Spring Will Come


“It’s been a long cold lonely winter.” – The Beatles (George Harrison), Here Comes the Sun

It’s a tale of two markets these days, in more ways than one. For the last couple of weeks there’s been a big rotation out of higher beta names (“mo-mo” stocks, short for momentum morons) into defensive issues like utilities and telecom stocks. The mo-mo’s are getting killed – market darling Netflix (NFLX) is down over 20% from its high in the first week of the month. That’s quite a move in a short amount of time, and trying to catch the falling knife has been brutal – the stock price has declined all but two trading days since that time.

In the meantime, the broad market as represented by the S&P 500 is essentially flat on the month with one day to go – whoever wins the psychological battle on Monday to close it up or not (two S&P points to go) really isn’t important. The market is just as apt to go on selling off into mid-April unless next Friday’s jobs report can turn it around. The momentum sentiment of the market in general has been bruised, not just for the momentum stocks. The repeated failures of the market to hold an up opening has taken a toll on investor psychology.

The small-cap sector and the Nasdaq have taken a hit. Both are virtually certain to finish the month down, needing about a 3% move on Monday to stave off that ending. The heavy IPO calendar seems to be taking a toll on first-day gains.

The weakness of these sectors is telling, but it’s more of a signal of trouble coming later in the first half than one to get out of the market now. There are several events looming on the near horizon that would pull the market back from the brink, starting with the advent of first-quarter earnings season (yes, yes, there is the jobs report next week, but I wouldn’t dream of trying to call it) in about two weeks time. A weak start to April followed by a rebound that starts in mid-month is a classic pattern, and the first-quarter rally is inviolate on the Street, even in bear markets. April isn’t the best month of the year for equities for nothing.

A second catalyst for a rebound is the possibility of more stimulus. There were already hints in the air about the ECB taking another step, in particular asset purchases. After the decrease in the Spanish CPI revived deflation fears in Europe, European Central Bank (ECB) President Mario Draghi now has more political cover to undertake a program that was once adamantly opposed in inflation-sensitive Germany as tantamount to financial ruin. No doubt the country has been influenced by the US experience, whose $3.5 trillion dollar central bank expansion has produced virtually no inflation – it’s lower now than it was three years ago. I don’t expect the ECB to move as early as next week, as they favor a deliberate style, but even a hint of further easing would excite traders.

An example: The private HSBC purchasing survey (PMI) in China produced another decline into the contraction zone, this time to 48.1 from 48.7. Stocks in Shanghai exploded the next day on the presumption of more stimulus, while Hong Kong went on an absolute tear, rising every day until they had traveled an astonishing 10% higher before backing off late Friday. That madness led to further trading excitement about prospective ECB stimulus, and by the end of the week some traders were even predicting the imminent end of the Fed’s taper. After all, how can our central bank stand idly by while Facebook (FB) is down 10% in a month, or the S&P barely breaking even on the first quarter? Time to crank up those printing presses again!

After Friday’s close came also the possibility of a thaw in the Ukraine situation, with news of Russian czar Vladimir Putin seeking a diplomatic solution to the crisis, probably in the hopes of heading off a Russian recession. If that development holds up – and it may not – markets could roar on Monday. The virtues of counting on Putin may be dubious, but traders worry about that kind of thing later. Much later.

Markets could still remain choppy the next two weeks or so, with the eventual direction likely to depend on next week’s jobs picture and what happens with Russia. But a spring rebound is practically certain, and I suspect that we will eventually move above 1900 with room to spare before more mundane realities like the economy, growth and the Fed staying the course on the taper come back to puncture our little dream-bubble.

The Economic Beat

The two reports that stood out last week were the February editions of durable goods and personal income and spending. On the surface, all seemed well – new orders were up 2.2%, besting consensus estimates for only 1.0%. Personal income rose 0.3%, a tad above consensus for 0.2%, and spending rose 0.3%, matching estimates. But therein lie a couple of tales.

New orders for durable goods are up only 0.2% year-on-year, and January took some big revisions downward. Excluding the volatile transportation category, they were up only 0.2% in February, and most telling was that business capital goods spending barely rose at all. Through the first two months of 2014, cap goods spending is up only 0.1% versus 2013. At the same, Friday’s personal income report revealed that manufacturing wages had fallen for the third month in a row (seasonally adjusted).

