Wait ‘Til Next Week

“Only the true Messiah denies His divinity.” Monty Python, The Life of Brian

A lot of theories were put forth on Friday as to why the market would be selling off – however modestly – instead of pulling off its usual afternoon reversal and managing to eke out a gain. Maybe it was the stronger dollar being bad for overseas profits, though the euro actually gained back a little ground on Friday. Others advocate the idea that a stronger dollar is attracting inflows into US stocks and bonds, even as they sold off during the week; there have indeed been episodes in the past where stocks would trade inversely to the dollar.

Was it ISIS? The Ukraine? Scotland? Two crosscurrents popular on Friday have been popular all year, the first one being that the economy is really starting to get stronger (we’ve been listening to this for four years running now), and the second one being that the economy is still too fragile for the Fed to seriously consider raising rates (I sometimes see these ideas repeated by the same people on the same day). Falling oil prices are being cited as evidence of global weakness.

A lot of blame went on the retail sales report for August. Since it beat consensus (sort of), the theory is that the Fed would certainly be leaning more hawkish at next week’s meeting. As the stock market rally has been about the Fed for the last few years, at least that one is on the right track. The notion that the retail sales report might have been especially strong is seriously mistaken, as you may read about below in the Economic Beat, but the thread is right. As the putative end of quantitative easing (QE) draws near, the market does appear to be a bit nervous about a potential change in language (anyone who thinks the Fed will set a date next week for raising rates, let alone raise them, is dreaming). It does look like some there is some selling the rumor ahead of the news.

That could lead to a rally after the Wednesday afternoon statement, if the Fed doesn’t seem too aggressive. Relief buying on the news (it could have been worse!) is classic stock market behavior. Whether it might only be a reprieve, as QE is still set to disappear in the next few months, is another question. An important unknown is whether Yellen et al. decide to finish QE in one swoop or keep some residual amount going for the rest of 2014. My guess is that the timid Yellenites will try to throw some sort of bone in that direction, but that’s just speculation – it’s mad to bet on policy decisions. The most sensible compromise is to maintain the status quo of rolling over maturing coupons and principal while letting go of the extra purchases. So I expect something different.

There was also some excitement over the quarterly services survey released on Thursday. Apparently the latest estimate of second-quarter health care spending is now higher, which could lead to an upward revision of GDP for the quarter. Forgive me for being skeptical, but more spending on health care – much of it forced – doesn’t strike me as a classic lift in output. It feels more like celebrating higher gasoline prices. Still, a higher print is a higher print, right?

Did you know that gasoline prices are nearly 3% below a year ago? Right on cue, the usual articles and pundits have come out in the business press talking again about how this is going to rejuvenate consumer spending. It drives me crazy. If you have a hundred bucks to spend every week, two dollars less in gasoline and two dollars more for a bag of chips or extra cup of gourmet coffee might be good for the chips or coffee vendors, but you’re still spending the same hundred bucks. Growth in income – earned and/or borrowed – is what drives real spending growth and thus genuine output. Not growth in consumer sentiment, not mix changes like higher health care spending or a fill-up that’s $2 less.

If the Fed doesn’t blink next week – like it did last year at an identical time and place – then QE money will end soon. It’s quite possible that the committee does quail, however, at the thought of stock prices selling off for another week. The FOMC is not exactly being led by a bunch of monetary hawks these days, and a lot of attention has been drawn to the fact that the two previous terminations of QE have been followed by double-digit corrections in stock prices. It could happen again – stocks aren’t exactly cheap, and anyway there’s a fair-sized collection of Things That Could Go Wrong in the World these days.

Every time one of these powder kegs doesn’t blow up is always another occasion for another market rally, but if one of them ignites, even at half-strength, that would provide the catalyst for a good-sized sell-off. I don’t think it’ll be the Scotland vote – though if the secessionists win, it will be certainly cause a dramatic reaction in asset prices – but one never knows. Many argue that Scotland shouldn’t matter, but that’s naive – the economy is still anemic, earnings growth is nothing to write home about, and valuations are high. If Scotland votes “yes,” the Fed would probably back down from any thought of sounding the least bit tough and opt to keep QE going longer. Sentiment matters in a sentiment-driven market. I don’t know what the Fed will actually say this Wednesday, but I do know that they will likely either revive the rally or quench it until Thanksgiving.

The Economic Beat

The report of the week, as expected, was the retail sales report for August. I’m afraid you’re going to read a lot of rubbish about it, going by most of the early reporting I saw and heard. As usual, many seem too infatuated with the fact that the report beat consensus – sort of – to bother with examining the data. The ex-auto, ex-gas number was 0.5% versus consensus for 0.4%, though the 0.6% total increase was either spot on or a bit short, depending on whose version of consensus you use (I was expecting 0.7%). But July was revised upwards by three-tenths, oh my!

The trend in consumer spending is still lower, not higher. The year-on-year change in August sales (unadjusted) was 3.2%, the smallest such gain for the month since the recovery August of 2010 (2.8%). The twelve-month rate of change fell to 3.7%, also the lowest since August 2010, when a fearful Ben Bernanke first instituted QE2. The same rate excluding autos fell to 2.7%. Don’t forget either that we’ve only been enjoying warmer weather since mid- to late May, a bounce that is fading, as the year-on-year change indicates. The real silver lining is that the twelve-month growth rate in sales excluding autos and gasoline is about the same as it was a year ago: 3.47% in 2014 vs. 3.35% a year ago. More than half of it is inflation, so take any talk about a “newly resurgent consumer” with many grains of salt.

The other big report of the week was the employment hire-and-fire report known as JOLTS. The good news is that the rate of openings is back to 2007 levels, the bad news is that hires have not caught up to seven years ago. It also suggests we are at or near the peak of the cycle again – it’s hard to say, as the survey only goes back to 2004.

A week ago I wrote that the jobs report was better than the headline number made it appear, and that still appears to be the case. Some outsized seasonal adjustment factors have been at work in recent weekly jobless claims data, but the trend looks fine. Year-to-date claims are still down 8.0%; a year ago the decline was 7.4%. As of September 6th, the four-week moving average of unadjusted claims is down 7% from a year ago, not enough variation to make much of a claim beyond status quo.

Inventory and sales data suggested that the inventory portion of the second quarter was a little less than expected, but that July sales were fairly decent. That said, I can’t find anything in the data that suggests anything beyond the usual oscillations of inventory use-and-refresh cycle.

Mortgage activity fell to a 14-year low; the year-on-year decline in purchase applications remains around 12% lower than a year ago. I’m afraid that mortgage lending in this cycle just isn’t going to happen on even a medium scale, let alone big one.

Import and export prices both fell in August. The year-on-year rates remain within a band of plus or minus one percent, depending on the category and whether petroleum products are excluded. Global trade must be booming.

Next week has the all-important FOMC meeting on Wednesday, which presumably will know about the fresh housing data (housing starts are released the next day, but the committee should have the data), including the homebuilder sentiment index from that morning. It will also have August industrial production, which is released on Monday. Consensus for that one is 0.3%, which seems a bit light to me in view of the strength in the auto sector. A consensus beat might further depress a market fearful about diminishing central bank largesse. The FOMC will also update its staff forecasts.

The New York Fed releases its manufacturing survey on Monday, with the Philadelphia Fed following on Thursday. China releases retail sales and industrial production data Sunday night.

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