometimes August turns ugly, as it did in 2011 when Standard & Poor’s downgraded the US credit rating. Normally, though, it rebounds in the days leading up to Labor Day, a time I have taken to calling the market’s “silly season” in recent years. Next week’s Fed minutes, or possibly an oracular statement from the monetary conference at Jackson Hole (though nothing is expected and Bernanke will not be in attendance), should tell the tale of the tape.

For myself, I expect that the Fed will begin its taper in September unless the markets are completely coming apart. There could be some heavy weather afterwards, but Bernanke and his brethren may well believe it’s better to take the hit now before too much helium has gotten into the financial markets – the issuance of junk credit has been roaring lately.

It’s even possible that Chairman Ben has had the Machiavellian thought that a market taking a 10%-plus hit in the wake of the meeting might force Congress into confronting the debt ceiling with a realistic compromise, rather than another kabuki episode of playing to the base while accomplishing nothing. It may happen regardless of what he thought, and that wouldn’t be such a bad thing.

The Economic Beat

The highlight of the week wasn’t retail sales, at least not for the market. Yet it was the most important report of the week, usually third in the monthly honor roll of data releases after the jobs report and the Fed meeting. The latter isn’t quite monthly, but in recent years the market usually tries to make up for the occasional absence by going berserk over the release of the minutes.

Overall retail sales gained 0.2% in July, said the Department of Commerce, +0.4% when excluding gasoline and auto sales. Somewhat surprising to me was a fall in the sale of building materials, unusual for July. Some press accounts blamed this on above-average wet weather on the East coast, though I have to say it wasn’t apparent in the Boston area.

The other surprise was the astonishing enthusiasm the report was greeted with in the press, at least initially, as yet another herald of a redoubtable consumer and economy. I didn’t get it. June was indeed a wet month and held back some shopping for warm-weather apparel, so some July rebound was expected. More importantly, retail sales momentum is unmistakably slowing, with the latest read in rolling 12-month sales at +3.62% (unadjusted). That’s up from the last few months, but the fifth month in a row below 4% and not far ahead of the inflation rate. The last time sales descended to this level was late 2007 and early 2008. Inflation is a tiny bit lower now, but this is a worrisome trend.

The media glow was puzzling in light of sales and earnings warnings from retail chains American Eagle (AEO) and Aeropostale (ARO) that surrounded the Commerce report. The glow was subsequently extinguished by further reports from Wal-Mart (WMT), Kohl’s (KSS), Macy’s (M) and Nordstrom’s (JWN). The unifying theme: sales are weak. Given the increase in cotton prices, it would appear that unit sales in apparel are flat at best. Macy’s added that increases in auto sales were cutting into other consumer spending, bruising the image of the resurgent consumer super-buyer.

The report that bothered me the most was the Nordstrom’s report. If the upper half is cutting back, the economic strain is spreading. The company’s stock got crushed in August 2010 and August 2011, only to roar right back on the back of quantitative easing. Will the Fed come to the rescue this time? Will it be able to?

Thursday’s data seemed to leave the market thoroughly confused. The New York and Philadelphia Fed surveys both came in below expectations, though the reports themselves weren’t bad, +8.24 for New York and +9.3 for Philadelphia. They provided a good illustration of how stock prices can color the news – had prices been rising (on stimulus rumors), the headline might have been “New York shows third consecutive month of expansion.” But they were falling, so the story lines were all about missing expectations and declines from the previous month.

The Philadelphia survey suffered similarly, reporting a +9.3 result that was half of July’s and a significant miss for expectations in the mid to high teens. It also had the unfortunate timing of coming right on the heels of an assessment by Goldman Sachs (GS) economists that the Philadelphia survey is a key piece of timely data for assessing the overall health of the economy, along with the Chicago Purchasing Manager Index (PMI), the national PMI (now called the ISM) and initial jobless claims.

So perhaps the economy was weakening – except that initial claims fell more than expected, to the lowest level since October 2007. The worst of both worlds, for traders: the economy is slowing, but the claims data backs the Fed’s position of tapering. Does the latter really matter to the economy? No not really, but it does matter to the automated trading programs that rule the stock market, and those matter to everyone else.

Goldman criticized the heavyweight monthly payroll report as an economic indicator, due to its lack of timeliness and a history of revisions that are often quite sizable. However, the latest claims number might not be all it’s cracked up to be either.

The state of California makes up a sixth of claims nationally. Here’s a chart of its claims in 2013:

Note the pattern of the monthly spikes. They don’t correspond with the seasonality of the national adjustment factors. Apparently the state is estimating claims most of the time while doing a more thorough count around the middle of the month, which results in a spike. That spike is due to show up next week (the details of state data are released a week after the national figure), which should produce a rise in claims – and perhaps a market rally. Since the jobs report cuts off around the 12th of the month, give or take a couple of days, it’s preceded the spike, perhaps a partial explanation of why recent revisions in the jobs report have been to the downside.

The latest housing data was decent, with homebuilder sentiment rising to the level of 59, the best since 2005 (keep in mind it’s a trend sign, not a measure of activity levels). Housing starts and permits were in-line with expectations, but that should suit the builders fine. The industry consensus has been not to build too fast, and with credit still tight that shouldn’t be a problem. The year-to-date improvement over 2012 is 23.9%, and I expect that the entire year will probably end up in the range of 20%-25%.

Industrial production was unchanged in July, according to the central bank. That number is also prone to some large revisions, but as it currently stands the year-on-year increase in production has fallen to 1.42%, the lowest rate since February of 2010 and the fourth consecutive decline. There haven’t been four such consecutive declines since August of 2007. I don’t like it.

Inflation remains static, with annual producer (PPI) inflation at 2.1% in July, and annual consumer (CPI) inflation at 2.0%. Excluding food and energy, they were at 1.2% and 1.7% respectively. Import prices were up only 1% through the last twelve months, while export prices averaged a smidgenly increase of +0.4%. Maybe the latter is where the BEA found its 0.7% annual inflation rate for second quarter GDP.

The latest sentiment measures showed declines, which doesn’t tell you anything but that the stock market is down since the last survey. The eurozone finally broke its string of six quarters of negative GDP with a reading of +0.3% for the second quarter. The press trumpeted the development as the end of the European recession, but one little bump up does not a recovery make.

Next week’s focus is most likely going to be the FOMC minutes, released Wednesday afternoon. The other main items of interest will be existing home sales earlier that morning, and new home sales on Friday. The former might be feeling the pinch of higher mortgage rates, though there is no indication that new-home sales have been affected: The latter depend more on trying to get any mortgage at all, rather than an extra quarter or half of a point on the rate. I’ll be checking the Chicago Fed’s release of its national activity index on Tuesday.

Oh, and let’s not forget Jackson Hole. The annual monetary policy conference begins Thursday and ends Saturday, with vice chair and potential heir to the throne Janet Yellen leading a panel discussion on Friday. It’ll be the first time in 25 years that the Fed chairperson is not in attendance; probably the reason why so many other central bank heavyweights (e.g., Draghi, Carney, Summers) will not be making the trip.

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