“If I go there will be trouble, and if I stay it will be double.” – The Clash, Should I Stay or Should I Go
Last week was about two things – first, a bit of “Brexit” fear (the UK referendum on staying in the EU), accompanied by the usual scattered worries about the lack of growth; second, managing Friday’s quarterly expiration prices. On Thursday, I saw a headline about “dip buyers” that brought a smile to my face. Dip-buyers my foot, thought I, it was options dealers stepping in to start moving the tape back to the right position. Easy to do in the oversold market, the target was about 207 on the SPYder ETF (SPY) (as noted here last week). It closed at 206.52; QED.
Oh yes, there was a Fed statement along the way. The bank blinked again, lowered its growth forecasts for the year (see also the Economic Beat below) while remarking that “growth in economic activity appears to have picked up.” Excuse me, how’s that go again?
Let’s remember that the Fed is not in the business of predicting bad times. Institutionally it is constrained from saying times could get bad until everyone else knows they already are, and then the staff can be quite gloomy about the future. But not before, so don’t expect them to ever predict a recession. I’m fine with that, as to do otherwise would be destabilizing and surely invite political interference.
Sunday night, polls about Brexit were showing a surge in the “remain” vote and so financial futures followed suit. I had also pointed out the week before that while some of the looming geo-political crises could tip the global economy into the ditch, if they instead averted the worst at the last minute, as most do, that it would set off another fool’s rally in the stock market. Once again, QED.
The Brexit vote takes place this Thursday and barring an excruciatingly close vote, the resuls should be known on the Street before Friday’s open. Too much rally ahead of time and you could see a “sell the news” reaction, but if past practice is any guide – the trading algorithms that dominate short-term action are very big on patterns from the recent past – we’ll see a rally not unlike the Greek relief rally, one that was good for several days. If the vote goes the wrong way (i.e., “leave”), it’ll be look out below. I don’t think the short-term reaction would be immediate disaster, but the global economy is staggering and the cycle needs little more than a good push from somewhere to end. A Brexit vote might do it, though it would probably take weeks and months for that to be clear.
This week will mostly be about Yellen (she has to go listen to our Congress pose and posture for the masses this week, please be advised that is not suitable for children and other naive souls) and more Brexit currents. The fundamentals have not changed – the global economy is at stall speed, the expansion awaits the last fillip to end it, and the stock market will soldier on in denial until it’s too late. The wait is indeed tiresome
The Economic Beat
The report of the week was slated in this corner to have been the retail sales report for May, but the Fed meeting overtook it after all. It wasn’t the Fed non-statement or non-move on rates that caused the least bit of stir, but the downgrade on the central bank’s 2016 GDP forecast: from a range of 2.1%-2.3% (real) in March to a current range of 1.9%-2.1%. While we’ve become accustomed to the Fed lowering its forecasts every year as the calendar marches on, that’s a big drop so early in the year and if memory serves, one of the lowest June forecasts in years. I was puzzled by a Bloomberg article calling the outlook “little changed,” even as the reporters bemoaned the Fed’s loss of Street cred.
No doubt some frustrated bond traders gave the Bloomberg journalists an earful, but the FOMC could hardly be raising rates in the same breath as cutting its growth outlook to a measly 2%. The mystery that remains is why, especially when looked at in light of the FOMC staff’s practice of cutting forecasts as the year goes on. Are they trying to get ahead of the curve for a change, or is it business as usual and we can still expect further cuts as the year goes on? And how does one reconcile the cuts with the official statement’s observation that “economic activity appears to have picked up?”
Maybe we don’t. The Fed has been playing games with the market for ages, trying to talk tough when it’s afraid to act and trying to be meek in the wake of finally raising rates a quarter point. If the Fed wants to creep towards normalcy, it should start by putting an end to rolling over expiring government paper and coupon payments, but we are dealing with one fearful group. Considering what other major central banks are getting up to, perhaps it ought to be expected.
I’m guessing that the number one example of “increased activity” mentioned in the statement was based on the market reaction to a so-so retail sales report for May. What really matters is not the expectations game, but the hard data. The consensus was for 0.3% and the headline number was 0.5%, but therein lies much that is obscured.
To begin with, the Commerce Department claims that sales were up 2.5% from May 2015 on a seasonally adjusted basis, though they were up only 1.9% on a non-adjusted basis. The series was recently revised back to 2008, and the results were slightly lower, not higher, so you will excuse me if I doubt the adjustment. A further reason is that trailing twelve-month (TTM) sales now stand at 2.74% (NSA), and while this is up from the last few months, it is still below the 3% stall-speed level and down considerably from the 3.6% rate in May 2015. The ex-auto, ex-gas year-on-year comparison fell for the fourth straight month to 3.4%, while the TTM rate for the ex-auto and gas category went from 4.25% to 4.27%. The average for the last six months is 4.2%, so you will excuse me if I don’t see the same signs of strengthening activity. I do see the benefits of the winter-depressed first quarter of 2015 dropping out of the comparisons, but not much else beyond that and monthly noise. June retail sales have been sluggish so far.
I didn’t see signs of strengthening activity in the May industrial production report either. The initial estimate from the Fed-produced report was for a (-0.4%) overall decline in May, with declines in every category but mining (+0.2%). The year-on-year comparison is an estimated (-1.4%) overall and (-0.1%) for manufacturing. At some point we have to stop making excuses; the business inventory/sales ratio is still far too high at 1.4 0.
Perhaps the central bank took heart from the two big regional Fed manufacturing surveys released last week. New York checked in with +6.01, while Philadelphia stood at +4.7. Both have been negative for most of the last few quarters, and the New York result was quite a jump from last month’s (-9.02). The internals of the New York report were mixed but positive overall; the same could not be said of Philadelphia, where the internals were weak. I look for both of these to weaken over the summer.
Deflation moderated in trade, where the year-on-year declines in export prices (-4.5%) and import prices (-5.0%) moderated about half a percent, thanks to sharp monthly gains (1.1% and 1.4% respectively). Most of it was due to the recent back-up in petroleum prices. Producer prices, however, moderated from 0.0% year-on-year to (-0.1%), though the difference isn’t really significant. Consumer prices followed a similar path, from 1.1% to 1.0%, though the so-called “core” rate (ex-food and gas) rose from 2.1% to 2.2%. Again, not significant.
The warmer May weather led to an uptick in the homebuilder sentiment survey, from 58 to 60, while starts remained at a level pace of about 10% annual growth, the same zone as 2015. Permits have softened, something to watch, as are weekly claims, where a jump meant another week of year-on-year increases in claims.
Next week rounds out monthly housing data with existing-home sales on Wednesday and new-home sales on Thursday, along with a couple of home price indices thrown in during the week. Housing isn’t really moving the market much these days, so expect a lot more attention to be paid to Janet Yellen’s testimony on Congressional Hill over Tuesday and Wednesday (it’d get the lion’s share anyway). Durable goods for May are out on Friday.