Waiting for Spring


“Blessed is he that expects nothing, for he shall never be disappointed.” – Benjamin Franklin (ed.), Poor Richard’s Almanack

April started off with volatility again, as it so often does. Yet despite the many triple-digit swings in the Dow, last week wasn’t all that interesting. The price of oil bounced around again on the usual rumors of production freezes (don’t hold your breath for a real one, even if announced) and an unexpected drop in U.S. inventories. The FOMC minutes were released and revealed exactly nothing that was new, which seemed fine for the markets. Another weak wholesale sales report was ignored except for the effect it had on GDP tracking estimates, which are wilting rapidly towards zero real growth for the quarter. March data should offer a little but not a lot of improvement from that, partly thanks to Easter and the mild weather.

We’re entering the season for the first earnings quarter of 2016 this week, and consensus estimates are for a decline in S&P 500 earnings of 9%-10%. History suggests that a decline of something like 4%-5% should be about what is actually expected, as analysts seem to build in bigger cushions in more challenging times. Apparently it’s important to give companies lots of lipstick to put on these quarterly pigs.

The week also features the March retail sales report, options expiration on Friday and a growing sense of central-banker fatigue. I’m starting to see more stories more frequently expressing doubt about whether the monetary policy attempts of negative rates and quantitative easing can work anymore (if they ever really did) in Japan and Europe. Many have made similar observations about the waning policy effectiveness of our own Federal Reserve, but don’t look for the equity markets to throw in the towel on the Fed quite yet. The onset of noticeable doubts about any investing credo takes time to take root through the investment community, usually longer than one would think, as logic and the movement of herds often have little in common. I expect that investor faith in the Fed will be undermined in termite-like fashion – things will appear bonny on the outside right up until the sudden collapse.

I do expect continued volatility throughout the month. Besides this Friday being an options expiration day (you could see options traders at work positioning the tape on last Friday’s close), it’s also Tax Day, which can have some sudden effects. There isn’t much in the way of 2015 gains to be selling to pay the tax-man, but there could be a knock-on effect afterwards as retirement plan contributions work their way into the market. How much of that will go into equities is a good question, but many will probably follow their existing recipe with perhaps a minor tweak or two.

Other cross-currents at work involve the inevitable earnings “surprises” – apart from the very worst of times, about two-thirds of corporate results will beat estimates and I don’t expect this quarter to be different. Running against that will be corporate outlooks, almost certainly more important than results this time. The low growth rate of the first quarter argues for expecting lowered outlooks, but in the first quarter companies are often reluctant to give up hope and prefer to shift the heavy lifting for making up the year’s revenue and earnings to the second half. Hope springs eternal.

April is supposed to be the best month of the year for stocks, and so-called “black box” trading programs are keenly aware of such seasonal trends. They should provide some buy support. I do expect the usual first-quarter earnings rally to try to gain some traction at some point in the month, but if corporate outlooks are lacking, the month could end awkwardly if the “sell in May” trade takes flight early. The one thing we should expect is more triple-digit swings in the Dow, and all of the nonsense that will go with them. The recent rebound rally has swayed many – even including the Fed staff! – that the market must be on to something, presumably better times. But taking stock market rallies as evidence of anything but the stock market is a risky business. In 2007, the market made new highs in the spring, sold off in the summer, then made fresh new highs in October, two months before the worst recession in seventy years. Caveat emptor.

The Economic Beat

The little-watched “Labor Market Conditions Index” from the Fed led off the week with an initial March reading of (-2.1), where zero is neutral. That makes the first three months of the year a doubtful-looking (-1.9), (-2.5), (-2.1). Though it was constructed going back to 1976, the index itself hasn’t been around long and nobody is really sure how much attention the individual governors of the FOMC pay it, perhaps including the FOMC itself, as the week’s release of the latest FOMC meeting minutes displayed about zero concern over employment. Whatever you may think of the index, its recent results can’t be counted as an employment-driven argument (one of the central bank’s two mandates, along with price stability) for raising rates.

