Sense and Nonsense


“Good Sense is a Thing all need, few have, and none think they want.” – Benjamin Franklin (ed.), Poor Richard’s Almanack

Another week, another bout of lunacy. What else is there to say when the stock market puts on its best day in years – 1 1/2%-plus gains across the board – precisely because our new President did not scare the globe half to death with his first address to Congress the night before.

You may recall that as Mr. Trump’s victory became probable on election night, stock futures plunged so sharply as to set off their circuit-breaker limits. However, when the President-elect’s speech ended up being surprisingly mild and modestly conciliatory, prices rallied back to unchanged by the next day’s open and a veritable stampede got quickly underway as traders suddenly decided that one, tax cuts and deregulation were now on the way; and two, that the President-elect must have been kidding with all of that other crazy stuff he said (or tweeted).

After some rancorous recent weeks that included the departure of the newly-installed National Security Advisor (Michael Flynn), a highly contentious travel ban thrown out by the courts, a new Attorney General forgetting he really did meet with Russia last year (thereby adding fuel to the Russian-connection rumors that have been swirling around the new President), it’s easy to understand why the markets might feel a sense of relief.

It’s also easy to understand that traders love to recycle winning trades, and so last Wednesday’s big rally can easily be described as nothing more than Election Night 2.0. The idea is that Trump’s newfound demeanor means (again) that he is going to leave off the eccentric stuff and concentrate on the “pro-growth agenda” that currently functions as sacral organ music on Wall Street.

Two problems come to mind with the rosy price verdict, one being that the Congressional address contained no new information about the agenda, merely more repetition that something really big was on the way. Which the market had already seemed to price in. The other is that some of the changes seem to be getting pushed farther and farther down the road, with some predicting tax reform for 2018.

I would add a third problem, namely that neither former President Bush’s “pro-growth” agenda, nor President Reagan’s “pro-growth” agenda, were able to stave off the end of the business cycle – and they were both passed within eight months. But you can’t argue with religious belief, and that is the closest thing to market sentiment these days.

Another example of religious belief is the notion that stock prices are going up because the economy is getting better. It isn’t. GDP is running at about the same anemic rate as it did last quarter (about 1.8% annualized), as can be seen in the Economic Beat below. But commentators constantly fall into the “better than expected” trap over a couple of sentiment surveys and blithely assume that stock prices must be right. The belief gets massaged by dubious statistics, like the ones I’ve seen going around over fourth-quarter earnings. The current estimate from FactSet for Q4 is that year-over-year earnings for the S&P 500 grew by 4.9%, with 98% of companies having reported. But the week before last, I saw a report that “as reported” earnings (whatever that means) were actually up nearly 13%, and then I saw a tweet a couple days ago that proclaimed that they were really up 24%, the best performance in decades! This time, the qualifier was “as reported operating earnings.”

This is all brokerage-fed nonsense. Companies love to eliminate all kinds of things from their earnings reports and claim organic growth rates that don’t exist (and that certainly don’t exist in their SEC filings). The Street is always happy to go along with the illusion that if you eliminate all the bad stuff, earnings growth is great. Of course it is. Non-GAAP means non-real, but it’s always good for a wheeze on the Street.

Sentiment waves don’t just stop from one day to the next. The price rally has faded since Wednesday, but that could just set us up for another rally – partly because a few days’ sag gives the market a chance to work off its oversold condition, and partly because when we worry more and more about what’s going on in Washington, it sets up another opportunity for the President to rally stocks by acting normal for a day. We’re still overdue for a 3%-5% pullback, but so far selling has been unable to gain any traction. I don’t know how much longer this kind of thing can continue, but I do know that it can go on longer than you think, and that the longer it does, the longer the way back.

The Economic Beat

It was another week of disparity. The two national purchasing manager surveys known as ISM raced forward with bonny-looking results: 57.7 in manufacturing, a result well above average, with 57.6 for services. Manufacturing had a growth-contraction sector score of 17-1, very high indeed, while non-manufacturing was at 16-2, with the business activity index at a lofty 63.6% (50 is neutral in all the measures).

Put it down to more euphoria over how good things are gonna be with all them tax cuts and all of those pesky regulations gone. Some of the contradictions included declining employment readings in manufacturing and declining price expansion in non-manufacturing (the best leading indicator for that sector). Neither were bad or telling on their own, but they didn’t echo the headline results. Nor did the latter dovetail with the Federal Reserve’s Beige Book, a regional compendium of business conditions, that reported that manufactures saw a slightly declining sector, not at all in synch with the many robust opinion reports that have been coming out of the surveys (diffusion reports that do not comprise actual activity data).

There is more: both of the Markit PMI surveys, which are broadly similar to ISM (though Markit is relatively new and has more of a smaller firm component), reported lower scores from January to February – from 55 to 54.2 in manufacturing, and from 55.6 to 53.8 in services. And that’s not all – the Commerce Department reported that new orders for durable goods fell by 0.2% in January, excluding transportation. Orders did rise by 1.8% overall, but that was due largely to aircraft orders which have very long lead times and do not immediately translate into increases in activity (they can also get cancelled in tough times).

Other surveys displayed similar behavior. The energy-centric Dallas Fed survey has taken flight in recent months, rising again to 24.5, which may not seem high except when considering that the sector languished in negative territory for most of the prior two years. The prospects for oil have improved, certainly, but the rally in prices flattened out some time ago at levels that are hardly cause for exuberance. The auto-centric Chicago regional purchasing survey soared to 57.4 (from 50.3) in the face of reports of slowing auto sales and rising inventories. The Richmond Fed rose from 12 to 17. Strength everywhere in the surveys, yet the latest estimate from the Atlanta Fed shows GDP running at a mere 1.8% annualized growth rate so far this quartet, a slight decline from last quarter (1.9% after the latest revision).

Home sales rose smartly last month, but the latest pending home sales report shows an estimated decline of 2.8%. The trend is probably the mean of the two, as January sales were likely fueled by mildly rising mortgage rates and fears of even bigger rises on the way, making the February pullback little more than a return to trend.

Speaking of trend, the latest GDP revision showed little change, but one interesting piece was lost in the headline noise – namely that nominal GDP was revised downward a tenth, though the headline number was helped by a revision to the price deflator, leaving real (inflation-adjusted) GDP unchanged. It must be said, though, that the change to nominal GDP was barely distinguishable from a rounding error.

Construction spending fell 1% in January – maybe. The report showed that public spending fell and that private spending rose, but the data series is prone to such large revisions that a mere 1% decline (or the 1% gain in single-family) could easily be overturned.

The initial estimate of January personal income showed a gain of 0.4% – seasonally adjusted and annualized- and a spending increase of 0.2%. Real spending fell by 0.3%, the largest such drop in years, possibly a hangover effect from December sales, as weekly Redbook reports suggest that February spending has recovered. The PCE spending report is certainly at odds with the Commerce Department’s retail spending report for the month – we’ll see any revisions the week after next.

The coming week is a mostly quiet one that ends with a bang. Monday leads off with factory orders, which are mainly watched for the revisions to the durable goods data released the week before. International trade for January is on Tuesday, affording a slight revision to GDP forecasts, and wholesale sales are due on Wednesday. The ADP payroll report is also due that day, giving a hint of the all-important jobs report this Friday. The ADP report, however, tries to anticipate the government report and so is prone to missing shifts in hiring. The consensus estimate for the government report is in the 190,000-200,000 range.

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