August Times

“The summer’s flower is to the summer sweet…but…lilies that fester smell far worse than weeds.” – William Shakespeare, Sonnet 94

Remember how August used to be? A month when the tape gently meandered along and instructions could be left with junior assistants not to bother us at our vacation pools? The light summer volume has always been a staging ground for faked rallies and one-day panics, but trading markets and robots have made the month positively annoying.

Last week’s rise should rightly be attributed most of all to the light economic calendar. It usually means that the market keeps heading in whichever direction it was last headed in at the end of the previous week. Weak news from China and Europe led to red pre-market action in the latter part of the week, but those places are so far away. Besides, they have central bankers that can cut interest rates, so it will surely turn out for the best.

Attempts to push the tape higher again towards the end of the month are also common in August. For our money, the “silly season” in golf has nothing on the one that occurs at the end of every summer in the equity markets. Despite the sense that nearly every account this weekend of the current five-week rally included the words “stimulus hopes,” have a wary eye out next week. We will need some pullback first to get proper footing, and mid-month sell-offs are also common in August.

The market’s silly season usually comes later, around the final week of the month and running through the first week of September. Whether or not you want to trade the calendar is up to you, but just keep in mind that absent a bolt from the blue, most of the action over the next few weeks rates to have no significant meaning.

We wrote in Seeking Alpha last week that there is a joker in this month’s playing deck, namely European Central Bank (ECB) chairman Mario Draghi. Though no action is expected on his part, it would make an ideal time to pull a stealth attack on the markets. What’s more, Draghi could then play the role of scapegoat for disgruntled parties and voters. It would certainly be a bold gambit on his part, as there is anything but unanimity for such a move, not within the ECB nor the eurozone. Indeed, there is opposition (and justifiably so) from other banks for the very reason of not giving elected officials another easy opt-out from tough decisions. We don’t expect it, but perhaps that would be the point.

The notion that more central bank easing will pull the global economy out of its slowdown is a delusion. It does not solve structural problems. Easing can cushion downturns, and that is one of its principal objectives, but it doesn’t flip a switch. Economies can still crash and burn in spite of easier monetary policy. However, it’s been dangerous since the 1990’s to trade immediately against policy easing, and in the last decade trading higher on hopes of easing that never comes has become routine. Better to wait until markets make new highs, and then get ready for the crash.

The Economic Beat

Although last week was the light week for data, there were some reports worth noting. The press took some notice of the disappointing Chinese data, but the markets skated right past it with self-assurances that it would only lead to more easing by the Chinese central bank, and thus the quick fix and a chance to buy more equities. You know, much like the Fed did in 2001 and 2008. Paradise is on the way.

In last week’s issue, our dissection of the jobs report concluded that the jobs market has not really changed all that much during the year. It’s running at a steady improvement over last year, also reflected in the claims data, but the only “escape velocity” has been in the over-excited Wall Street hyperbole of the first quarter. The seasonal factors have thrown off some of the numbers, but overall the difference, including the latest claims week, has been consistent. It’s worth noting that the insured work force is now the largest it’s been in two years – yet that is still six million fewer than this time four years ago.

The Chinese data reflect the slowing global trade picture, as well an economy still heavily dependent upon exports for growth. Retail sales, industrial production, imports and exports were all softer than expected. Europe’s woes are weighing particularly on trade, yet we didn’t see a single press account that didn’t blasely treat it all as a simple way-station on the route to further central bank accommodation. How the latter might increase European purchases of Chinese goods is, we imagine, a rudimentary exercise left for the benighted.

Back in this country, the wholesale sales and inventory data for June was released on Thursday, and although it doesn’t ever excite the markets – the data don’t lend themselves to instant line drawings – it’s a useful report and has become more so in an age of leaner inventories and exaggerated seasonal distortions.

Economic activity is slowing. The first quarter increase in wholesale sales for 2012 (7.8%) was about 40% weaker than the first quarter of 2011 (12.5%). One can argue that the larger increase was based upon an economy recovering from a lower base in 2011, but that doesn’t quite justify why the second quarter 2012 sales decline of (-4.7%) was the biggest since the end of 2008. The year-over-year rate of inventory increase has been falling nearly every month for a year, a pattern typical of recessions (though not always followed by one). The inventory-to-sales ratio rose to its highest level since the end of 2009. The markets also ignored Friday’s news that July import prices excluding petroleum fell for the third month in a row (export prices also fell). Prices are the most sensitive of leading indicators. This kind of hubris is what leads to bigger corrections.

Next week the calendar picks up again, starting with the July retail sales report on Tuesday. Consensus calls for increases of 0.3%-0.4%, but that looks impossible to us without some magnificent seasonal adjustment. Weekly data was weak throughout July. The report will be released at the same time as the latest small-business optimism report.

The week will be heavy on price data – which the market doesn’t care much about these days – as well as industrial data and housing data. Price inflation consists of the Producer Price Index (PPI) report for July on Tuesday, and the Consumer Price Index (CPI) report on Wednesday.

Manufacturing data will be in the form of July Industrial Production on Wednesday, along with the New York Fed survey the same morning and the Philadelphia Fed survey on Thursday. These have all been weak lately, so expect the markets to try to focus on housing data instead. The homebuilder sentiment index comes out Wednesday morning, and July housing starts on Thursday. It all wraps up with the somewhat anti-climactic leading indicator report on Friday and another consumer sentiment report. The Cisco (CSCO) earnings report on Wednesday afternoon should matter more than either of the Friday reports.

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