Bad Beginning


“When you’re on fire, people get out of your way. ” – Richard Pryor

It was the momentum traders this week that brought Richard Pryor to my mind. They really do wear their hearts on their sleeves. Jim Cramer (a dyed-in-the-wool momentum trader no matter what he says) was talking only a couple of weeks ago about an “epic” bull market. This week he came on Friday evening after a long succession of longer faces on CNBC to suggest that you might want to sell into any opening rally on Monday. It wouldn’t be accurate to say that he or the other momentum guys appearing onscreen had actually thrown in the towel, as many of them (including Sir Jim) were still talking about the importance of getting a chance to buy the “best” names, but you could see the care lines.

That’s the way it usually works. So long as the dips were one percent or less and the Fed money dial was set on eternal pump, everyone not only wanted to buy the dips, they would moan about never getting a chance to buy a decent-sized one. Now one has come along, with the Dow losing over 5% and the S&P down 3.6% in January – and no one wants to get in the way. They rather seem to be more focused on selling every rally, the way they did on Friday: After another brutal down opening, the indices battled back to break-even with just over an hour to go – then ended up plunging into the close.

Traders are still talking about a chance to jump in and buy – only, maybe wait a little bit longer, you know? See if goes any lower first. The 100-day average on the S&P has been tested and held several times, but should the index break down past that point, it will probably be a quick trip down to the 200-day average at 1700.

It might happen, but it might not either, at least not yet. The main catalyst for the sell-off has been the one-two punch of breakdowns in both the Fed’s infinity pump and the narrative of accelerating global growth. The “taper” started back in December, but the idea was that the Fed would hand the relay baton to the long-awaited higher growth rate. But earnings this quarter have been a mixed bag, with many high-profile misses and a lot of lowered guidance, mixed in with a sudden string of disappointing release on jobs, housing, spending, China, you name it. It all came right in the wake of hopeful forecasts from the International Monetary Fund (IMF) and World Bank. Two of the largest names in the indices, Apple (AAPL) and Amazon (AMZN), were both down ten percent or more this week on earnings report letdowns (in my opinion, the latter was the more psychologically damaging of the two).

If you’ve been a long-term bear, you’re probably all over this correction and taking some victory laps. Yet though I’ve been a long-term skeptic, and do believe we will have a serious correction this year, I hesitate to predict that February will be a down month.

Next week holds the key. If the ISM surveys and jobs reports behave, we should see a strong reversal in equity prices, especially with the current elevated levels of fear. If, on the other hand, the big kahuna from the Labor Department gets beached and its jobs number disappoints, we are unquestionably headed for a test of that 200-day average.

As I discuss below in The Economic Beat, there have been positive indications in the weekly claims data that suggest the jobs report will be back to its 180K-200K run rate (consensus for January sits at about 180K, though Wednesday’s ADP payroll report may change that). The two data series don’t always line up, so I’m not going to make any predictions, but the relationship did seem close in the two most recent months. A good report would give the growth narrative another chance to sing.

I’ve wondered in print a couple of times if 2014 would end up being a rerun of 1973. Last year, like 1972, did not have a single day of the S&P closing below the prior year’s close. It took forty-one years for that trick to repeat. The follow-up to 1972 was the bear market of 1973 that also started falling almost immediately in January, though for a different set of reasons. Some parameters were the same – bountiful accommodation from the Fed and some very high valuations in popular stocks. The 1970-1972 era was the birth of the “nifty fifty” growth stocks that you could own forever.

What the market feared in early 1973 was not the lack of growth, but the excess of it. An overly compliant Fed had kept the money supply growing strongly at a time of economic growth, with a pick-up in inflation being one of the early fruits. Many think it was the Arab oil embargo that did the market in, but that didn’t start until October. The Watergate hearings began that year too – but not until May. No, it was really the combination of very high valuations, an overdone bull run (1970-1972) and loose policy that put the market in a place where there was no room for error. The trouble is, there are always errors.

I’m not ready yet to say that this year will be a repeat of 1973, but I’m certainly watchful. I’ve been saying the last two weeks that we could still have a big reversal and rally to new highs this quarter – but it’s going to have to start with next week’s jobs report. Otherwise, you should indeed get out of the way.

The Economic Beat

The report of the week was the Fed’s statement, which seemed to symbolize the very mixed nature of the data. The Fed is continuing to ease back on bond purchases, but still plans to buy $65 billion this month and possibly in March as well, as its next meeting isn’t until the third week of that month. Yet all the market cares about at the moment is that the direction is less.

That was partly the case in housing, where the pace of growth is slowing. New home sales badly missed estimates and prior months were revised down, leaving the 2013 growth rate at an initial estimate of 17%. There is no doubt that the pace eased significantly in November and December, with combined sales of 60K (actual, unadjusted) for the two-month period, only 7% higher than the comparable span in 2012. I was skeptical about the initial November estimate when it was released, and wrote last month that despite the hype that greeted the release, the 2013 total was only going to be about 430K. The tentative tally stands at 427K. There is growth, but not some massive engine.

I also said that new home sales would be hard pressed to get to 500K in 2014, and that still looks to be the case, given that growth would have to continue in excess of 15% to get there. To put that 500,000 into context, the last run rate below that level in pre-crash days was the savings and loan bust of the early 1990s.

Pending home sales reported a very large (-8.7%) drop in December, following the tone set by last week’s disappointment in existing home sales and coming up well short of estimates for a small decline to no change. Despite the string of negative reports, though, I would caution on reading too much into them. The weather in November and December was indeed not conducive to home shopping, particularly in the new home sector, and it’s legitimate to attribute some of the decline to 2013′s frigid ending. Credit remains very tight, but not tighter than it’s been for the last few years, and we may also be seeing a slowdown in investment purchases as funds fill out their allocations.

I don’t see the major banks loosening up residential lending anytime soon, either. It’s typical bank behavior, following the inertia of sentiment and doing what should have been done years ago instead of taking advantage of the present. In their defense, until they’re done paying all the penalties and fines from the bubble, it’s hard to see them wanting to embrace looser standards, regardless of how much sense it may make. In another era, double-digit home price increases (November year-on-year was up 13.7%) would have had lenders salivating, but the rises now seem to be curbing demand growth.

The picture was mixed over in manufacturing too. Tuesday’s durable goods report for December was a big disappointment that put another smudge on the picture of higher growth being passed around only a few weeks ago. The sharp decline of (-4.3%) was in sharp contrast to the expected gain of 1.6%. Much of that was down to transportation, with the ex-transportation category down a more measured (-1.6%). Still, business investment also fell (-1.3%). Shipments fell from just over 6% in 2012 to under 2% in 2013.

The regional manufacturing surveys, though, all combined to make it clear that weather played a role in December data. After some weakness last month, the new orders index registered strong gains in the Richmond and Dallas surveys. The Chicago survey, which is private and has been taken over by Deutsche Bors (lamentably so, in my opinion) came in at 59.6, about on target and with the vague comment (the report’s details are now only available to subscribers) that the new orders index “increased slightly,” helping to turn the market around. It’s not a lay-up, but the regional picture is certainly pointing to a good national result on Monday (ISM manufacturing).

The first estimate of fourth-quarter GDP came in on target, showing an annualized rate of 3.2%. The fact that it didn’t miss cheered a market more than willing to forget December’s talk of a print of 3.6%, as well as overlook the boost the number got from the price deflator. The latter fell sharply to 1.3% and helped cover up the declines in domestic sales, whose rate fell from 2% to 1.4%. Nominal GDP was estimated to have had a heftier drop, from 6.2% to 4.6%. Alas, January 2013′s predictions for GDP didn’t pan out, as real GDP came in at 1.9% on the year instead of the 2.5%-3% that most strategists were penciling in at the beginning of the year. The irony is how far stock market gains exceeded their predictions, even as the economy came up short.

The GDP result was described in loving tones in many places, but I never once encountered a mention of the fact that real disposable income grew a lousy 0.7% in 2013. That stinks, frankly, and I can’t make much of a case at the moment for an improvement in 2014. With labor market participation at quarter-century lows, it doesn’t seem likely that the employment market will tighten sufficiently to drive gains. Income finished the year on an austere note, unchanged in December, though spending rose an estimated 0.4%. For the year, nominal income rose 2.8% while expenditures rose 3.1%. Both figures represent a considerable slowing from 2012.

The indications from the weekly chain store sales reports are that ex-auto ex-gas sales will be weak in January, but the reaction will be all in the expectations. Two consumer sentiment numbers came in over 80, relatively good, but the Conference Board survey took place before the stock market cracked. Beyond telling you where the market has been and the occasional two-minute trade, I’m not sure what value these surveys have anyway.

Weekly claims reported a sharp rise, but it looked as if the problem was in the adjustment factoring. The unadjusted data is showing stable comparisons with 2013′s prior period, about 8% lower. Last week’s result is well past the cut-off date anyway for the January jobs report, but claims were also down about 8% during the sampling period in the first two weeks of the month. I’m not so foolish as to predict the headline number and much will depend on the adjustment factors from the Bureau of Labor Statistics, but the claims data were a reasonable guide to November and December, and they do imply a downward revision to the former with a strong upward revision to the latter. If the picture is decisive – and it’s possible it won’t be – the report will decide whether or not the current decline turns into something worse.

But the week begins with the national ISM manufacturing survey – probably good – January auto sales, and December construction spending.

Factory orders for December come on Tuesday and the ISM non-manufacturing survey, which showed some cracks in the façade last month, is on Wednesday. The main focus of the week will be employment, beginning with the ADP report that day. Last month’s ADP number was very much at variance with the BLS. A small number of companies report same-store sales on Thursday, along with international trade for December – the latter has continued to signal feeble economic conditions, despite the inventory restock in the second half that has seemed to bewitch so many analysts.

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