The wage decline is not great, and no doubt the weather takes some of the blame (though less so for December). That new orders for business capital spending should decline on a real basis (adjusted for inflation), though, is hard to attribute to weather, and in any case certainly not a reflection of the big increases that fund managers have been virtually asserting as fact since the beginning of the year, even after allowing for a bit of weather. I suspect that the surveys the managers commissioned may not be gospel. The manufacturing sector is not humming either, weather or no weather, though the Kansas City district, hard hit by February weather, did show a nice rebound in its March survey (Richmond, on the other hand, still battered by late storms, showed a sharp decline).

The year-on-year in growth real disposable income is now 2.1%, which isn’t bad but not the kind of thing to set GDP on fire either. It’s certainly better than 2013′s meager 0.7%, but the latter growth was skewed by the heavy acceleration of bonuses and dividend payments into the last months of 2012 that were designed to avoid a tax hit – and were thus not paid in the first quarter of 2013, thereby flattering comparisons for the first months of 2014, when bonuses and dividend were back on a normal schedule. The first two months do look better and there is also a beneficial comparison from last year’s increase in the payroll tax, but considering that the average year-on-year gain for the last 8 months is only 1.25% and was negative in the fourth quarter, there aren’t any grounds yet for talking about accelerating consumer incomes. Of the increase in the personal income rate over the first two months, only a third was estimated to be from private wages and salaries.

GDP for the fourth quarter was revised back up to 2.6% from 2.4%, though short of the estimate for 2.7%. The growth in real imports fell to 1.5% and in gross domestic purchases to 1.6%, reflecting a careful consumer. GDP was also held back by a sharp drop in government spending. On the plus side, exports increased (I’m guessing that Boeing (BA) had a lot to do with that), as did real non-residential fixed investment, which I attribute primarily to commercial construction.

A fall in weekly jobless claims to 311,000 (seasonally adjusted) produced some hope, including remarks by several services and observers that it was a good omen for next week’s jobs report. However, the measurement period for the March report had already closed. Claims typically do hit bottoms at the end of the first and third quarters on both an adjusted and non-adjusted basis, so I’d be cautious about reading much into them. The claims data from the first two weeks of the month looked slightly above average for the year, which could be a drag on the Labor Department’s seasonal adjustment calculation. At any rate, the better fix on where employment is headed for the year comes after the layoffs from the second quarter are incorporated.

There wasn’t much strength on the housing front: New home sales for January were revised downward and are no longer the 5 1/2 year high once heralded. The monthly rate slipped, the year-on-year growth rate slipped again and the first two months were flat with last year. Once again, weather got the blame.

But it isn’t just weather – pending home sales (which only measure existing homes) fell for the ninth month in a row. Part of the issue is stiff prices – up 13.2% year-on-year, according to the Case-Shiller data – and part of it is still tight credit. When I read about all the huge mortgage-related fines that Bank of America (BAC) and JP Morgan (JPM) are still dishing out from the go-go years, I can’t be very sanguine about residential credit standards easing soon. Mortgage purchase applications are down 17% year-on-year.

Finally, the Chicago Fed’s national activity index rose in February, but from a downwardly revised January, with the three-month moving average falling into negative territory again.

Next week is one of those weeks that can overwhelm markets. The three biggest items on the calendar are one, the March jobs report, set for release on Friday; two, the ISM manufacturing survey, set for Tuesday; and three, the ECB announcement to a stimulus-yearning market on Thursday.

There’s plenty more: Monday is the last day of the quarter, bringing with it all sorts of rebalancing, including the usual attempts to move the tape in one direction or another. To add more spice, the Chicago PMI comes out shortly after the open, followed ten minutes later by a speech from Fed chair Janet Yellen. Traders will be wondering if she backs away from the six-months horizon she gave as a possibility at the last Fed meeting (personally I think that the Fed is more worried about an asset bubble than placating them). The Dallas manufacturing survey also reports, though I suspect it will get lost in the shuffle.

Besides being the first day of the new quarter, bringing with it the ISM report and new car sales for March, Tuesday also has construction spending for February. Wednesday has the ADP payroll tease – it’s been pretty far off the BLS number as of late – and February factory orders. Thursday includes international trade and the ISM non-manufacturing survey, and then shortly after lunch on the East Coast ECB President Mario Draghi will start talking to the press. It could be a volatile week.

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