Cold Comfort


“Little strokes fell great oaks.” – Poor Richard’s Almanack (Benjamin Franklin)

The weather excuse may be getting old, but it’s still hanging in there on Wall Street. There are two types of interviews these days, it would seem – those who say you can’t blame everything on the weather and then do just that, and those who say there’s more to the recent economic weakness than the weather – and then tout the latest biotech or social media stock.

Nearly all of the potential catalysts I wrote about last week were negative, yet the markets managed to finish mostly higher anyway (though not the Dow). They even managed to shake off a hint of hawkishness Wednesday from Fed governor James Bullard, who seems to have switched from being a leading advocate of more QE to being a standard-bearer for the taper. That sentiment seemed to find some company in the Fed minutes released later that day – some governors even want to talk about raising rates.

The prevailing sentiment on the Street, though, was to follow the charts and assume that Yellen is your friend. There was also some upward pressure from options expiration Friday, pressure that fizzled in the last hours when it became apparent that there was a strong imbalance between SPY (the S&P 500 ETF) puts above 184 and calls above 184. There were far more call contracts between 184 and 185, and so the ETF finished gently at 183.89, a point below its late-morning high (i.e., all February calls at 184 or higher became worthless).

There’s been a kind of unholy alliance the last two weeks between naturally bullish fund managers who think it’s too early to call the year anyway, regardless of the weather, and traders playing the charts and/or options positions. Next week rates to be a bit less forgiving. Though the markets aren’t especially overbought on a short-term basis, they are overbought on an intermediate and long-term basis, especially tech and biotech, two trades that have become quite crowded as the latest sure source of growth (health care being a third). The latter part of February is usually the period responsible for the month being one of the year’s weaker times. Last year’s frenzy managed to blow right through the traditional February pullback, but I don’t expect it to happen in 2014.

Right now two scenarios loom for the coming months. In the first one, we have a seasonal pullback of a few percent, perhaps one that extends right up to the Fed meeting in mid-March (though the jobs report in two weeks’ time may have something to say about that). Then traders hear what they want to hear from the Fed statement (regardless of what the Fed thinks it’s saying) and launch a rebound. This would create a cup-and-handle pattern on the S&P (thought to be very bullish) that could gain additional fuel somewhere between mid-March and mid-April from an eventual weather-related rebound. However temporary, this could lead to the first-quarter top in equities I’ve been writing about since January (okay, so April is actually in the second quarter, but close enough).

That scenario seems more likely to me and fits with the market’s natural bullishness, though it could mean that stocks were only up a couple percent by mid-April. But there is another one, one in which there is no rebound from either the weather or the Fed next month (even if the snow does let up, we may not see any improvement in the data until April). In that scenario, weather-excuse fatigue sets in along with disappointment with the Fed. Throw in an overseas event somewhere – the Ukraine, Venezuela, the list isn’t short – and suddenly you’ve got the 10% correction people have worried about since the beginning of January.

The sentiment that seems to remain the most widely shared one on the Street, though, be it fund manager or trader, is that the Fed has everyone’s back. The parlay of “either the economy gets better or the Fed does” is an article of almost childish faith for many investors, too many to give me any feeling of comfort.

I’ve seen this movie before: An aging bull market (five years old in two weeks) is defended on the grounds that the Fed will rescue everyone if needed. It goes hand-in-hand with the fact that the market never sells off in the early stages of the Fed withdrawing accommodation; you always hear instead about how resilient is the market is and how wise is the Fed. Until the day you stop hearing it.

The Economic Beat

As noted above, most of the key reports of the week were poor, so the Street tended to focus on the Markit Economics “flash” PMI instead, which came in with a good-looking reading of 56.7.

Last month’s Markit reading was about 2 points higher than the traditional ISM manufacturing survey, and the current survey was clearly not asking the same people that responded to the New York and Philadelphia Fed surveys, whose results were dramatically different. Obviously New York and Philadelphia have gotten a lot of winter’s more punishing weather, but one has to wonder if there wasn’t some unintentional regional bias in the Markit survey as well.

