MidSummer


” There is no price set on the lavish summer, and June may be had by the poorest comer.” – James Russell Lowell, The Vision of Sir Launfal

The stock market turned in what was really a fairly good performance last week, though it may not have seemed so on the surface: The S&P 500 was down 2 points on the week, and the Dow was down nearly 100. But the Nasdaq rose in what is traditionally a challenging week for stocks, being the week after June options expiration, and the IPO pipeline remains red-hot, with the 2014 total already having surpassed 2011 and 2012, and running nearly double the 2013 pace.

Since the early part of the month, the S&P 500 has been getting overbought and then working off the condition with back-and-fill or sideways moves. Looking at both the calendar and the 6-month chart suggests one move up before a perhaps deeper pullback than the shallow one or two percent moves of the last ten weeks or so. The market usually hangs on into the 4th of July holiday weekend, so long as the last day of June isn’t too bad, and Friday’s at-the-close buying suggests that Monday, a traditional rebalance day, shouldn’t go off too badly. I wouldn’t be surprised to see stocks work their way past the 1980 level on the Dow (and the 17,000 level on the Dow that CNBC mentions about 50 times a day) as we get into the heart of second quarter earnings season.

The market may not deserve to be any higher, but as Clint Eastwood’s Will Munny (The Unforgiven) said, “deserve’s got nothin’ to do with it.” The claims data have been pretty good this year at indicating where the Bureau of Labor Statistics (BLS) is going to fit the latest data point with respect to the trend line, and imply a number above 200,000 for June (see The Economic Beat below), perhaps something in the 230K-240K range. That ought to restart the somewhere-over-the-rainbow myth of the accelerating economy, and on top of that the June weather looks to have continued the manufacturing rebound that got underway in May, meaning a good week of data next week. We might even threaten 2000 before momentum stalls out.

The period after second-quarter earnings isn’t so welcoming for stocks. A rise to 2000 – driven in part by round-number trading – would leave stocks overbought over the short, medium and long term, ready to correct. Earnings estimates that were at 6.8% growth for the second quarter at the end of March have now fallen to 5.1%, according to FactSet, and will probably drop about another half-percent over the next two weeks, leaving an easy target for companies to hit. But the ratio of negative to positive guidance has been running at 3 to 1 so far; even an improvement to 2-1 would leave stocks too high and ready to pull back at the end of the quarter.

The Fed’s James Bullard rattled stocks a bit on Thursday when he talked of a rate increase in the first quarter of 2015, possibly even earlier as the unemployment rate improves. Bullard isn’t currently a voting member of the FOMC (monetary policy committee), but he has often signaled Fed intentions in the past. The fact that it was the dovish Bullard talking up the rate increase and rapping the knuckles of investors by saying they aren’t listening to the Fed was not lost on the Street. Yet stocks mostly recovered later in the day, implying some desire for quarter-end window dressing and a lack of fear. The VIX option volatility index (or “fear index”) is plumbing lows not seen since early 2007.

The status quo is intact as we enter the third quarter – valuations are too high, but in the absence of a good catalyst the market will simply keep working its way higher regardless. I still expect a decent correction in the coming weeks, but I don’t think it will get out of hand without serious help on the geo-political front. I wouldn’t be increasing the equity allocation when you get your next quarterly statement. In fact, even though I believe that stock prices will probably get more overvalued before the descent back to earth gets underway, I wouldn’t be increasing quarterly allocations at all until this is all over.

Next week is a short-week, with Friday a holiday (Independence Day in the United States) and lots of traders heading for the exits by lunchtime on Thursday.

The Economic Beat

For splash effect, the highlight of last week’s economic batch was probably the “last” revision of GDP for the first quarter of 2014 (while GDP data is always getting revised, it’s the last revision for the quarter that gets its own press release). You may have already seen the damage – a surprisingly large drop of (-2.9%) annualized.

That number mirrored the drop in the 4-quarter growth rate in nominal GDP to 2.9%, the lowest since the first quarter of 2010. It’s probably a trough for the time being, and the timing of an inventory correction with the difficult weather was unfortunate. The real spending rate is now estimated at an anemic 1% (down from 3.1% originally), with the former increase in medical spending – widely attributed to Obamacare – now revised to a slight decrease (-0.16%, also blamed on Obamacare). Admittedly a backward-looking piece of data, it must be said that the equity markets took the news very much in stride.

The months following the first quarter should see some rebound in spending, and some time during the year inventory rebuilding will be a factor. That ought to produce a quarter or possibly two above 3% annual growth, but as much as I would like to see otherwise, there aren’t any real signs of a shift upward in economic vitality.

Personal income and spending data for May was released with mixed results. Income rose 0.4% for the month, but expenditures only 0.2% and were estimated at (-0.1%) in real terms. The number is subject to revision, but for now is a challenge in terms of spending growth. The year-on-year growth rates in real spending and disposable personal income fell slightly from 2.0% in April to 1.9%.

Housing sales had the usual spring improvement in May, with the annual rate for existing home sales rising from 4.66 million to 4.89 million. The year-on-year rate, however, remained in negative territory at (-5.0%) and mortgage-purchase applications were falling again through the first half of June. New home sales were estimated to have risen to a rate over 500,000 (504K) for the first time this year, but the monthly data are quite volatile and in the current case were boosted by a sudden jump in the Southeast region; such gaps are often revised downward. Through the first five months, new home sales are up an estimated 2.1% over the same period in 2013.

On the manufacturing side, the news was mixed as well, with new orders for durable goods falling 1% in the first estimate, though only (-0.1%) excluding transportation. Cap-ex business spending orders did show a pick-up of 0.7% for the month, but the longer-term growth rate (annualized growth over the trailing two years) continued to ease, now at 2.2%. The Richmond Fed survey at +3 and the Kansas City survey at +6 were both down from previous levels and below expectations, but shouldn’t be thought of as declines, just moderating from the April-May weather rebound. The Chicago Fed’s national activity index rose in the month of May – maybe – from negative to positive, though the more reliable three-month moving average fell. The revisions in this index are many and often significant, so early inferences are chancy.

Consumer confidence indices rose, though little was made of the fact by the market (and rightly so). The flash purchasing manager estimates from Markit Economics for both manufacturing and services rose.

The big report next week will come on Thursday, as the 4th of July holiday (Friday) pushes the jobs release up a day. The current estimate is for about 220,000 new jobs on the June payroll side. Weekly claims data are showing a 7.3% improvement year to date, while the two-week June measurement window for the BLS showed an 8.2% improvement, suggesting that the initial jobs release for June will be above trend as well.

It will be a busy week before the jobs report, with a lot of action (including quarter-end prices) being packed into the four days. Pending home sales for June (based on May data) start off on Monday, along with the Chicago purchasing manager’s index. The latter is followed by the ISM manufacturing survey on Tuesday and non-manufacturing survey on Thursday. Tuesday also has construction spending and May vehicle sales, important clues to second-quarter GDP. The ADP payroll report is out on Wednesday and the international trade report is Thursday; all U.S. markets and banks will be closed on Friday.

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