‘Tis the Season


“Bark us all bow-wows of folly.” – Walt Kelly’s Pogo in Deck us All with Boston Charlie

The holidays can make it very difficult to get this weekly column out on time – houseguests, cooking, college trips and so on. My apologies. The plus side is that there was little net change in the equity markets, and it rates to stay that way through year-end. Equities popped on Tuesday and then gave it all back with interest on Wednesday, which seemed to signal to participants that bubbly might be taking a breather, and so stocks finished slightly down on the week. Over in bond land, the ten-year yield popped up over 2.6% and is now up about 75 basis points since the election. That rise isn’t a comforting signal.

Other crises have started to loom, above all Italian banks, followed by growing doubts about China. They are acting as more of a mild brake than anything else, as it’s very difficult to take the market down significantly in December, even more so that we are past the monthly options expiration on Friday (partly responsible for Tuesday’s move). There isn’t much good news coming from anywhere in the world, but so what? For now, we are treated to endless reruns of panglossian Trump supporters taking about animal spirits that will turn the global economy on its head while making wide-eyed projections. Hard skeptics in the bond market wonder if anything will really obtain besides inflation.

Chairman Janet Yellen of the Fed wondered (as I have in recent weeks, along with many others) if a stimulus program is what the economy really needs right now. In short, it isn’t. An infrastructure program is needed on maintenance grounds, no question, but for economic purposes it would better to keep it in the back pocket for the next downturn, which isn’t far off at all. The stock market is pricing in sugar-plum fairy dreams of vast tax cuts and vaster spending programs that have no negative impact, but we are still four weeks off from inauguration and the beginning of battles over programs. Eden isn’t going to happen in the first week, and stocks staging a counter-trend sell-off on the day of a Fed meeting – as they did on Wednesday – isn’t a comforting sign either.

There is a great deal of talk about animal spirits, but beware of such things. In my lifetime, I have never seen animal spirits lift an economy up. What one does see, not surprisingly, is that a strongly rebounding business cycle will feed upon itself and give rise to an increase in optimism, thereby lending a tailwind to growth (and speculation). The other part of animal spirits usually seen is over-exuberant stock prices leading to very hard landings. Don’t expect traders to warn you, as they love bubbles and are always convinced that they will get out in time.

In the short term, equities remain highly overbought, which could make further gains difficult for a time. Unless geopolitical events intervene, though, we should drift the rest of the year with an upward bias. The talking heads will chatter about Dow 20,000 every day and the ever-dwindling band of floor traders are impatiently waiting to don their celebratory hats. It may well end up being another “what were we all thinking” moment, but ’tis not the season for doubts.

The Economic Beat

The report of the week was the November retail sales report, which was actually better than it looked. Although it was up only 0.1% (seasonally adjusted) from October, the year-on-year figure was +3.7% adjusted and +5.3% unadjusted (more weekend days) over November 2015, the best monthly unadjusted comparison of the year.

However, the underlying details showed little or no change in trend, and it’s important to keep in mind that calendar and shopping vagaries mean that November and December have to be added together for meaningful comparisons. Strong November comparisons generally mean weak December ones, and vice versa. The trailing-twelve-month (TTM) rate advanced to 3.16%, back above 3% for the first time since August 2015 (3.17%). The TTM rate also grew into the end of 2014 and the beginning of 2015, peaking at 4.3% before sliding backward the rest of the year, so calling this a new trend seems premature. That seems especially true in light of the fact that the TTM rate of growth for ex-auto, ex-gas sales currently stands at an estimated 4.26%, compared to an average of 4.22% over the last twelve months. What change?

Right on the heels of the retail sales report was the November industrial report, and it might have been the most interesting report of the month, if housing starts hadn’t displayed the exact same symptom.

Last week, both the New York Fed (+9) and Philadelphia Fed (+21.5) manufacturing surveys showed distinct improvement in their headline readings, reaching multi-month highs. However, the November industrial production report from the central bank showed an index decline of 0.4%, including a decline of -0.1% for manufacturing. Year-on-year, the index is down 0.6%. The report showing actual activity was anemic and distinctly weaker than opinion surveys, suggesting the election upset and subsequent stock-market rally has cast a rosy glow over actual events.

This could not have been more forcefully illustrated by the latest news in housing. The homebuilder sentiment survey leapt to 70, the highest reading since before the financial crisis. Normally, the monthly sentiment index has a very strong correlation with the monthly tally of housing starts and permits (which makes good intuitive sense), but actual starts activity showed a sharp decline in the initial November estimate, with permits shrinking somewhat as well. The year-to-date increase in starts fell to 4.8%, less than half 2015′s rate, though single-family housing starts (+9.6% YTD), are much close to last year’s growth rate of 10.3%. There may be a lot of optimism in the air, but as is the case in the stock market, real activity is far behind sentiment.

On the inflation front, both import (-0.3%) and export (-0.1%) prices fell last month, keeping the year-on-year rates mildly negative. A stronger dollar was partly to blame. Producer prices rattled the bond markets by jumping 0.4% last month, raising the year-on-year rate to 1.3%, though still only 0.4% when excluding food and energy. Consumer prices (CPI) rose a more modest 0.2%, thanks mostly to oil – excluding energy, prices were up 0.1%. The year-on-year CPI rate inched up to 1.7% overall, from 1.6% the previous month, though the core rate remained steady at 2.1%.

And then there was the Fed meeting and its forecasts. Three rate increases next year instead of two – is that supposed to be good for stocks? The changes in outlook from the last meeting were tiny: from 2.0% to 2.1% for GDP in 2016, and unemployment falling from 4.6% to 4.5%. The Fed’s staff forecasts, it must be said, have not been terribly accurate, but until recent months had persistently been overoptimistic. Recent forecasts have ranged from subdued to restrained and have not strayed far from 2%. Joyous stock market bulls would say that they’re tired of being wrong and so low-balling the numbers (or are just disgruntled elitists), but history would suggest that the kind of long-range forecast currently in place – real GDP falling to 2.0% in 2018 and 1.9% in 2019 – comes from a Fed that thinks that the current business cycle is ending. Remember that the central bank never openly predicts such things, it just grows more cautious.

Next week is quiet and will feature traders heading out of their cities en masse on Thursday evening and Friday afternoon. We’ll get existing home sales on Wednesday, new home sales on Friday, and then on the manufacturing side, November durable goods on Thursday, along with the Kansas City survey. Another revision for third-quarter GDP is scheduled for Thursday, along with November personal income and spending.

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