Charting the Course

“All that we behold is full of blessings.” – William Wordsworth

If you want to know why the markets rallied so last week, just look at the chart below.

S&P 500 May-Nov 2015

I thought I could wait until this week to tip readers off to the so-called “cup and handle” patter that was clearly setting up at the end of the prior week, but thought I had a few more days. Clearly I was wrong, as trading programs and their trader acolytes pounced on the confluence of the rebound and the release of the Fed minutes to get in on the move.

A cup-and-handle pattern is a trader mainstay, characterized by starting with the obvious big dip above, followed by a small retreat from the “resistance” line of the price level prior to the dip. Other plus factors were anxiety about not missing out on the year-end rally that might be enough to put stocks into the black for the year, and the possibility that such a move might start with a “breakout” above the resistance line.

You may well wonder what any of this has to do with investing, and the answer is of course virtually nothing. Stock market prices are often more about the stock market itself than the economy or earnings – the S&P 500 will show a small decline for the second quarter in a row – and there is probably no time when this is more true than the end of the year.

So, will stock prices finish at new highs? I hate to say it, but the answer is a very big maybe. There isn’t any compelling reason to buy equities apart from the calendar performance game, and the steepness of the recent rebound will probably invite some of the typical calendar weakness that comes in early December. Then we’ll get a rebound based on some spurious data, or perhaps the Fed meeting, but from what level isn’t so clear. The most likely outcome is a level near the one we are at now, perhaps new highs, perhaps not, with some mild surprises along the way on either the positive or negative side of the ledger. Equity fund flows have been largely negative of late, and while some chasing might occur, I wouldn’t expect anything significant without a geopolitical shock.

Indeed, the most likely message from the stock market for the rest of the year is that there will be no message – the stock market will be focused on its own navel-gazing, with some central-bank watching thrown in. I don’t expect stocks to be down on the year, despite being there for most of the second half, but only for the reasons above. Positive results for the indices are masking the terrific drubbing that high-beta names have been taking all year, as sure a precursor to the end of the bull as there is. In the same vein, trading from now until January will be mostly tactical and index-based, with “enhanced” managers trying to beat the indices by owning the same handful of big names, in the belief that such names offer safety as well as performance. If enough people believe it, it will come true – for a little while.

All U.S. markets are closed on Thursday for the American Thanksgiving holiday, and I wish my American readers a Happy Thanksgiving (and hopefully a four-day weekend)!

The Economic Beat

The highlight of the week was – as predicted – the release of the FOMC minutes. Reading the release, you would be at a loss most of the way through as to explain why the market thought the comments were the basis for a rally, but for two key factors: one is the 2015 trend that prices rally around the release of the minutes, and in an environment where there isn’t much else to build on but charts and Fed noise, program-driven trading of trends is the biggest game in town. The second reason would be the emphasis placed on raising rates at a slow and shallow rate – if indeed the Fed raises rates at all, because the data might provide yet another excuse to do nothing. Traders will subscribe to this framework until events force them to change.

The rest of the news was mostly below expectations, some of it outright bad – the New York Fed manufacturing survey – some of it mixed, such as housing starts. The New York November survey checked in with (-10.74), the fifth negative reading in a row (zero is neutral) and filled with underlying weakness. The survey is due for a dead-cat bounce at some point, but in the meantime no one seems to care. The more-influential Philadelphia survey rebounded to +1.9 from (-4.5) in October, above consensus for no change, though new orders remained negative for a second straight month. Kansas City also chipped in narrowly on the positive side with a reading of +1, the first positive in nine months.

Industrial production declined by 0.2% instead of gaining the expected 0.1%, but manufacturing rose by 0.4% versus expectations for +0.3%. Utilities and mining dragged down the overall number and so traders gave the headline a pass focused on the manufacturing reading instead. The last was something of a rebound from negative readings in the prior two months, and year-on-year reading for both manufacturing (1.9%) and total production (+0.3%) remain weak. Coming so late into a recovery the numbers are not a surprise and would seem to signal to even casual observers that the game was nearly up, but the FOMC staff blithely continues to predict two more years of above-trend growth, as they have wrongly done for several years now.

Housing news was mixed. It appears to me that the sector has plateaued and doesn’t have much left in this cycle, but I don’t expect it to be much of a leading indicator, as new building remained restrained throughout. Housing starts are up a little over 10% so far this year, slightly ahead of last year’s pace (+8.3%) with two months to go. The homebuilder sentiment index dipped a bit to 62 (from 65), still in the quite optimistic range. Next week will see the latest release on new home sales (Wednesday), as well as sales of existing homes (Monday).

The consumer price index (CPI) had something for everyone, with an expected gain of 0.2% in October. Year-on-year, the total is only +0.2% (deflation!), but +1.9% excluding food and energy (it’s just oil!). The producer index has been weak, but the CPI allows room for nearly any interpretation. In weekly data, jobless claims remained very low (good) along with retail sales growth (not good).

Next week starts off with the Chicago Fed index on Monday – not very watched – and existing home sales. The second estimate of GDP is due on Tuesday, with an expected inventory-driven upward revision to 2.1%. It will get paid back in the fourth quarter and perhaps the one after as well. I suspect that the report will be like the CPI – something for every point of view. GDP will be accompanied by a revision to quarterly corporate profits (perhaps more important), and followed by the Case-Shiller home price index, consumer confidence and the Richmond Fed survey. Don’t expect anything earth-moving.

Wednesday will be its typically packed pre-Thanksgiving day self, with October durable goods (consensus +0.4% excluding transportation), jobless claims, October income and spending, new home sales and a handful of lesser releases. Markets don’t close early, but many professionals will leave at lunchtime and not return. The early close comes on “Black Friday,” when the stock market will close three hours early (1 PM New York time) after its Thanksgiving holiday. Happy Thanksgiving!

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