Monday’s attention was more on the February factory orders report, which wasn’t so great. January was revised downward, business investment was revised downward and total new orders, down three of the last four months, fell by 1.7%. Shipments, down ten of the last eleven months were down 0.7%. The latter followed a negative January and meant further downward revisions to tracking estimates of quarterly GDP. The Atlanta Fed took it down to 0.4% after factory orders and international trade, though I suspect a later rebound from improvements in March manufacturing. Consumer spending looks weak, however. March should have gotten some boost from the early Easter, but the early indications from chain store data are that it wasn’t a large one.

The next day put some hope back into the markets with the March purchasing manager survey for the non-manufacturing sector. The index rose to 54.5 from 53.4 in February, a rise that Econoday rather hilariously called “very sharp.” Changes of less than a point are basically insignificant, and a 1.1 point difference is small change for the survey. That said, the growth-contraction score was a respectable 12-2, with several in the “no change” category. The business activity score was up as well to a much better-looking 59.8, though it isn’t very good as a leading indicator. It does look as if manufacturing and non-manufacturing activity were up from February, but I would be cautious about jumping onto one month of data. The seasonal adjustments might have been on the generous side, given the very balmy March after two dreadful ones in previous years. The Markit Economics services PMI expanded to only 51.3 (50 is neutral), with a much softer report.

The labor turnover report (JOLTS) for February was good, with the hire rate (not seasonally adjusted) at 3.8%, up from 3.6% a year ago. Job openings were up to 3.6% from 3.4%, and hires were up on an absolute basis too. The guess at how much this benefited from the weather comparison will probably have to wait until April data are out. Weekly claims continue to cruise along at low levels, but the year-year improvement is gradually disappearing.

As for the Fed meeting minutes, the committee doesn’t seem very sure of what it wants to do, perhaps another reason for equities to take flight that day. As ever, the FOMC staff is projecting that things are weaker than projected in the near term but will be better afterwards (one wonders if anyone ever rewrites this part of the statement). One item that caught my eye was the following, I-can’t-believe-what-I’m-reading quote: “Beyond the near term, real GDP was expected to increase slightly faster than in the previous forecast, largely reflecting a somewhat higher projected path for equity prices and a lower assumed trajectory for the foreign exchange value of the dollar.” Are you kidding me? A higher GDP projection because of higher stock prices? Does anyone on the staff know that the last recession began two months after stock prices made an all-time high?

The international trade report was soft (again), though better than a year ago, again perhaps due to better weather conditions. Weaker exports than imports nonetheless meant another subtraction to tracking estimates to quarterly GDP.

The week closed with another weak wholesale trade report. Trailing-twelve-month sales (not seasonally adjusted) would have fallen for the eighteenth month in a row but for the extra day in February; they now stand at (-3.71%) with the first estimate – and may have fallen anyway, as revisions have generally been downward, including January. The inventory-to-sales (I/S) ratio is still a very elevated 1.36, the highest since April 2009, yet the stock market was ripping along anyway in the wake of the report on refried rumors of a production freeze in oil. When the Atlanta Fed followed up with yet another downward revision to Q1 GDP as a result of the report, from the just-revised 0.4% to 0.1%, the rally began to fade. I don’t see the inventory situation improving much in March with the I/S ratio so high, but a rebound in industrial production looks likely and would help.

Next week features the March retail sales report on Wednesday, with preliminary indications for another soft report. Import-export prices precede it on Tuesday. The week will kick off with the start of the quarterly earnings season and Alcoa (AA) on Monday. The big banks get going with JP Morgan (JPM) Tuesday, Bank of America (BAC) and Wells Fargo (WFC) Wednesday, and Citigroup (C) on Thursday.

The economic week picks up after that, with producer price inflation and the Beige Book also due on Wednesday, the consumer price index on Thursday and then the New York Fed regional survey on Friday, followed by the industrial production report for March. The last report should show a bounce if all of the activity surveys were accurate.

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