Fall’s Beginning


“Men take more pains to mask than mend.” – Benjamin Franklin, Poor Richard’s Almanack

Don’t let the title fool you – it’s deliberately meant to be ambiguous, unlike the more prophetic “The Beginning of the Fall,” for example. The part that’s certain is that the autumnal season did indeed begin this past Sunday.

Less certain is what it will mean for the stock market and the economy. The two have been quite disjointed over the last year, with stocks roaring ahead as economic growth slowed. But they could be united as early as next week, if the political games turn rough and the government isn’t operating on Tuesday. That’s not my prediction – I don’t know what will happen and am positioned accordingly.

If the charade ends in the usual manner, one would expect a relief rally that gains additional joy from the first-day-o’the-month trade. That is unless some gimmick has been introduced, which could very well be the case. Perhaps the latest “continuing resolution” (in its present form, Congress will never agree on a budget, not at gunpoint) will only have a duration of a few days or weeks. Maybe it’ll be tied to the looming showdown over the debt limit. Or maybe it’ll run to the end of the year. We’ll find out more next week.

I do have a couple of insights to share, of which I will let you be the judge (very gracious of me, I am sure). One is that we will all be heartily sick of the whole drama-cum-tantrum spectacle by the time it’s over. That kind of revelation hardly requires supernatural ability, to paraphrase Horatio, but the second one is more interesting. I was watching a fund manager on Bloomberg Friday morning tell us that the Fed was quite right not to taper because the economy had been weak of late, but he fully expected that things would pick up smartly in the fourth quarter, barring a Washington meltdown.

That kind of relentless optimism is to be expected from someone who manages equity mutual funds, so I might not have brought it up except for the fact that he expressed a belief that so far as I can tell, has quite a bit of traction in the investment community – we’re about to lift off from the fiscal headwinds. It’s true that we’ll cycle the payroll tax in January, and while that won’t put an extra dime into anyone’s pockets, it will at least let those hefty annual raises of two to three percent flow into the checking account this time around.

The part I’m concerned about is the fiscal headwinds. I’m not sure what they’ll get up to on Capitol Hill over the next few days, but like most I’m expecting – halfheartedly, perhaps – that some re-enactment of kick-the-can lies in store. But at what cost? The Republicans may have been emboldened by a Bloomberg poll that showed 61% of the respondents saying some sort of spending cuts should be included with the debt limit. If they do wind up winning additional cuts, it would mean more fiscal drag on an economy that’s already slowed to 3% nominal growth (from 4% the last three years). The cost of that deal isn’t priced in.

It might not need to be. There’s no assurance of anything out of all of this. Maybe both sides blink, maybe neither does. But the least plausible scenario in my mind is that the sequester will go away as part of the deal. I don’t see how the fiscal headwinds go away; many of the cuts are still in the process of being implemented.

One of the ironies of the last debt ceiling battle was that the economy slowed exactly as predicted in the wake of a sequester, from 4% nominal growth to 3% nominal growth, a result currently being masked by the incredibly low inflation adjustment being used by the Bureau of Economic Analysis (BEA) in its report on second quarter GDP (you can be sure the Federal Reserve noticed). That didn’t seem to bother the stock market none as program trading led it ever higher – but one wonders how long that can go on. Another hit to nominal GDP and the economy will go from sluggish to a recession waiting to happen, despite the Fed’s annual forecast of, “wait ’til next year.”

We’re close enough as it is – during the week Bloomberg reported that Wal-Mart is cutting supplier orders as unsold inventory piles up; Hertz (HTZ) cut its quarterly earnings outlook based on softness at American airports, and United Airlines (UAL) was downgraded right afterwards. If the economy is about lift off in the fourth quarter, it’s certainly doing an admirable job of being stealthy about it.

Those thoughts notwithstanding – and it hasn’t paid this year to think about valuations – stocks are poised to reach for all-time highs in October. If the can does managed to get kicked enough, stocks could leap from one rally to the next – no shutdown, no default, no Larry Summers (i.e., Bernanke proposes Yellen). Will earnings matter? Perhaps not right away, but I’ve an uneasy feeling that my beginning-of-the-year prediction for an October top may be on course – and that would imply a fall from grace for stocks. If we get there.

