“The wheel is come full circle.” – William Shakespeare, King Lear
My oh my, what was that? A bravura Friday rally, fueled in part by a delayed reaction to European Central Bank’s (ECB) President Mario Draghi’s latest easing decision (and the subsequent rally in Europe), in part by technical trading factors, led to a near-2% advance in equities on the day and pulled a losing week back into the black. The net result was the fourth consecutive week of gains in the S&P 500.
The rally has stretched into the beginning of significant resistance territory now, the 2020-2050 range on the S&P 500. Springtime rally or no, I will certainly be throwing remaining equities over the side should the advance continue. The market is now overbought, a state it hasn’t achieved since the end of last October.
That’s not to say it couldn’t get a little more overbought. We’re not quite into nosebleed territory yet, and a continuation of the move through the first half of next week makes sense from certain angles – Monday is virtually devoid of domestic economic news (favoring whatever trend happens to be in place, in this case up), and a rally into the release of the Fed policy statement on Wednesday would be fairly standard stuff, especially when riding an upward trend. It’s also springtime, and even bear markets rally at this time of year. The so-called “pain trade” is definitely to go higher, and there was more than a little short-squeezing going on Friday.
There are a couple of obstacles in the market’s way, beginning with the release of some Chinese data Sunday night: industrial production and retail sales. Worries about Chinese growth at the beginning of January helped set off a sharp decline in equity prices, and the data coming from the Middle Kingdom hasn’t been too cheerful of late.
I don’t know what to expect either from the retail sales report due on Tuesday. There isn’t any strength in weekly reports, but the bar is set quite low, with the consensus estimate settling on a loss of (-0.1%) in total spending. So the game will be to look at ex-auto, ex-gas spending. Moving dollars from gasoline to somewhere else even as total spending declines really shouldn’t fool anyone, but they seem to love this diversion on Wall Street. In sum, even another weak report that shows a continuing deterioration of the twelve-month trend in both total spending and the ex-auto/ex-gas result might get enough lipstick put on it to make traders temporarily overlook its pig-like appearance.
Growth worries will return again, as evidenced by the continuing deterioration in the outlook for corporate earnings for the first quarter, where the consensus for the S&P 500 now sits at (-8.3%) and keeps going lower. I expect it to be in double-digit decline territory by the time earnings season rolls around, and while estimates have been building a bigger cushion than usual in recent quarters, it looks like expectations are for a fourth consecutive quarterly decline for the index as a whole, this time exceeding 5%. We can’t blame the dollar anymore either, as it is now weaker than it was one year ago.
That dose of reality is still a good six or seven weeks away, however. In the meantime, traders will be wondering if algorithmic buying is eying the return trip to the beginning of the year as much as they are. I mean what’s more important, reading the charts correctly or a lot of dull talk about profits? Too, there aren’t many believers in this move, which in the perversity of Wall Street suggests there is still room to climb higher, even if it’s on lower and lower volume.
I think that renowned DoubleLine fund manager Jeffrey Gundlach had it right when he said late in the week that the current move – which he also characterized as a bear market rally – as having a “10-1″ risk-reward ratio, with a roughly 2% upside versus a 20% downside. That is perhaps the short term, as I believe that the eventual move downward will be much greater than 20%. But that won’t happen next week, which is far beyond the attention span of most traders. In the meantime, enjoy the spring forward.
A reminder to our European (and other) readers that Daylight Savings time begins Sunday morning, March 13th, so the NYSE will appear to open and close an hour earlier on Monday. The European time difference will be an hour less across the Atlantic until they shift over at the beginning of April.
The Economic Beat
A very quiet week for data didn’t really feature much of anything on the domestic side. The latest story on struggling Chinese trade or the ECB’s meeting got more attention than anything here. Probably the highlight of the U.S. calendar was that weekly jobless claims fell to a multi-month low (seasonally adjusted).
It shouldn’t have been. Wholesale trade put up a dismal result for January, with the year-on-year decline for January falling to 6.4%. That’s a large decline. The inventory-to-sales ratio is now at its highest level since the recession, in April 2009, so it’s not as if we should expect sales to pick up soon. I wrote about the implications for Seeking Alpha, but the short version of it is that it the short-term trend ain’t good, nor is the intermediate one. Inventories will definitely be a negative for first-quarter GDP.
Import-export prices for February were theoretically the highest-profile data released, but they’ve been weak for so long that they get little attention now. Another month, another decline, this time (-0.3%) for imports and (-0.4%) for exports. Coming on the heels of ECB fever, it was barely noticed. Optimists talked about how the year-on-year decline in import prices moderated from (-6.2%) to (-6.1%). Exports went the other way, though, from (-5.7%) to (-6.0%). What deflation?
Another report that went little noticed was the Fed’s Labor Market Conditions Index, partly because it’s relatively new and partly because nobody is sure how much attention the Fed really pays to it, even if Janet Yellen does mention it from time to time. The January reading suffered a big downward revision, from +0.4 to (-0.8), and the initial February read was a rather low (-2.4). One would think that such a reading would push back against the Fed raising rates again next week if the bank is really serious about its employment mandate and being data-driven. However, no one is ever sure what the Fed will do (including the governors, judging from their remarks that wander all over the landscape) and there is some push to get rates a bit higher in time for the next recession. Besides, it’s only transitory, right?
Yes, the Fed meets next week and Wednesday’s gala affair, replete with updated forecasts and quarterly press conference, should be the highlight of the week. I never make policy predictions, but I do have sympathy for the camp that says the Fed will find itself headed back to zero before it ever gets to 1%. For what it’s worth, the bond market is currently pricing in a very low probability of a rate hike this week.
The week will start off with the February retail sales report on Tuesday, and going by the weekly chain-store reports, it won’t be a good one. However, neither was the month of January and that report was warmly received (it beat expectations). We’re due for a surprise one way or another, and the heavily adjusted February data (with an extra day, no less) would appear to be a good candidate. We’re also due for another negative surprise soon, I just don’t know what month it will be.
It’s going to be one of the busiest calendars in a long time next week, and the typical result of so many reports is that individual reports tend to get a bit lost in the noise. For example, the New York Fed’s manufacturing survey comes out Tuesday morning at the same time as retail sales at the same time as February producer price data. Later that morning are business inventories and the homebuilder sentiment index. And, of course, we’ll all be speculating on what the Fed will do the next day.
Besides the FOMC to-do, Wednesday morning will start with consumer prices and housing starts at 8:30, followed by industrial production at 9:15. That’s enough for the week right there, really. The rest of the week is a bit lighter, with the Philadelphia Fed survey on Thursday, followed by the labor turnover report (JOLTS) and the leading indicators (mostly ignored now), and then a consumer sentiment report. The latter won’t matter much, but the fact that it’s also the quarterly expiration date for options and futures (“quadruple witching”) will.