“For there is nothing either good or bad, but thinking makes it so.” – William Shakespeare, Hamlet
Well, we’re at it again. The European Central Bank (ECB) talked up the possibility of new and radical stimulus on Thursday and the Chinese central bank (PBOC) followed that up the next day with more easing of interest rates and reserve requirements. Coming near the end of the usual quarterly earnings rally, the news gave a strong push to stocks at the end of the week, leading traders to start eying the possibility of closing the gap in the chart below.
However, before you assume that August-September was all a mistake and put your buying shoes on, think again. Earnings growth is still projected to be slightly negative this quarter – they look to come in about (-1%), give or take a few tenths – and that’s no good basis for stock price appreciation. Oh yes, we can exclude energy and materials and industrials and tell ourselves that soon the dollar will weaken and oil prices rise and that will make everything fine again (!). It’s a familiar pre-recession script – pay no attention to those naughty sectors that have fallen down, they’ll get back up eventually. They will, too – someday.
But two consecutive quarters of S&P 500 earnings declines aren’t something to be brushed aside. It hasn’t happened since 2009, and while the declines are much smaller this time and not every quarterly earnings decline is the end of the world, we’re still looking at the event happening eight years after the last cycle ended. That kind of timing should make you sit up and take notice.
The stock market is now short-term overbought, and once the Fed statement is behind us (Wednesday), the usual quarterly earnings rally will give way to the usual end-of-earnings season pullback. You might not be able to take the tendency completely to the bank, but the declines that come in late October and early November have a tendency to be nasty. I don’t expect the latest economic data (see below) to be of any help this week either. At some point this late in the cycle, the realization that monetary policy is only a cushion and not a magic cure for the end of the business cycle will set in, as it does at the end of every other cycle, and people will wonder why we didn’t see it coming. Many do of course, but it’s not the kind of news that people like to dwell on.
We should still have some time before things start to get really tough. The good news is that I don’t yet see anything that looks likely to derail the sacred end-of-year stock market rally, and while the business cycle may be ending, full employment makes a decent holiday spending season more likely than not. The combination will provide more good-feeling cover as we enter the new year (if stocks are up, what can be wrong?), and bear markets are usually quite slow to develop. It could be another year before one finally becomes obvious to all. The bad news is that I can’t see anything either – central bank flailing included – that will give the business cycle an emergency extension on its demise.
The Economic Beat
A quiet week for data had the ECB and PBOC monetary policy statements being the economic events of the week, followed by positive earnings reports from Amazon (AMZN) and Google (GOOG). Housing reports were the main feature of the economic news.
The week led off with an optimistic survey reading from homebuilders, with the index at a decade-high of 64. It’s a good illustration of how surveys are not useful as activity measures, as the level of homebuilding then was three times what it is now. Activity is improving broadly, the index tells us, but not how fast or the absolute terms.
Housing starts were released the next day, showing a good monthly increase of 6.5% (seasonally adjusted) and bringing the year-to-date rate up over 11%. The bump was all in multi-family units, which conversely saw a big drop in permits, so the increase may have been the last burst of the building season’s peak time. New home sales are due up next on Monday.
Continuing the parade, so to speak, were sales of existing homes rising to a 5.55 million home rate in September, a 4.7% increase over the downwardly revised August rate. I’d hesitate to say anything has really changed in existing home sales, with the last two months probably just showing the kind of up-and-down noise that comes with small sample sizes. Federal data showed the year-on-year rate of price appreciation easing to 5.5% from 5.8%.
While stocks were partying on Thursday over the stimulus fantasy, the Chicago Fed released its national activity index, showing a September read of (-0.39) and the three-month average at (-0.09). Good news of course (yes, that is tongue-in-cheek), since the weakness implies more easy policy, while the danger zone for the three-month average – about (-0.7) – is still far off. The index does belie the notion that the economy is doing fine, but it ought to be said that the measure is not a great leading indicator and the oft-substantial revisions to the monthly figures make all but the most obvious conclusions risky. Redbook data continue to show very little growth in retail sales.
Next week will start with new home sales, but the event of the week will be the Fed statement on Wednesday. Presumably the FOMC members will know the first estimate of third-quarter GDP (Thursday), currently tracking at 0.9% according to the Atlanta Fed but with the Street consensus at 1.7%. The latter is often subject to hopeful padding by Street economists, but that’s still a large gap. How are we going to blame the weather this time?
The other big report that the Fed will see for their meeting is the September durable goods report, released on Tuesday morning. New orders were down 2.3% for the trailing twelve months through August (seasonally adjusted), and the consensus estimate is for another loss of 1.0%, though only (-0.1%) excluding transportation. Business cap-ex spending has comped negative every month this year, getting excused by strength in the dollar and weakness in energy. Both are true, but after nine months a downturn is not a blip.
Kansas City reported a regional survey reading of only (-1) last month, leading some street strategists to practically run a victory lap, as the index has been more deeply negative for some time. Having fallen for so long, though, even a reading of zero is still problematic and an occasional sideways reading is hardly grounds for celebration. The Dallas survey is next up on Monday, followed by Richmond on Tuesday and the private-sector Chicago purchasing survey on Friday. Case-Shiller home price data comes out on Tuesday and Thursday’s release of pending home sales will round out the monthly housing news. Friday sees September personal income and spending, though it will be largely known after the prior day’s release of third-quarter GDP.