Waiting For Direction


“There is nothing like first-hand evidence.’ – Sherlock Holmes, in A.C. Doyle’s A Study in Scarlet

One year ago, the stock market rally was relentless in January, much as it had been the year before and the year before that. Last year’s market roared out of the gate on the strength of the budget deal and didn’t stop for breath until the spring. This year, we’re halfway through the month and the S&P 500 is locked in a seesaw battle, neatly illustrated by last week’s big up and down moves. With the index currently sitting about half a percent below its year-end level, that feels like a two percent decline – seasonally adjusted, of course.

Two issues loom, the first being the Fed, and the second being earnings. When the Fed’s QE policy was fully engaged, market participants felt nearly invincible and paid little attention to declining earnings growth. So long as there was some growth and the estimates game worked reasonably well, earnings could more or less be safely ignored.

Now the Fed appears to be embarked on a policy of smaller interventions in the Treasury and mortgage-backed markets. Still, it’s only been about a month, with the bank still buying at a substantial rate, and there are not-so-secret hopes that the very dovish incoming Fed chair Janet Yellen will hit the pause button.

But will she? I saw an interesting tweet from the Boston Federal Reserve on Friday, with the headline, “Policymakers must carefully balance a state’s capital needs with efforts to keep debt levels affordable.” I haven’t read the article yet and so perhaps should not draw too many conclusions, but the lead from the heretofore dovish branch certainly seemed suggestive. Recent commentary from governors have been mixed, but there hasn’t really been any sign of backing down from the approach of winding down QE. That’s keeping the markets on edge.

In the Fed’s perfect world, it would seamlessly hand off decreasing accommodation to a growing economy, with accelerating earnings offsetting decelerating intervention. So far that’s been a mixed bag, as earnings haven’t set the world on fire yet. Some of the big banks had positive surprises (JPM, WFC), some had negative (C) and some were mixed (BAC, GS, MS), with some bigger industrial names on the light side – Intel (INTC), GE, and UPS.

Since January is a much-watched indicator – positive years usually have positive Januaries, and the first-five-days test has already failed (if the first five trading days are positive, the year is up about nine times out of ten. This year they were negative), there is understandable edginess about what may happen. After all, the bull market will be sixty months old in March, if we make it that far. The gauges vary, but most put the average and median at about fifty months, and the last one lasted from fifty to sixty months, depending on your perspective.

It would be premature to give up on the month yet – indeed, it should all come down to the last week. The earnings focus should switch to tech stocks, with Apple (AAPL), Google (GOOG) and Amazon (AMZN) all reporting. Apple has a huge weighting in the Nasdaq, Google is an institutional favorite and Amazon in recent years has only needed to report its results for the stock to go up again – earnings and their conspicuous lack thereof haven’t mattered to its price at all. I make no predictions, but would watch prices closely for indicative reaction.

Most of all, the Fed has another announcement the last week of the month, on the 29th to be precise. If it maintains the status quo and says it will continue to reduce the amount of bond purchases, don’t expect equity markets to feel great about it. It will hardly come as a shock, so perhaps the impact will be limited and not even immediately visible, but it will continue to whittle away at the most important prop of this sentiment-driven market. If Yellen pauses, on the other hand, we could see quite a rally the last few days, one that could gain strength from a desire to push the month well into the green. And so we wait for direction.

A reminder to readers that all US financial markets and government offices will be closed on Monday, January 20th, in honor of the Reverend Dr. Martin Luther King.

The Economic Beat

If you were looking for more of the same, it was in last week’s Federal Reserve’s monthly Beige Book report, a compendium of regional write-ups, with 9 of 12 districts reporting “moderate” growth. There weren’t any real signs of impending boom or bust.

Nor were there any in the retail sales report. There was a lot of misleading headline talk about the December report beating estimates, but the December gain of 0.2% (0.7% excluding autos) had more to do with the late Thanksgiving holiday. Retail sales were up 4.2% in 2013, about the same annual rate they’ve been at for some months now, and ex-auto ex-gas sales were up 3.89% on the year, about where they’ve been since March. As for that accelerating, confident consumer, fourth quarter sales were up 4.18%, compared to 4.2% a year ago. January has started out weak.

The picture was similar with the regional Fed manufacturing surveys from New York and Philadelphia, with the former reporting a January activity index of 12.51 (zero is neutral for both reports), versus an upwardly revised reading of 2.22 for December. Philadelphia had a reading of 9.4 vs. a downwardly revised 6.4, with new order activity more widespread in New York and more restrained in Philadelphia. Somewhat higher readings have been typical at this new-budget time of year since the crash, so one should expect similar readings in February.

Indeed, one should take all of these reports of “accelerating momentum” with a grain of salt: the year-on-year increase in manufacturing production was 2.6% in 2013, according to the Federal Reserve. Overall production increased by a more respectable 3.7%, led by utilities (7.6%) and mining (6.6%). Consumer goods were in line at 3.6%, led by a 6.6% increase in autos. Construction was above trend at 4.4%, but business equipment was well below at 1.8%. At 79.2%, industrial capacity is creeping back towards its 40-year mean of 80.2%.

The jobs report that has borne the brunt of “it can’t be true” criticism got some further corroboration in the November labor turnover (JOLTS) survey. As I wrote last week, it appears that the November jobs estimate was too high and December too low, thrown off by massive holiday-related swings in weekly claims that most pundits seemed to have missed; probably they were too busy being pundits to examine the raw data.

The monthly JOLTS report continues to feature lead descriptions of “little changed” conditions, and indeed the November 2013 hire rate of 3.3% (seasonally adjusted, or SA) was unchanged from November 2012, while the adjusted rate for the private sector actually edged down to 3.6% from 3.7% a year ago. Looking at the unadjusted data, private sector hires were actually lower (-1.8%) than a year ago, when the retail sector is excluded; the last two weeks of post-Christmas weekly claims data are at nearly the same levels as a year ago, so there isn’t any reason yet to believe that the retail hiring was more than seasonal.

The homebuilder sentiment index edged down to 56 (50 is neutral) in January, with December revised down to 57 from 58. Naturally, the Bloomberg headline was, “Confidence Among US Homebuilders Holds Near Its Highest Level in 8 Years.” Who says the business media tries to position the news?

The small decline was, as usual, reflected in the housing starts data the next day, which featured declines across the board, including permits. I wouldn’t read too much into it, as the December weather was difficult in many parts of the country, particularly the Midwest, where year-year rates were down substantially, and November had been a bumper month. For the year, starts were up 18.5% overall and 15.75% in single-family. Those rates were in the mid-twenties at the beginning of the year, but some moderation is a good thing.

There is no sign of accelerating economic momentum in pricing data. Import prices were down 1.3% on the year, while export prices lost 1.0%. Consumer price inflation is estimated at 1.5% for 2013, with the core rate at 1.7%. Producer prices were estimated at 1.2% (overall) and 1.4% (core). Pricing is highly sensitive to increases in demand, and the data is one of the strongest reasons to doubt that the recent pickup in activity is anything more than another in a series of inventory rebuilding exercises that we have had since the crash. Atlanta Fed Governor Richard Lockhart said inflation “seems disconnected from the recent growth momentum,” but the illusion may be in the momentum.

Next week is a quiet one, marked by the federal Monday holiday in honor of Dr. King. Existing home sales are due on Thursday, along with the “flash” manufacturing PMI, leading indicators, federal home price data and of course weekly claims. Apart from that, earnings and Fed guess-work should dominate the news.

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