“The most exquisite folly is made of wisdom spun too fine.” – Benjamin Franklin, Poor Richard’s Almanack
It’s only a few days more now. The simple part is over, with stocks completing a 3% rebound from their oversold condition, spurred by inaction on Syria and nudged along by hopes that lukewarm data in employment and retail sales might have persuaded the Fed to move but a little – or even not at all – with their plan to begin slowing the pace of monthly bond purchases, a.k.a “the taper.”
Those last two major economic reports – August jobs and retail sales – were sufficiently uninspiring that hopes for “taper-lite” have become the norm. A Bloomberg survey has expectations for a $10 billion diminution as being in the norm, while another article quoted the wonder of BNP Paribas chief North American economist Julia Coronado at how a central bank could be lowering its forecast (again) amidst a softening labor market and below-target inflation – and yet commencing a taper of asset purchases.
There is a common sentiment now that the mini-taper is already so built in to expectations that it will cause no reaction at all. That could happen, but I wouldn’t feel comfortable predicting it. And though I too am in the camp that thinks “mini-taper” is the likely way out, Bernanke has often surprised me in the past. Since getting Lehman wrong five years ago, the surprises have been always on the accommodative side, but were also before he was coming up to the end of his term. This is probably his last press conference with Fed policy at the forefront, the next one slated to be partly farewell and partly the transition to his successor (in theory, anyway, as the assumption that Congress can agree on anyone by then may be unrealistic on my part).
Ms. Coronado does bring up a much-debated issue hanging over the Fed’s decision – why the bank should be tapering at all in light of the softening recent data. Despite the dogged efforts in the business media to portray things otherwise, the consensus in the investment community is that the economy isn’t approaching any sort of escape velocity at all, just muddling along while we hope something better turns up eventually. Year-to-year nominal GDP growth has eased; without the miraculous drop in the deflator last quarter (to 0.8%), real GDP prints would be continuing to run at or below 2%.
At the same time, anyone working in the investment business should be familiar with the reasons why the Fed would like to trim its bond purchases: Start with its huge balance sheet and how buying $1 trillion of bonds a year isn’t making the future any simpler. Recent studies – from within the Fed system itself – suggest that any salutary effect of quantitative easing has waned. The market madness of May was disconcerting, whether it was the irrational parabola in equities in the first part of the month (lifting off from a long unbroken rise), or the blood in the fixed income market at the first backup in interest rates.
And yet Bernanke has been loathe to upset the markets since he was misled by then-Treasurer Hank Paulson on that fateful weekend five years ago (the latter on a current publicity tour to absolve himself of all blame for the crisis, with all the innocence of OJ Simpson). It would be just like him to put taper on hold this week. But I’ve been writing a lot recently about the perils of predicting policy decisions and won’t hazard one here either. My record at guessing his twists and turns is probably worse than a coin flip.
My best guess on the markets is that they will follow form and move up a bit more in anticipation of the FOMC statement before pausing. If the market’s hunch about Bernanke is correct – mini-taper – or my fear is born out – no taper – we could put up another big rally week. After that the seasonal patterns are a little rockier, but an October top is still within reach, if not reason.
There are always challenges out there somewhere for the markets, but we now face three rather immediate ones. The first one is the FOMC meeting, though it is more likely to drive the markets higher than anything else. Several more remain, however, that have real potential for destabilizing markets. The debt battle is going to come back into focus next week, and has been driven off the radar screen for the most part by Syria and the Fed. Any negative developments will be in the unwelcome surprise category for markets.
The third and most enigmatic one is the potential shift in black-box trading. Though a mini-taper may be built into the expectations of active human investors, we’re not going to find out what it means to the programs until afterwards. For my money, black-box trading has supplied the marginal buying power during the year, and I cannot presume that a posture of tightening, however mild, will keep the bias on the buy side, however measured the step. That said, I freely admit to the mystery of it – and so we wait.
