Waiting Again for Something


“Wise men learn by other’s harms, fools by their own.” – Benjamin Franklin (ed.), Poor Richard’s Almanack

As last week drew to a close, the same momentum traders that had been predicting the end of the world in February had confidently switched to predicting an imminent market melt-up and breakthrough to new highs. After all, the Goldilocks-like (“not too hot, not too cold, but just right”) combination of the May jobs report taking a Fed hike off the table, and stronger economic data signaling the end of the first quarter slowdown (you read that correctly, though you won’t see evidence for it anywhere but in the mouths of people already long on equities) is irresistible, right?

It was indeed an impressive run last by stocks last week, perhaps not so large, but still in the face of early June usually being a treacherous time for equities. Then again, in a typical year equities have gotten ahead of themselves by May, making a June pullback more of a natural reaction. As MarketWeek goes to press, the major indices have gone about nowhere this year.

But the month isn’t over yet. One byproduct of the recent push higher by prices in the face of widespread doubt – making an equity rally the “pain trade” – is the conversion of the momentum traders cited above. As they finally jump onto the gravy train, the trade becomes more likely to reverse.

As for the economic recovery, there isn’t one. Current forecasts for second-quarter GDP stand between 2% and 2.5%, indeed something of a recovery from the first quarter’s 0.8% (before the second, or third, and then next year’s revision). But current forecasts were ahead of themselves last quarter too, with an end-of-January forecast of 2.7% coming to grief. This early in the quarter, the forecasts are relying more on optimism about what might happen than hard data.

Over in earnings land, the consensus for the S&P 500’s second quarter currently sits at about (-5%). Given the nature of how the process works, I would guess that consensus will sit at about minus seven or eight percent by the first week of July, implying another actual decline of several percent. Five quarters in a row of negative overall earnings, and the really bad part hasn’t started yet. Yes, yes, if we take out the sectors that are losing money the picture looks better. Great.

The principal excuses so far for the weaker earnings have been a stronger dollar and weaker oil (we all know how that’s bad for the economy, right?). The dollar argument evaporated this quarter, leaving us with nothing but oil – oh, if only oil prices would go up some more. Of course, tech sector earnings are supposed to be down this quarter too, but that’ll sort itself out. Eventually.

Last week the World Bank downgraded its outlook for the globe by a half percent, so clearly the economic “recovery” (the expansion is quite long in the tooth and nearly over, yet some continue to write as it is about to begin) is about to take flight. Right after the British-EU referendum vote. Or the Greek debt negotiations. Yes, we do have a scary slate of political obstacles to cross this summer, and the bad news is that any one of them could tip the expansion into the ditch. The good news is that if they move up to the brink of the abyss and then swerve, the way crises usually do, it’ll set off another fool’s rally in the stock market and another chance to exit longs or look for some short positions.

So sit back and wait, because it won’t be much longer, and don’t count on averted crises to prop up prices. Sometimes they come to pass (cf. Lehman).

The Economic Beat

There was no obvious candidate for the report of the week, so I am going to nominate the virtually unnoticed Labor Market Conditions Index from the Fed.

My nomination isn’t entirely whimsical. The markets ignored the report, perhaps partly on the grounds that the Fed doesn’t seem to pay much attention either to its own still-young creation. The reason I am nominating it, however, is because one, it has been negative all year, and two, it just hit a new low of (-4.8), the lowest since May 2009 (zero is neutral). April also took a big revision downward, from an originally reported (-0.9) to a far more serious (-3.4).

Certainly the whole business invites speculation. Does our central bank not really trust its index yet? The May 2009 value was created after the fact and after all, the stock market has been doing pretty good, a remark that may seem sardonic, but the sense that the Fed’s single most important indicator these days is the stock market is a widespread sentiment on the Street.

