“Who has deceiv’d thee so oft as thy self?” – Benjamin Franklin, Poor Richard’s Almanack
As last week went on, a real malaise settled over stock prices. In particular, the issue of the budget deadline and the so-called fiscal cliff, an issue that seemed to have vanished from the investment radar before the election (“they’ll muddle through, we’re sure of it,” would about sum it up), seemed to gather destructive force over the view from Wall Street in the election’s wake, much like Sandy had over the region shortly before it.
End-of-days warnings multiplied. Wall Street strategists seem particularly distraught, which is in itself something of a puzzle. The deadline has been in place for over a year. Where were the warnings – and certainly the volume – before the election? It may be that many had come to count on a Romney victory and got caught up in the kind of cloistered group-think that the business is prone to. It’s also possible that an element of jilted-suitor effect is at work.
There is a silver lining to the turmoil. In the spring, I was writing that one problem with the markets floating higher on their own momentum was that they were creating the very complacency politically that would remain an obstacle to action of lasting significance. Now the reverse is true, with politicians under pressure to compromise for the good of the country. Looked at in this light, turmoil is good.
The current conditions have improved the possibility for a Greek extension next week, and is focusing the minds of our elected representatives in Washington on the importance of reaching a deal. Yes, there is the usual amount of posturing and staking of distant positions, but it’s all part of the deal-table process. Compromise is necessary in the end, but so is starting out by announcing tough, principled positions. Else your own supporters will hang you afterwards, as Representative Barney Frank (D-Mass) observed.
Two items during the week that are cause for hope in this respect came out of the CEO meeting on Wednesday and an interview that Representative Frank – the ranking Democrat on the House financial services committee – gave to CNBC television. The CEOs seemed to emerge optimistic about the exchange (it’s also possible that the pessimistic ones elected not to speak to the press). It does feel like there is a will to get something done, which was not at all the case in July 2011.
In his interview with CNBC, Congressman Frank spoke about the budget problem in its two pieces, one being the sequestration, the other being the tax issue. His focus was on avoiding the sequestration, on the grounds that the sharp automatic cuts – which were expressly designed to be so draconian that Congress would be forced to avoid them – would cause far more damage. Taxes, he explained, could always be fixed afterwards, given that quarterly payments aren’t due until April and many paychecks wouldn’t see an effect until the middle or end of January.
[When the CNBC interviewers (including Maria Bartiromo) seemed surprised by the notion that the tax aspect could be fixed after the end of the year, Frank dryly replied that the number of people who would strenuously object to a retroactive tax break was likely to be very small. Love or hate Rep. Frank, he has long earned the distinction of having the sharpest wit on the Hill.]
This viewpoint is positive in two ways, the first being that such an attitude seems to make it less likely that a line in the sand over tax rates will be drawn that leads to the spending shock that the original August 2011 debt extension ominously built in as a deterrent (since it imposes severe cuts on programs favored by both sides, neither has an interest in seeing them come to pass).
Frank’s point about the tax increases not having an immediate effect is a good one, though the payroll tax increase seems destined to return. It would also give the two sides some extra breathing room to cut a deal, and indeed I would not be at all surprised to see some sort of package that includes at least a partial extension of some of the issues, particularly taxes, in part based on the reasonable proposition that the newly-elected Congress should have the final say.
In a piece I wrote for the Seeking Alpha website Thursday morning, I remarked that the market is ripe for a rally, and that still appears to me to be the case. Negative sentiment measures are quite elevated, and any breath of good news from Washington or Brussels would be a catalyst for a reversal. It was enough on Friday to see a bit of hope about the budget process for prices to stage a rebound that was better than it might have appeared, considering the day’s weak start.
Absent the Middle East situation getting out of hand, conditions favor a grind higher into the end of the year as budget negotiations proceed and Greece’s debt problem is taken off the calendar until next year. Genuine budget progress may not happen until mid-December, but once it happens we could see a sharp run-up in the final weeks and days.
The Fed may also be supportive at its December meeting, as noted by PIMCO co-chief Mohammed El-Erian. If Fed action ties in with a constructive budget backdrop and some Sandy rebound data, prices may recover much of their lost ground by year-end (though a return to the September highs seems unlikely). Recent earnings reports from consumer companies have ranged from moderate to positive, without major setbacks and with signs of resilience in the middle and upper and strata.