The Economic Beat
The report of the week was retail sales, though it caused little stir. The headline number for overall sales was +0.2%, below the consensus expectation for +0.4% to +0.5%. However, the miss was mitigated by a goodly upward revision to July that took it from +0.2% to +0.4%, averaging out the miss and perhaps leaving hope that August sales will get the same treatment next month. Futures even rose on the news, probably on the thought that it was Goldilocks-friendly and another obstacle to the taper.
More revisions are undoubtedly coming, but looking at the trailing 12-month total for sales excluding autos through August, and the data point towards stasis. Sales are getting neither better nor worse. As you will see below, this is not isolated, as both the labor market and business seem to be in the same place. The growth rate in 12-month ex-auto sales fell steadily throughout 2012 into 2013, but since March it has bounced around a narrow range of 3.43%-3.66%, with the latest tally right in the middle at 3.52%. Some of this is doubtless due to auto sales, which rather than expressing a rebounding consumer as originally hoped, are apparently only taking a bigger piece of the pie.
Looking at July-August combined, unadjusted total sales were up 5.96% year-on-year, better than a year ago (4.48%) and above the 20-year average of 4.64%. The caveat is that July data are irregular, partly because of the weather, and it’s better to wait a month and look at the more consistent patterns of combined August-September sales instead, a better trend indicator. Back-to-school is one of the three times of the year (besides Easter and Christmas) when consumers open their wallets nationally. The weekly chain store reports both indicated strength last week, so shoppers may have been filling school orders at the last minute.
Incidentally, the initial estimate on clothing sales was that they fell 0.8% in August, a number I’m inclined to credit after the recent dismal results from teen retailers; even Nordstrom (JWN) has disappointed of late.
Wholesale sales are in a similar pattern. The data for July show the growth rate for trailing 12-month sales has leveled off. Since March, it’s been running in a narrow range of 2.5%-3% a month. Year-on-year inventory growth is at its lowest point since July of 2010, but it may tick up next month, given the inventory-to-sales ratio being at a seasonally-adjusted fifteen-month low.
Turn we to the labor market, and it is much the same story. The latest JOLTS (labor turnover) survey was released on Tuesday. The quits rate is at 1.9% vs. 1.8% a year ago. Job openings and separations eased from June, but year-on-year there is on the whole almost no change; they have been going sideways for months, at levels well below the peaks last decade. As good an example as any is this chart of the hire rate:
Sideways is the new norm.
Sentiment indicators fell, but these are better indicators of where recent headlines have been than where the economy is going. Doubtless the August pullback and the Middle East took their toll.
Looking at the other data, the mortgage market continues to be challenged by higher rates, while a copy of the latest import-export price data should be handed out to anyone who keeps writing that US trade is reviving the globe. Export prices are down (-1.1%) over the last year, while import prices are down (-0.4% ) and (-0.2%) excluding oil. Strengthening activity doesn’t translate into falling prices. The Producer Price Index (PPI) edged up 0.3% to a year-on-year rate of 1.4%. I can still remember a time when these reports were avidly awaited market-movers; now they come and go with barely a stir. The CPI index for consumers comes out Tuesday.
Looking ahead to the rest of next week, we have the event of the year, the FOMC statement and press conference on Wednesday. Or perhaps not; September can be a funny month. The Fed will get a couple of helpful extra bolts of data before the decision is handed down, beginning with August industrial production on Monday. July’s initial estimate was zero growth, at odds with that month’s ISM survey, so I will be interested to see what the revision might be, along with the August result – the August ISM manufacturing survey was nearly identical to July. The New York Fed will also release its business survey Monday morning.
Tuesday brings the homebuilder sentiment index, followed by housing starts on Wednesday morning and my presumption is that the members of the policy committee will have had an advance look at it. The Philadelphia Fed survey is out Thursday morning, though most or all of that information will likely also have been available for the meeting. Friday is a quadruple-witching day; in September it often precedes a period of weak performance for the rest of the month.