We probably won’t know for some time whether or not the Fed should have been paying more attention to its baby, or redoing it early on. Yet I still find it quite intriguing that the report has put forth its lowest number in seven years and almost no one is talking about it. A composite of 19 indicators and presumably constructed for an ability to signal momentum in the labor market, historically a lagging indicator, it would be nice if one of the Fed governors would make some comment about it, especially after one of the weakest jobs report in a long time. Maybe the Fed doesn’t want the market to overreact to it, or maybe the governors aren’t quite sure themselves what to make of it. Maybe, just maybe, they simply lack the nerve to believe it themselves. In any case, the recent results are not bullish for anything except the postponement of rate increases, a traditional sucker’s bet.

Two other report caught my eye, the first being April wholesale sales. Here are some of the things the Econoday website had to say about the report: “the report…is a surprise on the upside, contrasting with what has been a recent downside run of economic data.”

If only it were true. Wholesale sales have been on a slide since last year, and the April number showed a 5.8% decline (unadjusted) from April 2015. The trailing twelve-month rate slid to (-3.77%), even with the benefit of the extra day in the February. The rate was already in recessionary territory, and the large year-year sales drop just made it worse. Econoday celebrated a 0.3% increase (seasonally adjusted) in inventories as a positive for second-quarter GDP, but that’s as false a dawn as one can see. The inventory-sales ratio is at 1.35 compared to a year-ago 1.29, meaning inventories are still too high and are going to contract – probably this quarter, not so good for GDP. Econoday also lauded the decrease in the I/S ratio to 1.35 from 1.36, hardly anything to celebrate about, especially when you consider that the ratio only went from 1.359 to 1.354 (before revision). That’s not even outside the margin of error.

Weekly jobless claims also came in for effusive praise from Econoday and many others, and this time with justification by an initial estimate of only 264,000 (seasonally adjusted). Yet I would advise caution here too – the week was indeed a good number and so was the year-on-year comparison, but the latter are becoming less and less frequent, a traditional sign that employment growth is about to end. The claims number that we see this week or next will matter more to the jobs report, as the Labor Department traditionally uses the 12th calendar day of the month for its dividing line when doing its math. The 12th is a Sunday this month, so whether it uses Saturday the 11th (the ending date for the weekly claims) as its cutoff or a later date will be a judgment call.

The labor turnover report (JOLTS) for April continued a familiar theme – job openings are up, hiring is not. Most of the strength in employment appears to be concentrated in entry-level occupations – food and drink, recreation, temp workers. Manufacturing and construction continue to weaken, which can’t be a good sign. I believe that the drop in productivity (-0.6%) in the first quarter is related, reflecting the concentration of hiring in low-wage service occupations that do little to improve overall activity.

The big economic report for the week of the 17th is the retail sales report for May. Consensus is for a gain of about 0.3% (seasonally adjusted). There hasn’t been much strength in the weekly chain-store reports and the year-on-year comparisons are going to be tougher, but the trailing-twelve-month (TTM) rate may benefit as the last weak month of early 2015 and its horrible winter finally drop out of the calculus. Perhaps a weak number will rally the market in its delusion that fading growth is somehow good for equities.

However, the stock market will be mostly preoccupied with the Fed meeting and its Wednesday statement. At the moment, no action is expected, so traders will be left to shout at each other about what micro-changes in the wording of the statement must mean, no doubt to the amusement of the governors. Whatever the market decides, you can expect the governors to fan out in the ensuing days to emphasize the opposite view and reinforce the sentiment that nobody can predict what the FOMC will do next. Least of all the FOMC.

There will be a lot of fresh data besides retail sales for the governors to look at. Tuesday will see also a release of import-export prices, while the morning of the statement gets May industrial production data, along with the New York Fed manufacturing survey. The Philadelphia survey is the next day, but surely the governors will have access to the number and preliminary text if they want it. Last month’s regional surveys were contracting across the board, so any improvement could light the markets on fire (if accompanied by no rate action).

Friday rounds out the week with housing starts – as usual, the homebuilder sentiment index is the day before – and quarterly derivatives expiration (“quadruple witching”). The latter should be good for some big moves and even bigger hot air that will try to obscure the typically dominant influence of expiration. Right now the options position suggest a close somewhere around 207 for the SPY, give or take a point, though the week’s trading could shift that. It is likely that options dealer profitability that will determine this week’s close, not anything uttered by the Fed, the data, or their many soothsayers.

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