“Is this a dagger which I see before me?” – William Shakespeare, Macbeth
As we edge closer to Christmas, the end of the year and the fiscal cliff, the bout of anxiety I’ve been predicting has begun to settle into the markets. A week of generally helpful economic data was largely overshadowed by the steady cadence of House Speaker John Boehner marching to the podium every two or three days to solemnly announce that President Obama had not yet joined the Republican party. Or at least, not the wing that inhabits the House of Representatives, and therein lies the rub.
The House of Representatives is by design a parochial institution, and many decades of gerrymandering have only made it more so. The Senate’s broader voter base doesn’t guarantee centrists, but it does tend to filter out candidates lacking in moderation or shrewdness, to the point of frequently producing surprise winners out of states that are otherwise solidly in the grip of another party.
Congressional districts are another matter, and in many of them the chief peril is in not being extreme enough to keep the local activists happy and avoid getting “primaried,” or lose the next primary contest in “yellow-dog” districts (the other party couldn’t beat a small yellow dog in the general election). The national figures in your party may be saying one thing, but they’re not going to vote in your district. Big business leaders tend to get warmer receptions in the Senate, where the money and halo effect are always useful, than in the House, where if the factory isn’t in your district, it might as well be on Mars.
So Speaker Boehner and President Obama both find themselves in tricky positions, as befits any big deal, and for now are going through the usual motions of trying to get the other side to appear to cave first. Fittingly enough, perhaps, the contest has resembled a union-management negotiation. Both sides have started out saying that the other’s proposals are unreasonable and out of touch with reality. A key GOP tactic, ironically, is the typical union stance of wanting management to make the first detailed proposal so they have something to tear up for the benefit of the members. Neither side wants an outcome of no deal, but both are pressed hard by activists to hold fast to principals. Both have a need to come out claiming victory “for the American people,” which roughly translates into “for our chances of getting re-elected.”
The strategy is all about trying to be the reasonable, yet true-blue side versus the other’s dangerous, radical inflexibility. Leaders try to out-posture in press conferences (“those unreasonable guys are wasting precious time”) while lieutenants feed back stories of flexible co-operation. The current buzz phrases include “slow walk,” “kabuki dance,” and “going off the cliff” in the headlines, while hopes are still nurtured for a deal in the last few days of the year.
Will it be enough for the market? While December is actually the best month historically for the S&P 500, it isn’t always up. In the last ten years, it’s been down in 2007 (well-deserved anxiety), 2005 (protecting a lead), and 2002 (still in recession). As I pointed out in Seeking Alpha a couple days ago, there is much talk of a big rally if we get an agreement, but we may need a big decline first to get the rally, and hence the agreement. I don’t have to tell you to stay tuned – you won’t be able to avoid it.
The awful, awful tragedy in Connecticut may push the budget story off the front pages for a day or three, but it’s also quite possible it won’t get the attention it deserves because of the cliff. Given the past, one has to wonder what, if anything, would change anyway beyond the bleak prospect of more drills for emergency mass evacuations.
Europe closed up its latest two-day summit with a round of self-congratulations, another bottle of oxygen for Greece, and a new bank-supervision agreement that is supposed to be another link in the chain towards solidifying mechanisms for ensuring the soundness of the banking system and resolving problems therein. Quite a bit of work remains to be done, with another meeting not scheduled before June and German Chancellor Merkel probably wishing not to hear anything more about problems until after the German elections next fall. I doubt that she will get her wish, but at any rate Europe should be off the radar for the rest of the year. That leaves the cliff versus Santa as the final showdown.
The Economic Beat
Sentiment surveys aside, the US data has been, if nothing else, resilient. The two main reports last week were November retail sales and industrial production, and both categories performed decently, in particular the latter. That said, seasonal effects and Hurricane Sandy are still misting over the readings, making any conclusions more tentative than usual.
Retail sales reported a seasonally adjusted increase of 0.3% for November, missing the consensus for 0.6%, while the ex-autos increase of no change matched expectations. However, “core” sales, which exclude vehicles and gasoline, rose 0.7%, beating expectations. It was a decent performance, but sales gains in the second half of the year have ebbed from a strong first quarter that was boosted by favorable weather.
On an unadjusted basis, November sales were up 4.76% year-on-year, compared to the 20-year average of 4.61% for the month and a median of 5.16%. It looks better in the light of the large number of people affected by Sandy, which may also have been responsible for softness in department store sales. October and September received slight downward revisions.
