Hope Floats


“April is the cruellest month.” – Chaucer

“Hope Floats” is the title for a column I write every spring around the end of March or the first week of April. The reason is the same every year – prices have levitated in some sort of logic-defying manner (even in bear markets) that owes some of its raison d’etre to quarter-end price primping and above all to historical precedent, as all the trading algorithms are very aware of said historical tendency and more than ready to jump aboard at the first sight of the others jumping aboard. What’s that you say, circular logic? Whaddya trying to do, make trouble?

Fed chair Janet Yellen and her compatriots have led the way in the last ten days, first by talking down economic conditions and their earlier outlook for raising rates, and then by a determined display of dovishness by Yellen herself during the week just ended. The irony of it is that the reason for stepping away from tightening is the central bank’s fearfulness over the strength of both the global economy and our own. Ironic that such a view would induce markets to go higher, but the reaction is by no means new. It seems to happen at the end of every cycle that when the Fed starts being more accommodative (or talking about it), markets rally, ignoring the Fed’s concerns and focusing on the prospect of looser money. Then the cycle ends and everyone blames the Fed.

The labor market conditions index is a Federal Reserve creation that the bank claims to pay attention to. Going into the meeting, the latest reading had been (-2.4) for February with a downward revision January that pushed the latter slightly into negative territory. The index doesn’t get all that much attention, but I had noted that if Yellen was really paying attention to it beyond lip service, it certainly didn’t argue for a rate increase.

The jobs report that followed last week’s burst of Fed verbal softening was only average, yet the media has mostly talked about how “very strong” and “robust” it was. It was decent, but it was not “very strong” unless you were fearing worse, and I do get the sense that much of the Street has been breathing a sigh of relief lately at every jobs report that isn’t a clunker. Job growth is not as strong as it was during the first quarter a year ago. But so long as the Fed isn’t tightening, the thinking goes, all is well for equities.

That view can perhaps best be exemplified by a nugget in a piece by the popular Barry Ritholtz, a money manager who regularly tweets (he’s got a good nose for useful content) investment information and writes about the economy. In a Washington Post essay written over the weekend, Ritholtz opined about why a recession is “further off than you think.” I read the piece as a great example in confusing causation with correlation, but I’m not to tire you with a piece about deconstructing Barry, whom I think is generally sensible.

Nope, what I want to draw your attention to is what is meant to be the coup de grace in his checklist for the death of a business cycle: “And last, an aggressive Federal Reserve tightening that takes interest rates too high.” This is so because the tightening cycle “reduces available credit, makes the credit that is available more expensive, and — voila! — a recession occurs.”

It’s one of those pseudo-facts that “everybody knows,” like the earth is flat or flying machines are impossible or they cannot fly past the speed of sound with breaking up into pieces. “Everybody” knows it so well and so thoroughly (the lead writers at the Wall Street Journal posit it as an absolute article of faith) that nobody stops to think about the implications of the supposition or the historical experience of the last two recessions, neither of which came about because of rising rates.

If you asked any of these writers I allude to above, be it Ritholtz or one of the WSJ staff or some other pundit if it were possible to eliminate the business cycle, they would likely snigger and say “of course not.” However, if you were to follow up that statement with an extension of their logic by saying, “then all the Fed has to do is never raise rates and we will never have a recession,” they would be put in a most uncomfortable spot. I don’t believe any of them would agree to the latter point, but that is exactly what they are saying in other words when they say recessions come about from the Fed raising rates too high. If that is so, then don’t raise rates ever = no recession ever. No one would want to go on record saying something as silly as the business cycle can be repealed – and for good reason, because it can’t be – so the solution is not to mention the contradiction and perhaps better yet, not to think about it either.

It doesn’t work that way, but the explanation is too lengthy for MarketWeek. A short summation is that once the economy reaches full employment, which corresponds to an unemployment rate of roughly five percent, real economic growth – that is, growth not based on price increases – will start to flag. The ancient wisdom is that reaching full employment induces inflation, so the Federal Reserve will start to raise rates to head it off. The result is that credit becomes throttled and so the expansion dies, as Ritholtz wrote. It’s a beguiling view and I confess that that I once believed it myself, partly because everyone else “knew” it was true, and partly because it will work if the Fed raises rates high enough, which it hasn’t done since the 1980-1982 recession. That hasn’t stopped us from obsessing on it.

Once growth slows, businesses will respond by slowing their own expansionary activity in the same way they responded to increasing activity earlier in the cycle. Activity eventually contracts and we call it a recession. Once contraction is evident, it doesn’t matter what the price of money might be for expansionary purposes, because nobody is interested in expansion. The only genuine demand for funds comes from failing activities that can’t get it at any price. It isn’t real rates that stop banks from lending money, it’s the fear of losing it.

At some point we will get to the end of the cycle, with or without rate increases, and it’s quite likely that much of the Street will blame the Fed anyway, or the government, or some other dastardly unforeseeable activity besides the natural rhythm of the cycle. That end is coming sooner than people think, but as the cycle fails it will be accompanied by various entities getting into financial trouble, which at times is the stock market itself. That hastens the belief in the end of the cycle and serves as an additional catalyst for decline, but as I like to remind people, we were already three fiscal quarters into the last recession before Lehman Brothers failed. That debacle didn’t cause the recession, and the bank didn’t fail because short-term rates were 5 1/2 percent.

