A Burst of Good Weather

“It’s a marvelous night for a moondance, with the stars up above in your eyes.” – Van Morrison, Moondance

It was a nice time indeed to be long last week, as well a nice time to get outdoors again. Just don’t get used to it. There is plenty of volatility left this quarter, and return trips to both recent lows and recent highs appear to be in the cards.

Let’s start with the rebound in stocks. Several not-so-surprising factors came together, the most important of them being Thursday’s release of the dovish contents of the minutes from the last Fed meeting. When investors saw that the nearly-assured rate increase before the end of the year was by no means assured, stocks shot ahead. A rate increase this quarter had been largely priced into the dollar, so when the former disappeared from the horizon the greenback tanked, setting off a rally in oil – priced in dollars, anytime the buck goes one way, oil prices go the other. And as all know, rising oil prices are good for stocks, because, well, because this time is different.

Last week was also part of the calendar window between the end of the third quarter and the beginning of earnings season. Stocks nearly always rally into the beginning of earnings, and the end of the lugubrious third quarter also meant the end of a lot of selling for optical purposes.

The technical pattern helped too, with equities able to continue the rebound from the end of September and the retest of the short-term low in a “natural” ascent to a retest of the short-term high on the S&P 500, about 2015. Hawkish Fed minutes would have easily swamped the technical factor, but once the dovish current began, the chart acted as a nice following breeze.

Stock prices should be okay into the first half of the coming week, too, and ordinarily, I would expect them to rally into the coming options Friday. I feel less confident this time around, however, as both the impending September retail sales report (due Wednesday) and the beginning of earnings season in earnest could undo the current retracement. Equities are also getting short-term overbought, something that hasn’t happened since the last earnings season. That upward move also expired on an options Friday, so maybe we can repeat that push this week before it runs out of gas. Stocks aren’t that overbought, and some of the early reporters, such as JP Morgan (JPM), often give a lift to the market, as they typically manage about as well as anyone.

After this week, however, we could end up retesting the lows again, perhaps even the dreaded 1820 level on the S&P. A small aggregate loss is pretty much built into earnings expectations for the third quarter – pay no attention to the consensus of (-5%), they’re really expecting about (-1%) – but even so, it’ll be hard to avoid the usual end-of-earnings season sell-off if we get a net earnings negative. Then there’s the period that runs from the end-stage of third-quarter earnings season into mid-November. It’s often a noticeably weak one anyway, before it gives way to the end-of-year run-up that traditionally begins around Thanksgiving.

Bullish sentiment is likely to need one doozy of a Fed statement in the last week of October to jump the impending trench, and the first estimate of third-quarter GDP – currently running around 1% – is due the day after the Fed statement. I don’t know how much more weakness-is-good data the market can stomach before fear sets in again. In sum, if you expect more volatility for the next four or five weeks, it’s highly unlikely you’ll be disappointed – except for this Monday, when government offices and banks will be closed for Columbus Day.

The Economic Beat

It was a quiet week for economic news, with next week slated to start quietly as well, allowing some room for stocks to climb higher for a couple more days yet. With a weakening economy, the less news there is the better.

Things started off last Monday with the ISM national survey of non-manufacturing purchasing managers. The headline index reported a perfectly reasonable 56.9, not quite as strong as some recent reports, perhaps, but with a sector growth-contraction score of 13-4 still solidly in expansion territory.

Or was it? The business activity index shifted from 63.9 to 60.2, and while sixty is still a very good score, that’s an impressive drop. It was not as impressive, though, as the one in new orders, which fell from 63.4 to 56.7.

These are diffusion scores; the drops shouldn’t be taken as measures of output. The new orders category isn’t that meaningful anyway, and many sectors don’t even report them. The real leading indicator in the non-manufacturing survey is price, and that went from 50.8 to 48.4, showing slight contraction.

When numbers like the above show up in the early stages of recovery, you celebrate the good and kind of ignore the bad as being part of the rebound from the depths. Reports like this are more coincident than leading. In the middle of a cycle, the drops are a blip. When a recovery is as mature as the current one, though, one should be on the lookout. The ISM non-manufacturing survey is more of a confirmation report than a predictor, and usually doesn’t tell you the economy is getting into trouble (or getting out of it) until it’s too late. The September survey was okay, but it was the sort that makes you a bit nervous about what the next few months will bring.

Weaker prices were also evident – again – in the report on September import and export prices. Though imports fell by only 0.1% in the month, helped by a bounce in petroleum prices, non-petroleum prices moved to (-3.3%) year-on-year, the weakest reading since the recession. Overall, import prices are down year-on-year by double-digits at (-10.7%). Export prices fell more than expected, by 0.7%, and are down 7.4% year-on-year, with the core reading (ex-agriculture) at a very steep (-6.7%).

Wholesale sales also came out on Friday, and the news there wasn’t any better. August sales fell a steep 1.0% (seasonally adjusted), continuing the 2015 streak of every month comping negative. Trailing twelve-month sales growth went negative, a dark sign indeed. July inventories were revised downward to (-0.3%) and August inventories were said to have gained 0.1%, leaving the inventory-to-sales ratio at a still elevated 1.3 (seasonally adjusted). That will put more downward pressure on sales in the fourth quarter, with third-quarter GDP estimates coming down somewhat as well in the aftermath. The trade gap also widened in August, leaving the current Q3 forecast from the Atlanta Fed running at 1.0%.

Wall Street seemed more interested in the Costco (COST) same-store sales report for September than some crusty old Commerce report. The chain reported an ex-gas gain of 8% over the previous year. Costco is an old Street favorite and the results were no doubt helped along by a late Labor Day weekend. However, the Redbook readings have been better indicators of the monthly ex-auto sales totals from the Commerce Department, and the September readings were weak. The September retail sales report comes out Wednesday, and could bring an abrupt end to the stock market’s current move.

Things will start getting busy earnings-wise on Tuesday, and then the rest of the week heats up with high-profile earnings reports and economic reports. After retail sales and producer prices on Wednesday, Thursday brings the consumer price report (CPI) and a rare doubling up of the two highest-profile regional Fed surveys, New York and Philadelphia (due to government offices being closed on Monday). Friday brings September industrial production and the labor turnover (JOLTS) report for August; the Fed’s labor market conditions index was estimated to show no change in September after a big downward revision to the July reading, to 1.2 from 2.1.

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