Industrial production rebounded smartly from the Sandy-induced October decline with a gain of 1.1%, well ahead of the consensus for 0.3%-0.4%. It was a good number, though some of the gain was offset by October getting a substantial revision downward, from (-0.4%) to (-0.7%). Manufacturing also rose 1.1% after a softer revision from (-0.9%) to (-1.0%). Capacity utilization rebounded to pre-Sandy levels, and wholesale sales data showed an October unadjusted increase of 9%, though seasonal adjustments had it as a slight decline.
Seasonal adjustments also played a strong role in the weekly claims data, which reported a steep drop to 343,000 from 372,000. Adjustments are a tricky science, and I’m not pointing any fingers, but the model could probably have done a better job this time around. The unadjusted total of 429K for the December 8 week compares with a 436K total for the December 10, 2011 week. It isn’t quite as simple as sliding two days, but the year-on-year comparisons have been clustered around an average decline of 10% for most of the year, apart from the Sandy weeks. The latest figure isn’t even 2% apart.
All of that data, including a nice-looking increase in the PMI “flash” estimate from Markit Economics to 54.2, was in contrast with last week’s decline in consumer sentiment, the latest monthly decline in small-business optimism and a modest decline in the weekly Bloomberg “consumer comfort” index. (N.B. – the Markit number was well ahead of the ISM survey in last month’s reading). The low inflation data isn’t causing problems, with monthly energy-related declines in both the PPI (-0.8%) and the CPI (-0.3%), although both were up 0.1% ex-food and gas (“core”). I’m sure a lot of shoppers must doubt that food prices take into account the phenomenon of the incredibly shrinking package size. Import and export prices also fell, as did trade.
Overseas data was mixed, with the EU data still recessionary and European markets continuing to rally in spite of it, while China’s PMI has gone from slightly below 50 to slightly above 50 in recent months, occasioning a lot of fanfare over what has been at bottom a sideways direction throughout. One unpleasant thing that comes through all of the recent data is that global trade continues to soften, with the US, China and Europe all reporting anemic import and export data.
The overseas data was swamped by the cliff effect, but for one market: currencies. The Fed announced that it would continue its easing policies, while the European Central Bank (ECB) did not lower interest rates, causing currency traders to reflexively buy the euro and sell the dollar. That moaning sound you might have heard was economists bewailing the currency of a strengthening economy (the US) hitting multi-month lows against the currency of one going into recession (the EU), accompanied by a wad of bad debts it can’t decide how to treat. The currency market is a good example of Keynes’s observation that effective trading isn’t about knowing what data means, but about knowing what other traders think it means. A stronger euro is also about the last thing the EU needs right now.
That leaves only the FOMC meeting to review from last week, and I’ve surprisingly little to say on the subject beyond hoping that the Fed will finally put its checkbook away. Operation Twist, in which the Fed sold short-term securities and bought long-term ones with the proceeds has come to an end, due mainly to the Fed having essentially run out of short-term securities to sell. In a move that was not at all unexpected, the Fed announced it would “initially” keep buying the same amount ($45 billion) of long-term Treasuries anyway. “Initially” is the operative word.
Chairman Bernanke has gone all-in. While the Fed can always try buying more Treasuries (printing more money), I’m not sure it’s possible anymore to do so and still get a positive market reaction. It should be supportive of asset prices for now, but we are in uncharted waters. The key is solving the liquidity trap, and we can’t really be sure of the answer yet. The Fed also switched its policy targeting from the calendar to the unemployment rate – it will continue its extra easing until we get to 6.5% unemployment. That should also come under the heading of extraordinary measures; I’ve a feeling it won’t end up being cast as one of the policy pillars of the Federal Reserve.
Next week brings up more manufacturing surveys and more housing data. The survey data includes the influential New York and Philadelphia regions on Monday and Thursday. Consensus for both reports is suspiciously low – zero to slightly negative – given the likely snapback from Sandy. The agriculturally-oriented Kansas City district reports Friday, after the November durable goods and income-spending reports. Friday also has the Chicago Fed activity index and another consumer sentiment reading, on top of being a quadruple-witching futures-options expiration date.
Earlier in the week, we’ll get the homebuilder sentiment index on Tuesday, which should tell you how good the housing starts number is on Wednesday, yet will have nothing to do with the existing home sales data on Thursday. