Middle Air Turbulence


“What I want to know is, where does the time go?” – The Grateful Dead

The stock market finally stopped rising last week. The more surprising aspect was not that it finally took a week off, but that it was able to rally as much as it did, with the S&P moving up nearly 7% from its mid-May low to last Monday, a period of less than four weeks. The main reason for the pullback was that the market was already so overbought that prices were ripe for harvest. The main reason it had gone up was a combination of short-squeezing, electronic trend following, low volume, and a dovish-sounding European Central Bank, reasons to warm the heart of any analyst looking for solid grounds to base a return on investment.

Certainly there were some disappointments along the way last week. If there were any of them that could genuinely keep the market worried, it wouldn’t include House Majority Leader Eric Cantor’s primary election loss – while that may be of genuine political import, it’s also the kind of thing that a bull market forgets an hour after the next day’s open. Nor was it the consensus-missing May retail sales report (see below for details) – missing consensus may be a reason to take some tactical profits, but the stock market hasn’t taken weak growth seriously for years. Our equity castle hasn’t been built on profit growth.

What could really faze the market is a destabilized Iraq leading to higher oil prices for an extended period, with or without any US military action. Note that I say “faze,” not “crash.” One shouldn’t underestimate the peril in Iraq, but don’t underestimate either the ability of the stock market to quickly and efficiently change the channel in the absence of fresh horrors on the screen: By Friday, on-air traders on CNBC were already turning wearily dismissive of the whole affair on (you can bet they weren’t the ones short the market).

I suspect that the $10 hit to oil prices isn’t going to go away early, and neither are the Sunni rebels. You can surely read better analyses elsewhere about some of the more dire possibilities, ranging from the fall of the current government in Iraq to a deepening Shia-Sunni civil war. Perhaps Iraq will turn into a combination of Yugoslavia and Kosovo, replete with months of air strikes, tales of civilian slaughter and battles over what the true map of the region should, battles that will seemed anchored in long-ago ages of civilization.

The other resemblance to the disintegration of Yugoslavia could easily be a U.S. stock market that just doesn’t care. So long as it is far away and there is no recession, well, buy some oil stocks and wait for the end-of-the-war rally. Though a long-term ten percent step-up in the price of oil would indeed extract a toll on economic growth, equities are perfectly capable of staging a bigger rally on the prospects of the conflict ending than they ever actually shed while reading about the interim horrors.

That may sound cynical, but realpolitik is best when talking about the stock market – which is why I’m about to list reasons that it could continue to work its way lower in the next few weeks. Reason number one is that despite last week’s massive decline of nearly an entire percent, prices are still elevated and – much more importantly from a trading point of view – overextended technically. The short-term posture improved enough to allow some sort of mini-rebound around next week’s Fed meeting, but over the intermediate and longer-term, prices remain in the highly overbought regions.

Another reason is the calendar. Appeals to historic trading patterns tend to go awry if too many people try to trade on them, but the period looming after the June quarterly options expiration (next Friday) is often a red one for stocks. The Fed could obviate all of that with an ill-advised surprise decision next week to postpone the taper, so I would certainly wait to see what carrots and sticks the central bank may hand out first. Last September’s taper capitulation – you know, the one just in case the budget process went wrong – stands out as the kind of fine-tuning the Fed has lamentably come to believe itself capable of trying.

Finally, the narrative backdrop of the don’t-worry economy hasn’t been the most inspiring of late. The stock market can keep going up in the face of meager growth, but not in a straight line. Even this week’s Barron’s Roundtable issue led with a headline of “experts see a sluggish economy and a toppy market.” Nobody is talking about banner second-quarter profits these days, not yet anyway, and the rest of the month’s economic news is mostly housing-based. Though mortgage-purchase applications did stage a surprising spike last week, we’re going to be getting the May data next and they seem likely to remain on the tepid side.

The most recent rally came on the back of no real bad news, and we could well end up giving much of it back on the back of no real good news. Intel (INTC) helped stocks out by raising its guidance last week, but tech analysts were largely dismissive of it as a one-off forced by the expired Windows XP. If the Fed does what’s expected next week and simply recycles its previous meeting, it’s hard to see how the market can escape some bumpy air ahead. It’s not likely to be the kind of thing that presents a peril to the flight, but could be enough to make you want to hold off ordering any flutes of champagne until it’s over.

On a personal note, I am both pleased and stunned to report that my son graduated from high school last week. That he was able to do so is pleasant and in no way a surprise; that he could possibly be that old is a shock I have yet to get my arms around.

The Economic Beat

The report of the week was the May retail sales report, released on Thursday. With an increase of 0.3%, it seemed to miss consensus estimates of +0.7%, but it really didn’t, as April was revised upward: The first estimate for May sales was indeed +0.71% higher than the original April estimate.

As I wrote last week though, the month-over-month number wasn’t going to be as important this time, due to the various distortions from the weather and even Easter. The critical comparisons were the year-on-year for May, along with the first five months of 2014 against the same period a year ago. May 2014 is a provisional 4.5% higher than May 2013, which in turn was 4.9% higher than May 2012 (unadjusted). Through the first five months, unadjusted sales have grown 3.38% before revision, compared to the year-ago rate of 3.74%. The difference could be revised away, so it would be premature to claim definite evidence of slowing growth, but it does seem quite safe to say that it hasn’t picked up either.

Those kinds of nuances seem to elude black box traders, and I wonder if they aren’t also eluding a certain Canadian economist whose conversion to being a stock market bull apparently has him cherry-picking the data. He called the first quarter a “complete outlier” due to any number of special factors, which I would remind him has been the case with every quarter with an annual growth rate below 0.5% since 2009 – they are called outliers and blamed on special factors. The problem is that they regularly recur every four or five quarters. There is much more to annoy me, but I’m not going to engage in (more) tedious sniping, only wanting to contradict his statement that the end of emergency unemployment benefits and the tightening of mortgage qualification rules are “one-off effects” that “are over.”

Those effects are no more over now than last year’s increase in Social Security tax rates was over in February. The change may have occurred in one month only, but the longer effects of lost income (emergency benefits) and a tighter-than-ever lending filter for homebuyers are going to last throughout the year. The first week of June chain-store sales data wasn’t robust, and the growth rate in rolling twelve month retail sales excluding autos edged down to 2.7% in May, the seventh consecutive month it’s been below 3%. As Dr. Yogi said, “it ain’t over ’til it’s over.”

Wholesale sales and inventories both picked up in April, getting the inventory portion of second-quarter GDP off to a good start. Perhaps this will be cited up in Toronto as evidence that the economy is on its way to a new plateau of 4% growth, but I will report from Missouri with this data. The inventory-to-sales ratio has been following a steady tidal pattern for the last several years: After the high-water February reading of 1.3 in the unadjusted inventory-to-sales ratio, we should expect it to recede for the next 3-4 months before rising again.

The rate of twelve-month wholesale sales growth picked up to 5.2%, the first time it’s been above 5% since December 2012. That is definitely better than a poke in the eye with a sharp stick, but I hesitate to call it definitive evidence of anything, given that the rate also increased every month from August 2007 to September 2008. At that time the rate was more than double the current one, nearly 11%, even though we were already three calendar quarters into a recession. Business inventories as a whole rose 0.6% in April (seasonally adjusted).

The April JOLTS survey (labor turnover) revealed the same kind of tiny incremental improvement that has plagued this recovery. The hires rate of 3.8% and the quits rate of 1.8% for April 2014 compares with 3.6% and 1.7% respectively for April 2013 (unadjusted). In the last expansion, the hires rate didn’t fall below 4% once, and didn’t see that sort of lethargy until the second quarter of 2008, six months into the official recession. Still, some improvement is better than none.

Price data brought some contradictions – year-over-year import prices went positive for the first time in ages, while producer price data unexpectedly declined in May. The latter series, recently restructured, seems to be a bit noisy yet and the monthly change might not have been much more than a boomerang from a strong April reading. Rather than say the reading is a definitive sign of anything, it may be more reasonable to say what it isn’t a sign of, namely accelerating growth. At around 2%, the year-on-year rates remain relatively stable.

Next week will bring the start of May housing data, beginning with the homebuilder sentiment index on Monday and continuing with housing starts data on Tuesday. There will also be regional business surveys from the New York Fed (Monday) and Philadelphia Fed (Thursday), with the national bank reporting industrial production Monday. The main event is of course the FOMC (monetary policy) meeting on Wednesday, at which little is expected this time around apart from another continuation of the taper. If the situation in Iraq deteriorates, perhaps the bank will throw some candy to the market with some reminder hints it could slow the taper down or even reverse it if necessary. Or not – trying to guess policy decisions is like trying to find the right card in three-card monte. The only safe bet is that the dealer wins.

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