A Window Opens


“Lighten up, while you still can.” – The Eagles, Take it Easy

It was good to see the market rally last week, though I confess that in my case the rally has been principally helpful for exiting long positions and building short ones. The most likely outcome for the current move upward, it seems to me, is that it stalls around 1950 on the S&P 500, but I wouldn’t bet my life on it or any other short-term market move; indeed the market could even move back up to around the 2000 level, unlikely though that may seem. Bear markets rarely move in straight descending lines.

We should first consider the motivations behind the current rebound. They’re a mixture of relief, technical factors, a respite in energy, and hope for more ju-ju magic from central bankers. The relief case stems in large part from some misleading reports that have nonetheless spurred some lazy thinking that the economy is regaining momentum: growth in retail sales and industrial production that was better than expected, however anemic; stabilization in weekly jobless claims; a premature leap forward by the Atlanta Fed’s GDP forecast, and the flawed notion that central bankers might yet defy the business cycle, particularly in places like China and the EU.

Retail sales, I might remind readers, were anemic in December and January, despite the fact that the numbers beat estimates. Fourth-quarter sales were up about 2.2% from the prior year (unadjusted data), the weakest such performance since 2009. Compare that quarter with the last two full-employment fourth quarters that came just before recession: 3.3% in 2000, 4.4% in 2007. Twelve-month sales growth falling below 3% is a cyclical warning sign, but we exited 2015 at 2%. Yes, yes, but the report beat expectations!

Industrial production joined the parade last week, unexpectedly rising by 0.9% in January (at first estimate), driven by auto production and a rebound in utility output after a balmy December. The auto numbers are not going to stay there for long, as the industry exited 2015 with the highest December inventory-to-sales levels since 2008. Despite those and overall inventory numbers being dangerously elevated, the Atlanta Fed is forecasting – partly based on a weak December! – an increase in inventories for the first quarter. Not very likely. As for the bump up in industrial production, you might want to note that year-on-year industrial production is down for the third month in a row, something that over the last four decades has only happened during recessions. Well okay, but this time is different, isn’t it?

I can’t tell you where oil prices are going this month or the next. Supply factors could change from one day to the next, obviously, given political considerations. I do believe that as the recession takes hold over the next twelve months or so, it will hurt energy demand, but we are still some indefinite time – weeks, months, quarters – from having to cross that river yet. In the near term, any energy rallies will help stock prices. The correlation isn’t really reasonable, but trend trades don’t require rationality on Wall Street, only the belief that everyone else is following the trend. Until they don’t.

Monetary policy cannot prevent the ends of business cycles. Ideally, central banks should start removing accommodative stances somewhere past the midpoint of the cycle, and begin adding accommodation when the cycle has ended. The goal of the former is not to eventually (ruthlessly, mistakenly) end the cycle, as nearly every financial journalist would have you believe, but to try to head off the accumulation of excess leverage that can turn the eventual, inevitable end of the cycle into a more painful bust. The practice doesn’t always work (e.g., the last recession), for the same reason that pyramid schemes sometimes reach dizzying proportions – periodically, great masses of people want to believe in the promise of money for nothing and will throw large amounts of it away in the process.

Nor does monetary policy restart the cycle. Making money cheaper to lend works great when confidence is high and the economy is humming; when we’re in recession, few want to borrow and even fewer want to lend. Accommodation simply adds some grease to the wheels, something that will be helpful when the economy starts pushing again but doesn’t restart activity by itself. Rebuilding does. We seem to have largely forgotten the old maxim that monetary policy is only a cushion.

Price movements follow profits over the longer term, and those have been weak for three quarters going on four. In the short term, though, stock prices follow prevailing beliefs, and those can change from day to day and week to week. Every recession begins with a mix of good news and bad, anxiety and relief, despair and denial. The latest one doesn’t rate to be any different, so take advantage of the current good period to lighten up.

The Economic Beat

A week of mixed news pushed markets back a bit off the confidence in growth stance that the previous week’s retail sales report had built up. In short, the data all looked like what one would expect at the turning of the business cycle: poor yet mixed manufacturing numbers; a bit of non-core inflation; housing and employment leveling off.

Two industrial surveys last week from the New York and Philadelphia Federal Reserve branches continued to tell a negative tale. The New York district put out another disappointment, (-16.64) vs. expectations for (-10), though not as bad as last month’s (-19.37). It was the seventh negative month in a row for the region (zero is neutral).

The Philadelphia report was better with a reading of minus 2.8, about even with consensus expectations, yet still logging its sixth consecutive negative month. Shipments were positive, but new orders and prices remained weak. It all gets excused by weak oil prices and the dollar, but there is more than that going on with these readings and at the end of the day, contraction is still contraction. One cannot turn a blind eye to everything as “transitory,” as all factors are transitory.

Industrial production in January, however, was much better than expected and so of course was the preferred report. An estimated rise of 0.9% compared with anticipation of about 0.4%, benefiting strongly from a) a downward revision to December, from (-0.4%) to (-0.7%); and b) a large increase in utility production (+5.4%) as temperatures returned to seasonal levels after a warm December. Still, manufacturing is up 1.2% year-on-year, thanks largely due to a jump in automobile assemblies, though year-on-year industrial production is still down by (-0.7%). It may be that the Atlanta Fed is counting on auto builds for its current GDP estimate – it is forecasting a jump in inventories that I don’t believe will happen.

The two inflation readings, producer prices and consumer prices, largely told the same tale: headline numbers (overall index) weak, core numbers rising. Producer prices rose overall by 0.1%, taking the year-on-year rate from (-1.0%) to (-0.2%). Excluding food and energy, the year-on-year rate rose from +0.3% to +0.6%, 0.8% when excluding trade services. Consumer prices were unchanged in the January estimate, but that meant a sharp rise in the year-on-year rate from 0.7% to 1.4%, 2.2% when excluding food and energy.

The homebuilder sentiment index eased slightly to 58 (still a good number, as 50 is neutral and anything 60 or better is quite elevated), and so did housing starts, to a 1.099mm seasonally adjusted and annualized rate. The important thing to note in the survey is that sentiment about traffic is way down to 39, probably a consequence in part of higher prices, but it ought to be noted that the year-on-year growth rates for starts – single-family and otherwise – fell off, as total starts were up just under 1% from a year ago, and single-family starts up 3.2% (estimated). It’s only one month, but could signal that starts are leveling off (2015 growth came in around 10%).

Finally, the FOMC minutes produced little reaction. The good news so far as the market was concerned was that the committee seemed a little worried, but not a lot. Ergo, the members aren’t hell-bent on raising rates, and they’re not as freaked out about growth concerns as the stock market has been (whether the governors should be is a very good question, but the FOMC is not in the business of making dire predictions).

Next week is about housing in the front end and broad economic activity in the back. The housing slate includes the Case-Shiller price index on Tuesday, followed by existing home sales later that morning, then new-home sales on Wednesday. The federal agency-based price index is released on Thursday.

At the back end of the week is the quarter’s first report on durable goods, January. It’ll be followed on Friday by the second estimate of fourth-quarter GDP (consensus is expecting a decline to about 0.4%), along with January trade and personal income and spending. The rest of the week is sprinkled with regional Fed reports from Chicago (a national activity index), Richmond, and Kansas City.

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