“We had joy, we had fun, we had seasons in the sun.” – Rod McKuen
Some two or three thousand years ago, when the Greeks were busy inventing tragedy in its stage form, writers like Sophocles or Euripedes were fond of showing what can happen to those who make remarks along the lines of “gee, this day just can’t get any better.” To do so, it seems, was to invite the wrath of the gods, who seemed to take a special delight in reminding us mortals that we had better leave boasting about certain matters to those who lived on Mount Olympus.
So it was that one week ago, I invited a bolt or two by proclaiming that August was upon us and there was little on the horizon to disturb the torpor inherent to the month. Naturally the follow-up was China announcing a “one-off” devaluation in its trading currency, the yuan. Being the latest in a string of moves designed to stave off the inevitable (anyone remember Japan in the early 1990s?), the markets did not entirely believe the country’s profession of one-offness, and they were right: the country enjoyed its cheaper currency so much that it followed up the one-off with some more. Perhaps there was something lost in the original translation.
Fearing currency wars and more evidence of economic weakness in the Middle Kingdom, stock prices swooned and Treasury prices soared – for about a day and a half. Then wiser heads prevailed and more important fundamentals reasserted themselves. You know, like chart support levels and belief in the overarching supremacy of Fed monetary policy (so, this means they can’t raise rates in September, right? So, buy stocks again, right?). Oh yes, did I also mention that it’s August? The markets finished slightly up on the week.
The market showed its true state when the second day of nerve-rattling Chinese yuan devaluation led to a plunging morning session that had stocks down over 1% and the Dow Jones negative on the year. But then the usual trading magic occurred: the more important S&P 500 index rebounded from its 200-day moving average (the exponential one, or EMA), and those traders who bet on the rebound immediately followed up by telling everyone who would listen that the yuan devaluation would mean that the Fed would simply have to wait to raise rates, so you better get on board and not miss this rally, buddy. It was an impressive reversal.
But not that impressive. Usually such changes of fortune are followed by several days of further gains, but this time around the rebound was largely capped at where it ended the day. Without the usual Friday afternoon upward drift (on August volume, which is to say none), the markets would have been flat after the reversal. At other times this might lead me to advertise caution that the real selling isn’t over yet, but this is August. More importantly, we have just wrapped up the first half of August and are now entering the traditionally moribund second half, a time spent on islands named Long, Block, Nantucket, Catalina and the eccentrically-named Martha’s Vineyard.
The August pattern isn’t unusual – it’s occurred even in lousy years like 2008, which tells you how difficult it is to fight it. It takes seriously negative news to shake the stock market out of its hallowed pattern (and vacation siestas), and we are done with the major releases for the month. Earnings season is virtually over, and the two biggest items left on the month’s schedule are the FOMC minutes next week and another GDP revision in the last week.
Regarding the latter, if it or any other release is weaker than expected, that’s good news because it means the Fed can’t move in September (or so will say the soothsayers), and if it’s upward that’ll be good news too, because it’ll be hailed as a sign that the U.S. economy is gaining momentum. Critics might point out that it’s been three years now that the economy has been “gaining momentum” on this or that report without ever seeing any discernible change in trend, but you know how it is. Some folks are just mean.
The stock market does feel heavy after the last two weeks of dips and bounces, no doubt about it, leaving the impression that a bigger decline is just around the corner. Yet the history of the month is that we arrive at this state by the middle of nearly every August, and by Labor Day the markets are singing again. Explanations will be found for what is really mostly algorithm-driven trading that expects August to behave like well, August. We will all feel more reassured – if the markets are rising, then the economy must be okay. Stock prices couldn’t be wrong, could they? Perish the thought.
Nothing is ever a sure thing in the markets, including August and the year-end Santa Claus rally; reliable tendencies do get trumped by events, like the August 2011 credit downgrade of the U.S. by Standard & Poor’s. That one led to a price slump deep enough to get the Fed chair of the time, Ben Bernanke, to institute the beginning of quantitative easing. But China’s mild gesture of currency support at the end of the week didn’t look like a country hell-bent on further weakening (as ever I disclaim any ability to make predictions about policy moves).