A Happy Thanksgiving to all from Avalon Asset Management Co!
The Economic Beat
The bulletins on the economy suffered from the effect of Hurricane Sandy, but when I looked below the surface of them, there were some reassuring data points, in fact some surprisingly good. Not so much in an absolute sense, it should be allowed, but as a surprise relative to where we have been.
Start with retail sales, and start by discarding the seasonally adjusted numbers, as I did (-0.3% for October, if you’re interested, though actual sales rose). As I wrote in Seeking Alpha a couple of days earlier, the year-over-year change for both October sales and year-to-date sales – using the raw data – were above the 20-year average. They use real sales when reporting corporate revenues and profits, not seasonally adjusted ones.
Despite the wailing on Wall Street, the small business confidence index actually rose. It’s still below neutral, but for now it’s going in the opposite direction of the Street.
The industrial data was better than I feared, with the exception of the Philadelphia survey (which includes the Philadelphia area and southern New Jersey). The New York Fed reported a decline of (-5.2) in its survey’s activity index, which as a headline was better than expected, but the real surprise was in new orders and shipments. New orders had a hefty 12-point swing from about minus 9 to plus 3. The swing in shipments was even bigger, from (-6.4) to +14.6 (rounded). It’s too early to call it an upward trend, but it certainly isn’t Armageddon, either.
The Philadelphia survey was largely negative across the board, with a large decline in the activity index from 5.7 to (-10.7). New orders and shipments fell as well. However, there were two glimmers of hope, one being the future conditions reading, which was largely unchanged at +20. I have long said that the future conditions index is really a better measure of current conditions, which suggests that respondents are treating the current month as a weather hiccup rather than a trend. The big drop in inventories may also lead to an increase in new orders, probably in January when there should be more clarity on the fiscal situation.
Industrial production fell 0.4% in January, but the Fed staff estimated that Sandy caused a near 1% decline by itself. If that is so, then underlying conditions are better than I might have thought after the hesitation induced by the political situation. It suggests that the next two or three months should get some recovery benefit, though it might not really get underway until December (reported in January). The combined picture of the three reports suggest that the initial estimate of a half-percent hit to GDP in the fourth quarter is about on target.
Weekly claims reported a big surge (+78K), although not as big as the spike after Hurricane Katrina (+100K). I’ll have to wait until next week to be sure, but it looks as if California induced some variation again, as the drop in claims it reported the prior week looked improbably large and there may have been a catch-up effect. In any case, it will probably take a few weeks for the Sandy effect to subside. The drop in auto sales led to immediate layoffs at auto plants in the eastern half of the country, including Pennsylvania and Ohio. With the holidays and budget process approaching, claims data is apt to be volatile and possibly confusing for some weeks to come.
The decline in oil prices caused a (-0.2%) drop in the Producer Price Index (PPI), but the year-on-year rate is a steady 2.3%, with core (excluding food and energy) at 2.1%. The Consumer Price Index (CPI) reported a year-on-year rate of 2.2%, with core at 2.0%. They’ve both been stable this year, though pressure is surfacing in the CPI rent index.
European industrial production in October was weak again, but recent export data for some markets (notably Greece) were better than expected. The key November PMI numbers (France, Germany, EU) all come out on Thanksgiving, followed by German GDP and its business survey on Friday. The Europe problem is by no means going away yet, but the stress levels usually fall in December when its politicians stop talking.
Next week indeed includes Thanksgiving, which means U.S. markets are closed on Thursday and open for a half-day only (1 PM close) on Friday. In addition, Wednesday afternoon is usually one of the lightest trading sessions of the year. The shortened week does have the potential to give the market a bit of a sentiment boost, as housing data makes up the bulk of the reporting.
October existing home sales and the November homebuilder sentiment index will come on Monday, with October housing starts on Tuesday. The question will be how to sort out the Sandy effect from the underlying trend. Lately I have been seeing advice to buy homes in newspaper cartoons, which may actually be a better indicator of where the sector is really going.
Jobless claims will come a day early, on Wednesday, along with the Leading Indicators report and the initial consumer sentiment report from the University of Michigan. It will be interesting to see the effect of the election and stock market drop on the last report, although it won’t really be of much economic significance.