A Time for Caution


“Wrong does not cease to be wrong because the majority share in it.” – Leo Tolstoy, A Confession

The market was battling anxiety in the early part of last week, but the soothing dovishness of Fed chair Janet Yellen sounded the proper mixture of optimism on the one hand that things will get better, and deep parental reassurance on the other in case they don’t. It’s the kind of thing that never fails to have equity trading programs launching the buying missiles. In terms of policy, she said nothing new at all to Congress, unless you think saying the Fed isn’t about to raise rates is new.

Without the sort of auto-buying generated by Yellen’s testimony, the markets would probably have lost a percent or more on the week; as it was the Nasdaq was off more than that anyway. The question now is whether or not Yellen’s fuzzy assurance can suffice for stocks until the next Fed meeting in mid-June. There certainly won’t be any lift from earnings season, currently sporting a 2% nominal growth rate. Of course better earnings are predicted down the road, but in the current cycle they’ve persistently remained somewhere over the rainbow.

Next week’s economic releases should start to show more of the benefits of the weather bounce, but I wonder if they will be enough. I don’t think one can entirely blame the zero growth rate in the first quarter can on the weather. There will certainly be some measure of a rebound, we’ve already started to see it, but it might not be so large if last quarter’s weakness wasn’t all weather-related.

Sometime over the next four quarters, there should indeed be another 4%-plus GDP quarterly rate – but there’s been one every four or five quarters since 2010. They’ve been offset by quarters below 0.5%. The main difference between the two is that the 4% rates are always labeled as the start of something big, while the 0.5% rates are invariably blamed on special factors.

Despite the potential increase in rebound noise, the market appears vulnerable to me over the next five or six weeks. The cracks have been visible, as evidenced by the weakness in Russell and Nasdaq stocks. While a lot of money has rotated into defensive sectors in the large cap sector, I don’t expect we can count on trading programs to defiantly throw money at them. They’ll simply step aside and wait for any selling to exhaust itself. I shouldn’t think there would be a massive sell-off yet, not unless the geo-political situation blows up somewhere, but it could be alarming nonetheless. The Russell 2000 looks like it could easily lose another ten percent, and that will take a toll on market psychology.

The key to the short term is that the Fed is moving the needle from more-accommodative to less-accommodative. That posture does not dominate every market scenario, but it does matter in the current one of weak earnings and unproven future economic recovery. We’ve just entered a traditionally unstable period on the calendar for stock prices, and while “sell in May and go away” is not something one can really rely on, like most market aphorisms, it does have some basis in historical tendency. Really, the best defense the market has against an immediate sharp sell-off is that prices had done very little coming into the post-earnings period, despite the noise about “all-time highs.”

The market isn’t cheap, there is no earnings momentum, and the Fed is not currently in a state of actively trying to prop up the financial system. A negative outcome in the Ukraine may not be a sure thing, but one is certainly not priced into stock markets. I would use any near-term rallies as an opportunity to take some money off the table.

The Economic Beat

It was a light week for data, and what there was wasn’t especially revealing. The labor turnover survey (JOLTS) was released on Friday, and the good news was that the March hires rate finally bumped up to 3.4%, up from 3.2% in March 2013. Openings remained above the 4 million level for the second month in a row.

The bad news is that the number of openings is also at the level of March 2008, when we were in a recession. None of the turnover data – hires, openings, separations – has recovered to pre-crash levels. Some take this as a bullish sign – all that room to go higher – but the fact that we are five years into the recovery suggests something else, namely, that the current cycle simply is not going to reach the levels of the last one.

Wholesale sales and inventories for March were also in the good news/bad news category. The good news was that the rate of twelve-month sales growth improved to 4.9%, the highest since the end of 2012. Inventories rose more than expected, indicating a possible bump to first quarter GDP. The bad news was the sequential decline in quarterly sales growth. It was the first such decline since the second quarter of 2009 on an adjusted basis, and the largest decline on an unadjusted basis since the first quarter of the same year. The inventory-to-sales ratio was relatively steady and at 1.184, not showing any strains.

The week kicked off with the ISM non-manufacturing survey for April. The result of 55.2 was decent and above consensus, though about what you would expect from the long-awaited weather rebound. The employment reading of only 51.2 (50 is neutral) wasn’t sparkling, but perhaps understandable in light of weak first-quarter earnings results. First-quarter productivity fell 1.7% while unit labor costs, which have generally been subdued, rose 4.2%. That’s not a combination that will incite employers to expand hiring. The global manufacturing PMI survey, by contrast, eased to a reading of 51.9.

International trade looked a little better too, with imports (+1.1%) and exports (+2.1%) rising at a satisfactory pace. Even mortgage-purchase applications rebounded nicely, though they are still down 16% from last year. Jobless claims improved a bit after a spike the week before, but the overall trend for 2014 is stable.

Next week will be a very busy one after the lull of May’s first week. The highlight will be the retail sales report on Tuesday. The weekly chain-store reports didn’t indicate any particular strength for April, but they don’t always give a close reading on the Commerce Department’s seasonally adjusted monthly tally. If market psychology is to turn around, it will need a big number on Tuesday. The business inventory report, which includes retail inventories, comes out 90 minutes later and could be an even better clue to what retailers are seeing.

The cycle of monthly housing reports starts up again on Wednesday with the homebuilder sentiment index, which is usually a reliable indicator of the housing starts report two days later. The sector is certainly ready for a bounce. Manufacturing, by contrast, put in a decent month in April and will launch a slate of influential reports on Thursday – the New York and Philadelphia Fed surveys, with the central bank industrial production report in between. The reports usually arrive each on their own day; I cannot recall the last time they were all released the same day and have no idea what led to it this time.

We’ll also get the two primary monthly inflation indicators, with producer prices released on Wednesday and consumer prices on Thursday. There are some sentiment reports too – small business optimism on Tuesday and University of Michigan on Friday – but I consider these to be largely backward-looking and too biased by market headlines. China reports industrial production and retail sales Monday night.

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