At any rate, the biggest flaw of these surveys is that they do not measure the depth or pace of recovery, only the breadth. Even Markit’s own rather promotional press release boasting of the “fastest overall improvement…since May 2010″ is unfounded. The fact that more people are saying “better” than “worse” isn’t an indication of speed – business might only be a dollar or unit better – or even not better at all, since many of the answers are going to be gut responses by harried subordinates. The real value of the purchasing surveys is in their measurements over extended periods – six months or longer – and in ones that show pronounced reversals in trend. But traders tend not to trade on six-month figures.

The bad news in housing started with the homebuilder sentiment index on Tuesday. The reading of 46 was a decline from the previous month’s reading of 56 and represented the biggest drop ever in a single month. Even the normally optimistic Econoday admitted the negative factors of “unappealing mortgage rates, high prices, low supply, and a soft jobs market,” factors I’ve been consistently writing about. The silver lining is that like the PMI, it’s a sentiment survey. However sharp the decline, it doesn’t mean that the housing business actually cratered in January, just that business was down for most builders.

That was evident in the housing starts data released the next day. The starts came up far short of estimates, at an 880,000 seasonal rate versus expectations for 950K and a December reading (upwardly revised) of 1,048K. Permits had a big shortfall too, 937K versus 991K expected, and that is rather more serious this time around. The permit data is more volatile and many permits are never executed, but over time permits and starts track pretty closely together. Bad weather isn’t much of an obstacle to filing a permit.

More importantly, as I noted in my Seeking Alpha article earlier in the week, the annual rate of year-on-year growth in permits averaged only 11% over the last six months of 2013 and 10% over the last four. Since permits usually exceed starts, this suggests that homebuilding will grow by about 10% this year (permits usually pick up in the spring and summer). That’s not at all bad, but it is lower than what’s baked into most of the models calling for a pickup in US growth this year.

The penultimate piece of weak housing news was the existing home sales report, which didn’t bother the stock market much either. Declines were across the board, with sales falling to the lowest rate since July 2012. The realtors’ association that released the report did point to the weather, which is perfectly reasonable, but also cited “tight credit, limited inventory, higher prices and higher mortgage interest rates.” The sales rate fell for the fifth time in six months, so it isn’t all weather: First-time buyers continue to decline, while all-cash sales moved up to 33% of purchases. That’s high, as are the year-on-year price increases of nearly 11%. Two-thirds of 2013′s sales were at prices of $750K or more, according to the association.

The Philadelphia Fed survey plunged to (-6.3) from 9.4 the previous month, but the accompanying text made it clear that most respondents blamed the weather. The six-month outlook increased, suggesting that in March or April we should see a reversal in the activity index. In a similar vein, the New York Fed survey fell from 12.5 to 4.5, not as much as Philadelphia and indeed still positive, though new orders were flat (seasonally adjusted). A third “regional” PMI survey, this one involving China, was released during the week and indicated a second straight month of decline, this time on a slightly broader scale. A month ago that set off a growth scare; this time it was hardly talked about in the West.

Annual inflation remains tame, at 1.6% for the Consumer Price Index (CPI), while the Producer Index (PPI) is at about 1.2%. The latter has a new group of disaggregated series, revealing that goods inflation is only 0.9%, while services inflation is at 1.3%. However, goods inflation did show a preliminary monthly jump of 0.4%.

On the weekly side, retail sales reports remain muted and suggest another monthly decline in store for February. Mortgage purchase applications fell and jobless claims remain relatively elevated, with the improvement over last year edging steadily down. However, that too could be weather-related, so we’ll really have to wait for March or even April data. For the moment, the claims point to another subdued headlines jobs report number in two weeks time, but the underlying jobs growth rate might not have changed.

The last week of the short month will be a busy one, with the bigger releases coming towards the back half of the week: New home sales on Wednesday, durable goods orders on Thursday, and on Friday the Chicago PMI, where the recent weather has been brutal while the PMI data has been above the rest of the country. It should be an interesting result. There’s also pending home sales that morning and perhaps most interesting of all, the first revision to fourth-quarter GDP, now estimated to be around 2.2%-2.4% in place of the original 3.2% estimate.

Other reports provide plenty of background: The Chicago Fed activity index on Monday, three more regional Fed surveys – Dallas (Monday), Richmond (Tuesday) and Kansas City (Thursday) – consumer surveys (Tuesday and Friday), and yet another survey: the Markit PMI services “flash” report on Monday, not yet a market-mover. Home-price data will be released on Tuesday.

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