Thunder and Lightning


“O Caesar! these things are beyond all use, and I do fear them.” – Calpurnia, in William Shakespeare’s Julius Caesar

Okay, so the graves didn’t quite yawn and yield up their dead last week, in the manner they did for Shakespeare’s Calpurnia in the ill-starred days leading up to the death of her husband, Julius Caesar. Nevertheless, it was an evil week for omens, though perhaps not so evil that all might see them, as happened with the unfortunate Calpurnia, whose vision went unshared by her even more unfortunate husband.

It isn’t all that unusual for the first quarter earnings rally to start to lose steam at the end of April. It is unusual for there to be but one good week in the month, the one sandwiched between last week and options expiration week. Equities still managed a positive gain in the stock market’s favorite month, but it wasn’t very impressive. I wrote last week that if stocks didn’t settle at record highs, it would be ominous.

It is ominous, there were lightning flashes and growls of thunder, but there is both good news and bad news. The good news, as Friday’s rally (helped along by most European markets being closed) exemplified, is that stocks can still rally on the first of the month, indicating that the local climate is still hanging on and those thunderclouds are still on the not-so-close horizon. The bad news is that it looks like it’s the big one building up out there.

Let me be plain – the big storm is brewing up out there, but it isn’t here yet. I still believe the market to be more likely than not to scratch out some more new highs this year, a process that could go on for some months. Last week’s decline was hardly the end of the world, nor the end of the bull market, but it was still more a sign of strength that is fading, not budding.

Doubts about U.S. growth were fanned by a weak U.S. GDP report (see below), and doubts about global growth were fanned by more weakness in the Chinese economy – though not its financial one mind you, where all bad news is enthusiastically welcomed as ever more grounds for ever more stimulus and thus inexorably higher stock prices (you can do math, can’t you?).

I’m not buying it. The end isn’t coming tomorrow or next month, but it is headed our way. It might even get here this year. It’s too early to make that call quite yet, and if I had to guess I’d say not before the fall, but every week I uncover fresh signs of the cycle rolling over. It doesn’t have to, as nothing ever has to happen but death and taxes, but it sure is looking that way.

It’s an old saying on the Street that they don’t ring a bell at the top or bottom of a market cycle. It’s true. Bear markets typically (though not always) start out with months of sideways action followed by months of a slow grind lower, so slow as to have a fair number go right on talking boldly about buying the dips. The real nasty damage comes at the end. Similarly, bull markets usually start out with months of troughs and fitful starts that make one wonder if prices can ever turn positive again.

The last cyclical market peak was eight years ago this fall. The last peak in the business cycle was nine years ago, though it kept growing into the last quarter of 2007. Those are old cycles. Yes, yes, it’s thought on the Street to be clever to say “bull markets don’t die of old age,” but they never live forever either and rarely last as long as eight years. It’s getting high time to start selling peaks instead of buying dips, a point we’ll revisit more than once in the coming months. Watch out for those shrieking ghosts.

The Economic Beat

The report of the week was the release of first quarter GDP, below consensus at 0.2%, with even that low number benefiting from a rare negative price adjustment, meaning nominal (not inflation-adjusted) output was only 0.1%.

I covered the report in some length on Seeking Alpha, but the highlights are that four-quarter GDP rose to 3.91%, in line with its 3-year and 5-year average. By the time of the release, the report had already been excused on grounds of weather, the West Coast port strike, falling oil prices and the rising dollar.

That’s a fairly long list of “one-off” factors. Falling oil prices did indeed lead to a dramatic curtailment in energy exploration and production work, taking a big chunk out of total investment dollars, but the notion that cheaper energy is bad for our economy is a tough sell in this corner. I have always maintained that cheaper oil would be a mixed bag now that the U.S. has become one of the top producers, and it is hard to dispute the drop in energy-related production spending, but a falling cost of energy isn’t bad for the economy at large.

