An Indelicate Balance


“Just close your eyes, it’ll all be ok.” – In Fear and Faith

My foreboding that we were in for a post options-week letdown this week evaporated in the warmth of yet another relentlessly sunny Monday morning opening – sunny on Wall Street, anyway. It was an odd sort of week on the Street, with daily morning rallies being washed out by afternoon sell-offs. Thursday was really the only day to hold onto its gains, as Friday morning’s strong gains were again wiped out before the usual last-hour Friday rally restored prices to near their opening levels.

I don’t trust this current rally, and I trust this current market even less. I have been looking for a first-quarter top all along (perhaps we’ll get another one in the fall, after a summer dip), and we’re at one right now. But these daily little pullbacks are keeping the markets from getting dangerously short-term overbought. They’re still overbought in the intermediate, and scarily overbought long-term, but they can stay that way for extended periods. When I look at indicators for high-beta things like small caps, mid-caps, and tech, they all suggest taking money out. Then I look at the stock market versus the economy, and it suggests taking money out. But then I look at next week’s calendar and think, maybe not yet.

The main motive behind the market staying up last week, it says here, was Yellen fever. The market remembered the lift it got from the new Fed chief’s testimony before the House Finance Committee (she promised to be careful) and rallied up and through her weather-delayed Senate testimony, which I mostly expected. The bond market wasn’t having it, nor the snow-day excuses, and the yield on the ten-year fell.

So we should be ready to begin a fade, if not something bigger, but I look at the calendar next week and I’m not so sure. If form holds for the ISM manufacturing result on Monday, and it follows the trend of the Chicago PMI (or the Markit Economics PMI released Monday), then a consensus-beating number would coincide with the first day of the month and a Monday. How could the market not rally, unless the Ukraine gets into trouble? It could even rally further if events in the Ukraine take a benign turn (I have absolutely no predictions to make on the matter).

Then there is the jobs report at the end of the week. I don’t see strength in the weekly claims numbers, but the Bureau of Labor Statistics (BLS) is a source of endless wonder to me with its seasonally adjusted numbers. One can envision the market rallying on a 150K number with the unemployment rate unchanged, on the grounds that it might slow the taper (whether or not the markets would actually welcome that, or how good it would be for the economy, is another story). A 185K number (seasonally adjusted) is also plausible to me, given what the BLS did last year and the underlying trends in the establishment data. Perhaps the market will draw another advance on the weather-rebound rally. Or trade around endless will-she-or-won’t-she permutations of Yellen policy if the unemployment rate hits 6.5%.

So we are left with equities still due for a pullback, but not so much they couldn’t get another postponement (though any bad geo-political event will see prices drop fast). The market is still extended, but not so much that we can’t squeak out another percent or two over the next week or so. The stupidity quotient in the media about how fine everything is above average, but that’s never been a great indicator about the direction of the market, only the cupidity of its participants. We’re ripe to start a five to ten percent pullback, but prices could still go higher first.

It’s an indelicate balance, with the money river trying to decide how much longer last year’s model of, “Fed-is-your-friend plus nothing-else-to-invest-in” can be milked. Equities are being priced for their strategic value, not potential return of capital, the way WhatsApp was valued at $19 billion (with an estimated $25 million of revenue), or the euro at nearly $1.40, with the EU’s 12% unemployment rate and 1% growth potential. All I can say with conviction for now is that if March is another up month for equities, take some money off the table. I’ve never trusted marginal new highs, especially with growth so weak. The problem with multiple postponements of pullbacks is that one ends up with bigger corrections, however uncertain the timing may be.

The Economic Beat

The reports that garnered the biggest market reaction were, not surprisingly, the ones that were the most flattering to prices. The new home sales report came in well above expectations, at a 468,000 annualized rate versus consensus for 400,000.

But the number was heavily adjusted, much like the January 2013 number, and probably isn’t a good picture. Last January reported a similar outsized surge, the highest annualized rate of the recovery (458K), but it was just an outlier that wasn’t matched again until the latest report rate – the actual 2013 rate was 428,000. Perhaps some sales are reported late due to the end-of-year holidays, leading to weakness in December and overstated strength in January. Other analysts were also skeptical of the number. An increase from 1K to 2K sales in the Northeast, for example (rounded), led to a jump of 19K to 33K annualized for that region, a level it hasn’t been at since June. Given the difficult January weather in the Northeast, it’s more likely a reporting fluke than anything else (January 2013 also reported 2K sales).