Looking ahead, the market is solidly overbought coming into April. While it is the best month of the year historically for the markets (and prices float up in anticipation), the first half of the month is often rough going, so I look for increased volatility. The biggest problem the market has now is that earnings are scheduled to decline yet again, this time by a wider margin than the last three quarters, and that is no recipe for rising prices. The declines haven’t been deep enough or broad enough yet to do more than throw a couple of big frights into the market, but it is only a matter of time. Matters will not be helped by corporations sitting on the sidelines this month as they report earnings, for they have been the biggest buyers of stock by far the last year. Let the buyer beware.

The Economic Beat

The calendar said that the jobs report should have been the highlight of the week, though it was really Janet Yellen that was the cynosure of the stock market’s eyes. Getting back to the jobs report, though, it was one of the more down-the-middle editions of recent times. At 215,000 seasonally adjusted (SA), it was practically dead on consensus.

So was it “Goldilocks,” i.e., not too cold, not too hot, but just right? Though I wasn’t hearing the term Friday morning, it will probably start getting tossed around next week. I would characterize the estimate as very average. It was certainly better than March 2015, when the “snowpocalypse” led to a small 84K gain, but for all that the first quarter of 2016 is trailing the first quarter of 2015 in job growth.

Positives include the household jobs report, which showed a gain of 246K in employed workers, a drop in the not-in-labor-force category, and a slight tick upward in the participation rate to 63.0%, compared to 62.7% a year ago. Temporary help stabilized with a small gain of 4K after a few months of losses, and construction recorded a third straight month of improving gains, this time with a gain of 37K (SA).

Negatives included the weakness in manufacturing, which led all losses with (-29K), and goods production overall, recording a small loss for the second straight month of declines. Two months is too little to call it a trend, but these categories are far more economically sensitive than restaurant jobs (leisure & hospitality +40K) and bear monitoring. Wage growth is still lackluster, with average weekly earnings up only 1.96% from a year ago, and average weekly hours subdued at 34.4, down from 34.5 a year ago and 34.6 in January. In sum, to call the jobs report “strong” is misleading, say rather that it wasn’t weak.

Perhaps the weakness in manufacturing employment is set to pause, or even reverse for a time. The ISM national manufacturing survey recorded its first reading over 50 (the neutral line) in months with a 51.8 report for March. It isn’t exactly hitting the ball out of the park and would have worried traders had it represented a decline from say 53, but in this case it was a gain and close to being manna in the desert, so to speak. The internals of the report were fairly positive, with the growth-contraction sector score a respectable 12-5 and the published comments having an upbeat tone. Most categories showed modest improvement except employment, which continued to have a negative tone at 48.5, in tune with the jobs report. But the regional reports have all been improving, including the Chicago purchasing index, which reversed last’s month drop to 47.6 with a positive reading of 53.6. Even energy-centric Dallas was less negative this month.

On the other hand, weekly jobless claims are still showing signs to me that the party might be ending soon. Recent results have been in keeping with peak employment conditions and nothing looks clearly amiss, but it does look to me as if the growth aspect has been getting tired and will continue to fade over the coming quarters.

The revision to construction spending in January was strong, now at 2.1%, while the initial February reading was weak with a 0.5% loss. I don’t trust these numbers until the second revision is out, but the year seems to be off to a reasonable start and the year-year again is a solid 10.3%.

Over in housing, pending home sales had a boost of 3.5% after a couple of weakish months in existing home sales (pending sales does not include new homes). The Case-Shiller index of price appreciation for existing homes remained steady with a 5.7% annual rate.

The February personal income and spending report dealt a blow to first-quarter GDP estimates, as it was revealed that initial estimates of a spending boost in the quarter were off – the January spending gain was revised from +0.5% to +0.1%. Personal income was up 0.2% and has been quite stable. The Atlanta Fed was estimating a 0.7% GDP rate for the quarter as the week ended, while FactSet was reporting a (-8.5%) estimate decline for S&P 500 first-quarter earnings. A not-so-comforting item was the company noting that the estimate change for the first quarter, from +0.8% at the end of the fourth quarter to (-8.5%) at the end of the first, was the largest such change since the first quarter of 2009. That one was a bit larger, though, at about (-27%).

Next week doesn’t have as much in the way of headline-grabbing news, but there is nonetheless a decent slate. Monday will have February factory orders and the revised durable goods data, along with Yellen’s labor market indicator.

Tuesday kicks off with the international trade report for February (and so another adjustment to GDP), followed by the ISM non-manufacturing survey. Any uptick at all in the latter survey will be loudly hailed, whether it is significant or not. It will appear at the same time as the labor turnover report (JOLTS).

Wednesday afternoon brings the unveiling of the sacred Fed minutes, after which the calendar is quiet apart from the release of wholesale trade data Friday morning. It doesn’t get the attention it deserves.

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