Surely the biggest mistake (and most annoying to yours truly) over the fall in gasoline prices was the notion that cheaper gasoline prices would boost consumer spending by functioning as a kind of tax cut. Cheaper gasoline only alters the mix of spending; unless consumers earn or borrow more, they can’t spend more like they might with an actual tax cut. The best impact is being felt in businesses that use energy instead of producing it. Obviously fuel-dependent sectors like trucking and airlines benefit right away, but it’s also giving a big boost to the auto business selling bigger, more profitable vehicles, and the energy-intensive food business, as this comment from the food, beverage and tobacco sector indicates in the latest ISM survey: “Low energy costs continue to help the bottom line.”

If energy remains cheap for an extended period of time, businesses will be able to increase investment in their business. For now though, I suspect that most are simply banking the largesse or (more likely) distributing it as bonus payments and dividends. I saw some Street research optimistic (!) about a rebound in oil prices to $70 or $80 restarting the energy sector, but just as it takes time to convince businesses that lower energy prices are here to stay, it will take time for energy producers to restart investment spending on the premise that it will be profitable by the time projects come on line. The immediate impact will be on inflation, in particular food and energy, and a shift away from discretionary spending (like restaurants). I also have no doubts that the same companies that kept the benefits of lower prices will rush to pass on any price rebound. With demand anemic, it’s the simplest way to boost the bottom line.

The net of it all is that GDP should rebound in the next couple of quarters, but not as much as it did last year. The intermediate trend of nominal growth has been stalled at about 3.9%-4.0% for about eight quarters now. That looks very much like the plateau for the cycle, and cycles don’t end with permanent plateaus or second lives. That’s why they’re called cycles.

An unusual aspect of the FOMC report was that the market didn’t rally afterwards, even though the GDP report seemed to convince many that any rate increase was now on hold until at least September. I found the language of the first paragraph to be dour by Fed standards, something typical of late-cycle reports. The cycle will end with or without interest rate increases.

Personal income and spending for March presented an interesting contrast, with personal income rounding down to unchanged and real disposable income declining by 0.2%. Spending, on the other hand, increased by 0.4%, about a tenth ahead of consensus. The year-on-year rate of real income growth declined sharply, though, to 3.3% (from 3.9%), falling for the fourth month in a row, while spending fell to 2.7% year-on-year, a six-month low. It was a soft month.

Income for the quarter remained at the same nominal rate of 4.0%, however the employment cost index rose 0.7% in the quarter, the third such rise in the last four months. That took the year-on-year rate up to 2.7%, though as in personal income, most of the boost was due to a weak fourth quarter of 2014 dropping out of the comparison. Still, three in four months does indicate budding wage pressure.

Manufacturing surveys were mixed. The energy-centric Dallas survey posted another nasty negative (-16.0), not much improved from the prior month’s (-17.4). Production continues to contract, according to the survey. Over in the Richmond district, another negative month also followed (-3 from -8), with new orders and shipments remaining in negative territory. Chicago, however, posted an expected rebound to 52.3 (from 46.3). The national survey, called the ISM survey, posted a 51.5 result for April (50 is neutral), about in line with expectations. Though its activity index was close to unchanged, new orders and production improved and the growth-contraction score was an impressive 15.3. On the other hand, employment and prices scored negative (below 50). It’s a diffusion survey, so it’s mostly about breadth and little about depth. The best conclusion might be that manufacturing is growing, but at a slower rate, and in any case the survey is not much of a leading indicator. Construction spending reported a sharp 0.6% decline in March, though the initial estimates are subject to wide revisions.

Next week features the jobs report on Friday, and I have seen some indications of a weak report. That said, predicting the report is a mug’s game and I would not be surprised to see another 250K+ number instead. The cautious consensus is for a respectable not too hot, not too cold number of 215,000, though some are predicting much more.

Next week will lead off with March factory orders on Monday, followed by trade data and the service sector purchasing index (ISM non-manufacturing) on Tuesday. The ADP teaser report is Wednesday, along with a speech by Janet Yellen, one of many Fed speeches scheduled for the first half of the week. First quarter productivity is also on tap for that day. The jobs report tops off the week, but the wholesale inventories report later on Friday will also give a clue to what has happened to the very elevated inventory-to-sales ratio (and the contribution to second quarter GDP).

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