Pending home sales are down 9% year-over-year, but the Street preferred to focus on the fact that January was up 0.1% from an upwardly revised December decline of (-5.8%). Cold comfort indeed. Home prices, by contrast, are up between 7.7% (Federal mortgage data) and 13.4% (Case-Shiller 20-city average). With housing no longer enjoying the sure-fire wealth-creation image it once had, price increases now seem to be dampening demand rather than stimulating it.

Manufacturing surveys were mixed. Dallas reported no change, the Richmond district a sharp decline, and the Kansas City Fed region mild improvement. The Chicago PMI got most of the attention, coming in with a 59.8 reading versus expectations for 56.4. The Chicago number has been running consistently hotter than every other survey, a tendency I had been attributing to regional auto production, which so far as I know is running at constant levels. Lately it’s occurred to me that the stronger reading also seem to overlap the period that the report has gone private, with few details available. I may only be paranoid, but I wonder if the survey’s methodology changed along with its owners.

In any case, the Chicago PMI has always been the most prominent regional survey, and a good, though not perfect, directional indicator for the influential ISM manufacturing survey due Monday. The Chicago number has been ahead of the national PMI for most of the last couple of years, but is closer than the other regional surveys to the Markit Economics flash manufacturing survey estimate. Markit also showed quite a bit of leveling off in its services “flash” PMI this week, so a reasonable hypothesis would be that services are bearing the brunt of the weather.

Yet the picture is foggy. New orders for durable goods did decline in January, excluding defense, which may be partly related to the expiration of bonus depreciation in December. Motor vehicle new orders were up, but down on a seasonally adjusted basis, perhaps partly explaining last month’s weak ISM number. Business cap-ex new orders rose on a seasonally adjusted basis, but were below the level of January 2013 – which in turn, may have been inflated by catch-up business after the New Year’s budget deal. It’s hard to get a clean picture.

The same is true for GDP, where the nominal four-quarter rate was adjusted down to 4.02% and the annualized fourth-quarter real rate down to 2.4%, below consensus for 2.5% but ahead of the whisper number of 2.2%. Well, there are still more revisions to go.

The business media, however, seized upon the Chicago PMI and consumer sentiment numbers Friday as evidence that the economy is recovering from the cold. You’ve got to be kidding me. Consumer sentiment correlates with stock prices, not spending, and first-quarter real GDP is tracking below 2%. The Chicago Fed’s national activity index fell sharply in January.

I do expect that there will be some pent-up shopping once all of this drearily frigid weather breaks, but it may be nothing more than that. Because of the late spring – the first half of March, if not the first three-quarters, is due to remain unseasonably cold – and a late Easter – about as late as it gets, being the 20th of April – we’re probably not going to see positive monthly spending data until May. The Street has already started betting on it – the XRT retail ETF was up over 10% from February 3rd.

Next week could set the tone for the month. Monday leads off with the ISM manufacturing index, and Friday finishes up with the February jobs report, the latter especially important. I don’t try to guess the monthly jobs numbers, but I will note that jobless claims are still running at a level that suggests a muted seasonally adjusted number of new jobs. I haven’t seen any real trend change in the unadjusted data, but year-to-date jobless claims are certainly running at higher levels than a couple of months ago. Then again, the BLS has often been a source of surprise.

Besides those two numbers, we’ll get personal income and spending on Monday, along with construction spending and the first reports of February auto sales. Wednesday will see the ADP jobs report, which hasn’t matched up well lately with the Labor Department’s report, and the ISM non-manufacturing PMI. Thursday has factory orders, which should update durable goods, and Friday will also have international trade data. The market will also be waiting on Thursday to see if the ECB comes up with a rate cut or at least more dovish language. Many traders had already baked one in until the latest inflation data showed prices edging back up to 0.8% annualized – sovereign bonds in Europe have put on quite a rally of late. Where else are you going to put your money?

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