“When he went away, the blues walked in and met me.” – Arlen & Koehler, Stormy Weather
It really has been feeling like one storm after another, and not just for the hapless citizens of the Tri-State area (New York, New Jersey and Connecticut) who had to deal with another storm this week. Known in this part of the world as a “nor’easter,” they bring heavy winds and precipitation, in this case rain and wet snow, leading residents to liken it to the sequel to a horror movie. The storm itself was modest by nor’easter standards, but the timing was brutal.
Then Hurricane Obama hit Wall Street. In most ways, it was really rather a mild affair that had been widely anticipated for months; compared to the tragedy of Sandy and the follow-up of the nor’easter, it did not alter the landscape one bit. In fact, roughly half the population seemed to rather enjoy the whole thing.
Not so in the province of Wall Street. A late burst of confidence in the Republican camp that candidate Romney would prevail, including many who reversed field on Monday and Tuesday to predict not only victory, but an impressive one, led the Street to erect an instant skyscraper of hope that was to be powered by winds from the right for the next four years. When the wind turned out to blow barely left of center, the skyscraper collapsed, leaving its builders, backers and investors in a state of not-so-towering rage.
Especially incensed were those who had planned strutting victory parties from their new balconies. It was sort of like paying up for an expensive new luxury suite to watch the team’s new #1 draft pick, only to have him go down with an injury on the first play of the game, with all of your advertisers and clients in attendance. The natural reaction is to want to sack the coach, the general manager, the team owner, and maybe the kid in the parking lot for good measure.
The irony was that a hung election, widely agreed to be the most market-damaging outcome, was avoided. There was no inkling of trouble in the overnight and early-morning futures market on Wednesday morning. Then the secondary winds hit.
The first one struck about 7 AM Eastern Time, consisting of downbeat remarks by European Central Bank (ECB) President Mario Draghi about Germany and Europe, with the bank lowering its outlook for next year. That got the selling going. Right in its wake, and for the next few hours, a mighty wind of shrieking about the nearly-forgotten fiscal cliff arrived from suddenly-irate Wall Street strategists, who went from complacency on the subject to bulging-forehead tantrums overnight.
The S&P 500 broke through intermediate trendline support down to its 200-day exponential moving average on Thursday, then managed to claw back a couple points on Friday, leaving it back at the levels of mid-March. The central bank liquidity rally from September has been erased, and the fiscal cliff is indeed approaching. The volume of disaster warning has gone from about zero to one hundred in less than a week. Time to head for the hills?
Maybe not, despite the apocalyptic warnings that spring from jilted hopes. Seeking Alpha, the investment geek website to which I contribute every week, has been flooded with “end is near” signs. People who calmly wrote two months ago that the impact of the presidency on the economy is limited are now advising people to stock up their shelters with diesel fuel and canned food. Market sentiment has taken a hit, make no mistake. The same people talking about the resilient US economy and buying home-grown stocks last week are now talking recession and emerging markets this week. A prime example: The weekly Barron’s, which last week ran several stories predicting a Romney victory. This week’s cover blared, “Are We Headed For A Recession?”
Believe it or not, this is fairly routine. The markets usually sell off after a Democrat is elected – FDR’s elections were occasions for regular poundings. You could see it in November of 2008, when the market tanked 10% in the two days following Obama’s election. Last week was less than 4% in three days. Progress! Ironically, consumer sentiment rose to a post-recovery high on Friday.
It could take another week or so for the dust to settle down. Anxiety should remain high for a few days, without any major economic releases until Wednesday, when October retail sales are released. Banks and fixed-income markets will be closed in the US on Monday, a delayed recognition of Veteran’s Day (no such luck for the Europeans). We’re probably going to run up and down on stories of the fiscal cliff, and data will be seen in a different light for a few days.
Yet while sharp corrections in the early part of November are common, bad months for the market in November are uncommon. The last one was in 2008, when the market was in the middle of a crash. The markets are substantially oversold on a short-term basis, if not wildly so, and oversold on an intermediate basis. That’s not to say we can’t grind lower, but it’s going to get harder as we go. The next support level in the S&P 500 is around 1340, but as I wrote in Seeking Alpha, don’t start selling there without a very good reason (e.g., Greece leaves the euro. In which case, flee).