The Economic Beat

It was the usual mixed bag of data last week, with bits of life here and there along with some whiffs of slowing too. There really wasn’t anything to hang one’s hat on for either acceleration or deceleration.

Manufacturing might be slowing from the happy pace it had in August when auto production resumed. The Markit Economics “flash” PMI estimate declined from 54 to 52.8, the Richmond Fed manufacturing went to 0 (no growth) from 14 and Kansas City fell from 8 to 2. Last week the New York Fed also reported a lower level of growth; only the Philadelphia Fed index posted improvement. The good news is that the Philadelphia index is the most influential.

Perhaps reflecting this division, new orders for durable goods in August were also a mixed bag. They rose 0.1%, but were below expectations in dollar terms, as the previous month was nicked with a big downward revision. Excluding transportation, they fell 0.1%; excluding defense they rose 0.5% (which didn’t offset the revision to (-7.5%) for July); business capital goods rose 1.5% after a downwardly revised July. Outside of autos, the subcomponents were generally soft.

The news in housing was somewhat better, as new-home sales beat expectations, leading to a little flurry in homebuilder stocks. Falling interest rates precipitated a jump in the mortgage business, helping financial stocks. Although the pending home sales index for September declined, it wasn’t a good precursor of August sales – falling in advance of a big jump – so the change may not mean much. New-home sales are still at low levels overall: The latest count shows an annual rate of 421K, while normal would be closer to a million or so.

Prices for existing homes rose again in July, according to the Case-Shiller and the FHFA (Fannie-Freddie-FHA) reports, with the Case-Shiller year-on-year rate at 12.4% and the agency estimate – which excludes high-end homes – reporting an increase of 8.8%.

There was good news in employment, with weekly claims continuing to ease to the 300K level. That has raised hopes for next week’s release of the September jobs report, which could be good and might be treated as such by the markets. Perhaps auto workers were undercounted in August and we’ll get an upward revision this time. On the other hand, an upside surprise might bring back the subject of the taper, and at the risk of appearing to be a spoilsport, employment is a lagging indicator.

Personal income picked up in August, according to the first estimates by the BEA. The year-on-year growth in disposable real income rose to 1.6%, and while that may not seem like much (because it isn’t), it’s still an improvement over recent months and the best such showing of 2013. Unfortunately it too is a lagging indicator and the BEA data lacks granularity, with the monthly numbers only released as “seasonally adjusted annual rate,” so they need to be used with caution. Once again, auto production played a major role as manufacturing reversed July’s decline. Spending edged back up (+0.3%) with an upward revision to July (+0.2%). Given the declines in sentiment readings, September might see an easing, but it’s too early to tell. Weekly sales from the chain stores do indicate some mild softness – and of course there’s Wal-Mart.

The Chicago Fed reported an uptick in its national activity index to +0.14, though the 3-month moving average remained negative for the sixth month in a row. Along those lines, the BEA released another revision to second quarter GDP. The nominal rate was revised down to 3.1% (trailing four quarters), about the same as the previous quarter’s 3.08% rate. But “real” GDP stayed the same, thanks to another revision to the deflator, now pegged at a 0.6% annual rate in the quarter. I ain’t buying it.

Next week comprises the first week of October (already?), and as usual it’ll be a busy one. The last two regional manufacturing surveys are out Monday (Dallas, Chicago), followed by the national editions (ISM, Markit) on Tuesday. We’ll also get motor vehicle sales and construction spending that day – in theory, because if the government shuts down there probably won’t be a construction report (all of the others being private). So we’ll either get an announcement for August construction spending, or one that the government is closed for the day.

Wednesday has the ADP payroll teaser, Thursday the ISM services purchasing index, and – if the government is open – factory orders, jobless claims, and then Friday’s big one, the employment report. As of today, the consensus for the jobs number is around 180,000, with hopes for 200,000. The unemployment rate is expected to stay the same.

share this blog post
Facebook Twitter Plusone Linkedin Digg Delicious Reddit Stumbleupon Tumblr Posterous