Tidal Flow


“We must take the current when it serves, or lose our ventures.” – William Shakespeare, Julius Caesar

Yes, it was an ugly week last week, with one of the more unsettling features being that there was no sense of panic that traders could point to and say, “capitulation.” Friday’s volume was well above average by recent standards and should mark some kind of selling climax – though perhaps only the first day of a multi-day episode. Europeans, whose stock markets have been faring worse than our own this year, have been persistent sellers of every up opening and have been dumping stocks in buckets towards their own close (around 11:30 AM New York time) since late December.

The economy failed to co-operate by producing good-news bulletins, and some decent earnings reports by major banks not only failed to impress, but led to near-irrational further sell-offs. The earnings outlook for the fourth quarter is still for a slight loss (discounting expectations that are artificially set too low), but not a grand one. It’s not so much that we are being overwhelmed by reasons to sell, the latter being mainly technical and momentum-based, as we are being starved for reasons to buy.

Yet there are some grounds for optimism on a short-term basis. The market is deeply oversold for a start, and the equity markets being what they are, traders have a way of getting inured to worrisome events – if a piece of bad news doesn’t continue to worsen, it starts to get boring. Exhibit A in this respect is China, whose lurching stock market and monetary policy have helped spark the sell-off. More 1%-2% drops in the local (Shanghai and Shenzen) markets will move into the realm of tedium if the drops don’t start to stretch to 5%. Exhibit B would be oil – the freefall in the price has helped fan flames about global growth, but whatever bottom it’s going to reach is nearly here – the market has already priced in more falls in the price, and it isn’t going to zero.

This is not 2008, reminds the Wall Street Journal, and that is correct – we are not sitting on the same mountain of leveraged debt, and while there are probably going to be serious hits in the energy sector, with repercussions in the fixed income markets that aren’t to be taken lightly, the 2008 credit paralysis that was triggered by the Lehman bankruptcy was a rare event in the annals of the economy. Yet credit still runs in a cycle, the current one is nearly over, and there will be more problems down the road – just not 2008-style problems. If there is a parallel I fear, it’s the 1973-1974 bear market. Stock prices fell every month into June, paused briefly in the summer, and then resumed a long downward spiral that only ended after the S&P 500 had been cut nearly in half.

The selling has led more traders to talk about bear markets, and it may well be that one has commenced. The very fear of one is often enough to give a nascent bear market further traction. However, bear markets rarely do much damage in the early going, and there will almost surely be counter-trend rallies in the near future. What the consensus line in the sand may be I cannot say, though I do suspect that the current trend of selling has nearly run its course. Still, I do not have much optimism for 2016 as a whole. The tide is going out on equities, but not all share my opinion and some managers are looking for buy points. It’s the way of all bears.

All U.S. markets are closed on Monday in observance of Martin Luther King Day.

The Economic Beat

The week started off slowly and ended with a flurry. Monday saw the release of the Fed’s “Labor Market Conditions Index;” not surprisingly, it is at elevated levels. The December estimate is 2.9 (0 is neutral, 5 would be freakishly high) and November got a big revision upward from 0.5 to 2.7. The need to improve employment conditions is not something the Fed can currently use to justify low rates.

The labor turnover report (JOLTS) for November was much the same as it has been for months now, with openings up strongly (over 10% year-on-year), yet hires have barely changed. With the economy at full employment, it isn’t reasonable to expect much growth in hires.

The Beige Book (monthly compendium of regional Fed activity) came out on Wednesday, and was of no help to equities. The report has been a steady drone of “modest to moderate” repetition, but the December report did mark a shift in tone that did not go unnoticed. Overall it was mixed, with some sectors still good (real estate) and some continuing to weaken (manufacturing), but noted with some concern that auto sales may have peaked and that some districts appear to be flatlining. Even the weather got its usual blame, in this case for weak apparel sales.

Alas, weekly retail sales data returned to its anemic (<2% y/y) pre-holiday trend, and the improvement in the second half of December was not enough to lift the monthly retail sales report into the black on a seasonally adjusted (SA) basis. December was estimated to have had a 0.1% decline overall (SA), or no change when excluding autos and gasoline. November did get a strong upward revision, from 0.2% to 0.4%, but that was mostly based in the seasonal adjustment process. Unadjusted November sales remained with a weak year-year comparison of 1.69%, down slightly from October (1.75%); in case you’re wondering, anything below 3% is weak and below 2% has historically occurred around recessions. December improved a bit to 2.75%, but the year finished with an anemic annual gain of 2.1%. In 2007, the annual gain was 3.3%, and the last recession is thought to have started in the final month of that year (year-year December sales that month were only 1.9%). The report hit the market hard.

The December industrial production report didn’t help the Friday tape either. The total index fell by 0.4% (preliminary, seasonally adjusted), manufacturing by 0.1%, and November was revised downward from a loss of 0.6% to a loss of 0.9%. The initial estimate for all of 2015 is a gloomy-looking (-1.8%), and don’t think to blame it all on energy: consumer goods rose a very meager 0.3%. That said, the big drops in mining (-11.2%, includes oil extraction) and utilities (-6.9%) were certainly the biggest culprits.

The bad news confirmed more bad news from the New York Fed, whose newest survey result was an astonishingly low (-19.37), the lowest reading since the middle of the last recession (April 2009). New orders were even worse, at (-23.54). The survey is not an activity measure, indeed current levels of activity are probably well above the 2009 period. The depth of decline may be relatively mild. However, the breadth of deterioration is quite pronounced and the Beige Book noted weakening conditions in the area. One cannot blame energy, indeed the readings have been even worse than the energy-centric Dallas Fed, and it is simply not a report that one should ever see in a year with a positive direction.

There was no good news anywhere else. Producer prices fell 0.2% in December, more than expected and finishing 2015 with a 1% loss, though a 0.3% gain when excluding food and energy, Import-export prices were far worse, both down about 1% on the month and finishing deeply in the red for the year: (-8.2%) for imports, (-6.5%) for exports. One cannot count either report as showing any progress whatsoever in 2015 towards the Fed’s inflation goals. Finally, business inventories (part of GDP calculation) finished down 0.2% in December and took a downward revision to November (-0.1%). The Atlanta Fed’s running GDP estimate for Q4 fell to 0.6% after the day’s news had been tallied up.

Next week is a light calendar with the emphasis on fourth quarter earnings, perhaps with a better tone for the economy as it is mostly housing-based: Tuesday is the homebuilder sentiment index, Wednesday housing starts and Friday has existing home sales, though the last category has been challenged of late by rising prices and tight supply. The consumer price index (CPI) is due Wednesday, and the report to watch out for is the Philadelphia Fed business survey on Thursday – another bad reading will not help the markets. Leading indicators are also due that day, though the markets give the report scant notice.

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