Three things matter between now and the end of the year: The fiscal cliff, Europe, and the Fed. All that shrieking and moaning has left the market ironically vulnerable to upside surprises. In Europe, despite the usual pantomime of grumbling and moaning going on with the Greek debt situation (obligatory for placating German voters), the odds heavily favor some sort of extend-and-pretend this month. A silver lining of the US budget deadline is that it strongly discourages any EU thoughts of rolling the dice with a Greek meltdown.
Many expect that the Fed will replace the end of Operation Twist in December with outright asset purchases. I had thought that hopes of Fed liquidity had been washed out, but that’s one goose that’s hard to kill (I leave the question of golden to others).
A week ago I would have agreed without hesitation that there was too much complacency about the fiscal cliff. Clearly that’s no longer the case, while at the same time odds of an extension deal have in reality improved somewhat. Looking past the usual heated rhetoric of party loyalists in the days following an election, the GOP, having been smote at the ballot box but not trounced, will not be anxious to be seen in the 2014 elections as the party that led the country into a sharp recession. In 2010 it had the luxury of blaming everything but the weather on the Democrat majority in government. That position won’t be available if we go off the cliff.
The Democrats won the election, but really only incrementally. It runs the same risk as the GOP of being swept out of Congress in 2014 if held responsible for the cliff; both sides badly need the other to prevent self-destruction. Many Democrat pundits are talking about the exit polling that showed a majority favoring a tax increase on the top bracket, but they would do well to remember that a majority also said that the government does too much, and the deficit-based thumping the party took in the 2010 elections.
The Republicans need to be able to say that they reached a deal without overtly raising taxes. Oddly enough, the Democrats need to help them do that. The Republican position stems from the reality that any vote for raising taxes leads to sure death in the next primary election. However, the latest round of redistricting means that most Republican-held districts are going to stay Republican regardless of the cliff. The last thing that Obama and the Democrats need is a wave of 2014 Republicans that are further to the right, which they will get if they don’t give the current group a way to save face. I suspect that both Obama and Boehner will look for a way to get out of this alive. After the pessimism of this week, any sign of a path to agreement is an upside surprise.
That may all change again in January, when the performance derby is over and the new Congress takes session. There is also the temporarily-forgotten risk of a pre-emptive Israeli attack in Iran. It’s not a time for taking big chances. But if war and Grexit can be avoided, the markets should hang on through the end of the year.
The Economic Beat
A light week for data was of course overshadowed by the election. Going by all the predictions of recession and doom, you might be surprised to learn that the data was the same it’s been for most of the year – neither robust nor recessionary, but modest.
The ISM non-manufacturing poll was nearly lost in the noise, but it was a modestly positive result. At 54.2, it was about a point below consensus, and there was definite weakening in the activity and new orders subcomponents. But prices, a more sensitive leading indicator, were about flat, and the score of growing industries to contracting was a decent 13-5. The same measure applied to new orders resulted in 10-4.
Exports were a surprise gainer in October, which helps the third quarter GDP revision. Wholesale inventories reversed a long series of year-on-year declines and rose in September, which will also benefit GDP. Sales, though, are still running on the lighter side. That is worrisome, but also due to hesitation over the budget cliff. Any resolution could lead to a big rebound in the first quarter. Import and export price pressure subsided, and consumer sentiment rose to its highest level since July of 2007. I’d feel a lot better about that if sentiment peaks didn’t always precede market downturns. Jobless claims fell, but Sandy was partly responsible and we’ll have to wait a week or so to infer the real trend.
In Europe, the news was not good. Industrial production figures for Germany, France and Italy were weak, with only the last result not much worse than expected. China reported that retail sales and industrial production both rose a bit more than expected – if you can believe the data.
Next week is quiet until Wednesday and the October retail sales report, though we hard-core types will be looking at the NSBC small-business confidence index on Tuesday. The Producer Price Index (PPI) is on Wednesday and the Consumer Price Index (CPI) Thursday. There’s a flurry of industrial data at the end of the week, with Thursday bringing the Philadelphia and New York Fed surveys, and Friday industrial production.
The most influential release could end up being the release of the Fed minutes on Wednesday afternoon. Cisco (CSCO) reports earnings after the close on Tuesday, and is still an important stock in tech-land.