August Light


“And I reckon them that are good must suffer for it the same as them that are bad.” – William Faulkner, A Light In August

It might not quite feel like it yet, what with the Dow finishing with a narrow loss last week that left it down for the third week in a row, but the other indices moved up fractionally (even the technologically-challenged Nasdaq): It looks as if the annual end-of-August rebound has arrived.

It got a shot in the arm on Friday when Goldilocks stopped by for brunch and informed us that July’s new-home sales total was a lot less than everyone thought it was going to be. It didn’t take long for the market to realize the implication – tapering now has a better shot at being put off again, and that is something to rally on. Besides, the markets were oversold and it’s the latter part of August. Prices are supposed to go up.

If you’re wondering if it will last, you need to be more precise, as the real question is how long it will last. In the short-short term, things ought to be good for a couple more weeks. The next two big milestones are the jobs report, which arrives rather late this time on Friday the 6th, two weeks hence, and the sacred Fed announcement, which will be delivered by High Priest Bernanke on Wednesday the 18th.

In the wake of the Goldilocks visit, the FOMC (monetary policy committee) may indeed begin to have doubts about which way to go in September. After watching an interview with Atlanta Fed Governor Lockhart, I do get the feeling that if the July number jobs number gets repeated in August (around 160K), the Fed might put the whole thing on hold. It also seems plausible, given other comments, that the bank could opt for a token cut as a way of navigating a middle path. Either of those two developments could lead to the October top I’ve been talking about since the spring.

The August move picked up a bit of additional fuel from the mistaken notion that a “global economic rebound” is underway. China’s PMI showed no change from the previous month, but that read was up from a contraction reading the previous month. Since few journalists seem to understand how diffusion surveys work, the change was generally written up with great enthusiasm as a sign of expansion.

The notion of a rebound is a bit ironic, given that the same media has been talking up the global economy all year, but that’s how these things go and the idea could gain some additional fuel from Europe. There’s quite a bit of investor momentum around the old continent as the next big thing, perhaps partly because of US valuations being high relative to growth. I don’t see Europe’s recovery in the data, but the market may see things differently for some time before it can be talked down.

As we approach the end of August, I note that the Gallup employment survey showed a strong turn for the worse last week. It’s really only a poll, but it did prompt me to consider that as the summer winds down – a lugubrious prospect – the hefty estimates of new leisure jobs that the Labor Department has been providing the last few months might be winding down as well. That would be consistent with the poll results and probably provide another impetus to stock prices, as the Fed would probably feel obliged to stand down from any taper plans if the August payroll count should come in below July’s tally.

Until then, I strongly urge you to profit as much as possible from summer’s fading weeks.

The Economic Beat

Until Friday, I might have made the case that the Chicago Fed’s national activity index was really the report of the week, despite the usual volatility surrounding the release of the Fed minutes. At (-0.15), the index was down for the fifth month in a row, as was its 3-month moving average, also at (-0.15). This would seem to belie assertions about growth picking up in the third quarter, and present the Fed with a dilemma: The economy isn’t really strong enough that one actually needs to taper, but the silliness of the stock market rally suggests at the minimum that the punch be watered down, even if the bank doesn’t dare take it away.

However, the new home sales report for July changed everything, at least for the week, and now the employment report two weeks hence looms larger than ever in the context of the Fed’s September meeting. New home sales fell sharply (-13.4%) to an annual rate of 394,000, seasonally adjusted, against expectations for a gain to 487,000. That was a very large miss of expectations, and some hefty downward revisions to the previous three months were the proverbial salt in the wound. It was more than just one month of data.

That said however, a look at the chart below provides some useful context.

Sales doesn’t look too bad, apart from the drop in the last month. Some used the data to criticize the homebuilder sentiment index, which recently hit a high not seen since 2005. However, that is misguided for two reasons, the main one being that sentiment correlates best to housing starts rather than new home sales. The former are still doing okay:

The year-to-date improvement in new home sales fell from 26.9% to 23.7%. But that falls in line with the year-to-date increase in housing starts, which is at 23.9%. The fall in sales might thus be attributable in part to some of the most available inventory being worked off, with the new homes sales rate better aligning with starts going forward.

Another reason that homebuilders might have improved sentiment is that the fall-off in sales was concentrated at the lower end of the scale. The only category that comped below July 2012 was the $150K-$200K range. Every price range above that was either equal to or ahead of the same period last year, and overlooked in the wailing over the miss was that the average price rose by over $20,000 to $322,700, the second-highest level this year (and in many moons). Homebuilders are feeling better because they’re making more money with less work.

The increase in mortgage rates may have been a factor at the lower end of the scale, but if anything it pushed some buyers off the fence in the existing home-sales market, which rose past estimates to a 5.39 million rate in July (seasonally adjusted). The realtor’s association nevertheless cautioned that the pool of buyers would diminish with lower rates.

The data point to several inferences. One is that the new-home sales rate might simply be stabilizing at a more sustainable rate. A second is a point I’ve been making for months now, which is that housing is definitely improving but at absolute levels of activity that are still relatively low, not on some miracle comeback ramp that saves the entire US economy, as the media has often portrayed it.

Then there is what the report may mean to the Fed. At its next meeting, it will have another round of all the major manufacturing and employment reports, as well as retail sales, but the only major new housing reports will be starts and Case-Shiller prices. The bank has made it pretty obvious how much it cares about the housing market, so its stance on tapering could well be affected by the just-issued report. I’ve assumed all along that if and when the Fed starts to cut back, it will do so by cutting back on Treasury bonds, while leaving its purchases of mortgage-backed securities (MBS) intact. The market may not have shared this viewpoint, but the grounds for doing so are now stronger.

As to the Fed minutes, everyone seems to have a different impression. My takeaway was a sense of worry that the bank’s focus seems to mostly be on short-term issues, and that it is indeed a bit afraid of the markets. Most of the commentary was focused elsewhere, trying to explain in which direction the bank was moving so far as tapering, and the divisions seemed fairly even. A useful point of view from someone far away can be found in reading an Australian’s perspective, Bill Evans, the chief economist at Westpac. Sometimes the forest is better seen from a distance.

It is with great sadness that I regard the prospect of next week – it’s the last week of August. Where did the month go? It will have a fairly broad and interesting slate of data before the Labor Day holiday, too, beginning with Monday’s release of July durable goods orders. The manufacturing situation will also see reports from the Dallas Fed on Monday, the Richmond Fed on Tuesday, and the Chicago PMI on Friday. Kansas City reported last week a better-than-expected reading of +8.

Housing will round off the month with Case-Shiller pricing data on Tuesday and pending home sales on Wednesday. The biggest report might be the first revision of second-quarter GDP on Thursday, and most of the predictions I’ve seen are leaning towards a substantial revision upward from the 1.7% initial estimate to something around 2.2%-2.3%. Much will depend on the deflator, which in my opinion was artificially low last quarter (0.7%).

Personal income and spending for July are on Friday as well, so between that and durable goods we’ll be filling out the picture on July and the start of third-quarter GDP.

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