The debate about why China cheapened the yuan will continue, along with speculation about what the country’s real agenda is, along with its genuine capacity for realizing said agenda. While no one will come out and say that they have limitless confidence in the ability of the Chinese government to avoid economic problems, most are positioned in a way that implies faith until proven otherwise. Whatever the country wants to do in the end – its latest export data were definitely not good – will show itself in time, but I suspect that the country will aim to move in policy increments, since rattling the global financial system isn’t going to improve its economic position.
In sum, it will take bigger shocks to shake the financial markets out of the August syndrome. Until and unless you read about them, it’s probably best to sit back, enjoy your island and August break, and not take any rally as serious evidence of anything but the time of the year.
The Economic Beat
The highlight of the week was the yuan devaluation, but the domestic highlight was the July retail sales report. Days later, I still cannot believe how it is being positioned as encouraging news. It isn’t. Nor was the industrial production report, still being characterized as positive.
As a tale of one month only against consensus expectations, the retail number was good: plus 0.6%, versus expectations for 0.5%. Sales excluding autos were up 0.4%, as were sales excluding autos and gas, both hitting the consensus estimate.
As a tale of retail spending trends, the report was not good. The trailing twelve-month (TTM) growth rate declined again to 3.1%, the fifth consecutive month of decline. A slowdown to that rate is stall-speed, with a rate below 3% a signal historically that the end of the expansion phase of the business cycle is imminent. In other words, recession. The TTM rate for sales excluding autos fell below 2% (1.97%). The margin is close enough that a revision might push it back above 2%, but let’s not quibble here.
Looking at the TTM rate for sales excluding autos and gas, it declined but is still hanging in there at a reasonable 4.4% (4.37%). But before you write off weakness on falling gas prices, keep in mind that the growth rate of total spending continues to decline – falling gas prices are no substitute for rising incomes, and the latter continues to stagnate at about 2% growth. Labor costs are up an estimated 2.1% for the year ending June 30, according to the productivity and costs report, which also saw a big revision downward to the first quarter. Productivity is barely moving, up 0.3% on the year. The number is admittedly subject to large revisions, but 2% is consistent with both the employment and the personal income reports.
Industrial production did increase by 0.6% in July (first estimate), versus expectations for 0.4%. However, manufacturing excluding autos was weak (+0.1%). The real news is that the year-on-year rate fell to 1.3%, 1.5% for manufacturing. That is most definitely not good news, but further evidence that the cycle is about to turn. I burst out laughing in my car when I heard a public radio announcer solemnly intone that the increase in business inventories (+0.8%) for June was a sign of business faith in spending. It’s a reflection of weak sales, though the number was admittedly tilted higher by strength in autos.
On the brighter side, the latest labor turnover (JOLTS) report showed the hire rate improving to 3.7% from 3.5% a year ago (seasonally adjusted). The quits rate is also up by two-tenths to 2.1%. Weekly claims remain at cyclical lows,, though I confess to an intuition that the peak phase that began a year ago is nearly over. Keep in mind that employment is a lagging indicator.
On the darker side, import-export prices paint an alarming picture of the weakness in trade and the accompanying deflationary pressures. Import prices are down 10.4% (!) year-on-year through the end of June. Yes, prices were dragged down by energy, but they are still down 2.8% in aggregate excluding petroleum. Export prices are down 6.1% year-on-year.
The highlight of next week, assuming no more thunder from China, should be the Fed minutes release on Wednesday, coming after the release of the consumer price index that morning. Manufacturing surveys are due on Monday (New York Fed) and Thursday (Philadelphia Fed). Housing is busy with sentiment data on Monday, starts on Tuesday and existing home sales on Thursday. It’ll all get filtered by views on the Fed’s September meeting – will they or won’t they?