“Letting “I dare not” wait upon “I would,” like the poor cat i’ th’ adage?” – William Shakespeare, Macbeth
What a dilemma for the stock market. On the one hand, the U.S. government has shut down. More importantly, it will run out of money in two weeks. It’s not the rosiest of horizons.
But as is so often the case, there’s that other hand, isn’t there? The problem is that traders don’t really believe the first one. Yes, the shutdown is real, but no one really believes it will last much longer. In the interim we are daily serenaded by reminders about how great equities do in the aftermath of government shutdowns, a tune chanted practically around the clock. Yes, the government is scheduled to run out of money, but no one really believes that will happen either. Why, Speaker Boehner said it wouldn’t, and if you can’t trust Congress, who can you trust?
The logical thing for a trader to do, then, is to get long for the relief rally. Get long for the government re-open, get long for the debt ceiling extension, get long for the Fed no-taper meeting at the end of the month. All roads are long ones.
But there’s just that one tiny bit of doubt. It really is most unthinkable that the government will have a default. No, not even a technical one, however brief. It’s positively unthinkable. That would be so pathetic, so beyond stupid that it isn’t even worth contemplating. Except for one nagging little doubt, one tiny, nagging whisper that says, “psst – remember that bank called Lehman Brothers?”
The unthinkable did happen five years ago last month. That doesn’t mean that the market thinks it’s about to happen again – it doesn’t. But how would one ever explain to clients and investors that you got all longed and levered up just in time for the end of the world?
There’s an old Wall Street parable about big crises that makes sense: If you ever hear the nuclear missiles are on the way, start buying stocks and don’t stop. After all, you never know – the missiles might miss. Even better, the story might be a hoax. And if the story is true and the missiles didn’t miss, well then – it won’t really matter whether you bought or sold, will it?
Unfortunately, a Treasury default – however technical, however brief – would be a strike of the neutron variety. All of the buildings will be left intact while the traders get slaughtered. The investors will be right behind them. So while the odds favor being the clever one and loading up for all those relief rallies in the expectation of being hailed as a Shrewd Master of the Universe afterwards, there is that 5% chance that you will be pilloried as reckless, stupid, failing your fiduciary responsibilities (if any), and oh by the way, you are one of the Morons of the Millennium.
It’s a dilemma. It’s a little easier for the average institutional manager, perhaps, who by inclination or requirement will usually find it easiest to stick to the 95%-invested, even 100% mandate. They have their own choice to make, however, between adjusting or not adjusting portfolio holdings. Stick to your guns, ignore the noise and focus on the plan, or worry about performance and get more or less aggressive. Those choices can matter at sponsor review time, because no matter how much the client says you can’t be blamed for the situation, the odds are pretty good that if you have the wrong amount of aggression, they will do so anyway. Hindsight can be so penetrating.
One silver lining peeking through is that all of the non-earnings noise may help obscure what it likely to be another punk earnings season. We only need one dollar of overall earnings growth for the investment media to start braying again about record profits, and we may even get it. Another week or so of government shutdown could further muddy the data collection and reporting waters, leaving the Street to confidently ride more waves of no-taper by an uncertain Fed.
Yet at some point, corporations need to do more than axe another 5,000 workers and/or borrow another few billion dollars in the bond market to buy back stock. The stock market is going to need more than Fed meetings, averted disasters and the first day of the quarter; it’s going to need growth, growth more tangible than projections of “wait ’til next year.” But when that will happen is not yet clear. And anyway, the missiles might miss.
The Economic Beat
One result of the government shutdown that you may have noticed was the missing jobs report. It wasn’t the only report to go missing – others included construction spending and factory orders. Ergo, there won’t be as much to write about this week, with next week at risk as well. One report not at risk is the minutes of the FOMC meeting due Wednesday – the Fed has its own funding.
That leaves us time to peruse in detail the two ISM purchasing manager surveys for October, in manufacturing and services. It seems I write every week that the economic news was mixed, and last week was no exception.
The manufacturing survey came in above expectations at 56.2, not significantly above the August read of 55.7. The difference is small enough to qualify as not significant. But it did beat the consensus of 55.0 rather more, leaving the stock market only too happy to have another excuse to take off on the first day of the quarter.
The report was generally decent, with an improved tone in the responder comments. New order and export growth eased, but the former remained at a good level (60.5). Employment growth broadened; the growth-contraction score of eleven industries reporting growth versus six reporting contraction was about average. An interesting contrast was the Markit Economics PMI survey, which had a substantially lower read of 52.8; my understanding is that the Markit report includes more small firms. Last year it typically ran ahead of the ISM edition, but in recent times has been coming in lower.
The Chicago PMI rose from August, and at 55.7 was close to the national reading. The reading is strongly influenced by auto production; new orders rose while backlogs fell.
The services, or non-manufacturing ISM report certainly wasn’t a bad reading, at 54.4, but it was well short of consensus and significantly lower than the 58.6 reading of August, causing the politically disgruntled stock market to sell off further. That change was a substantial one, and so was the change in the business activity index, declining seven points from 62.2 to 55.1. The employment index also fell back closer to neutral at 52.7. The comments were more restrained, especially in retail and wholesale trade, though the growth score was better at eleven versus four. Exports were up sharply, though they aren’t a big part of the sector.
While there was no jobs report from the government, there was one from ADP, which tries to anticipate the non-farm payroll number from the Bureau of Labor Statistics (BLS). The ADP number was 166,000, a bit short of expectations, with a modest but noticeable downward revision to August (159,000 versus 176,000 original). CNBC’s Squawk Box had economics reporter Steve Liesman conjure up its own jobs “report” of 158,000 – it was a reasonable job of interpolation and I wouldn’t be surprised to see that close to the final number. That said, the BLS initial estimate does occasionally defy logic.
If the shutdown resolves itself by next Friday, there may be a retail sales report. Or there may not be, if the government should find itself still catching up. The weekly chain store reports from ICSC and Redbook were soft in September, and motor vehicle sales, while respectable, declined from the August rate. Taken together they suggest a soft September report for retail sales, but there are always seasonal adjustments to rescue the day.
Next week has a fairly busy slate, most of which will either be missed or delayed. The reports that won’t be affected include consumer credit Monday afternoon, small business confidence on Tuesday, the FOMC minutes on Wednesday (may or may not be the report of the week, depending on when the jobs report comes out), same-store sales for September (now a tiny sample) and the University of Michigan sentiment report on Friday.
Still in the queue with September jobs: August construction spending and factory orders. Slated for next week but probably delayed: International trade and labor turnover Tuesday, wholesale trade Wednesday, import-export prices, producer prices, retail sales and business inventories. At this point it’s a guess as to what will arrive and when it will get here.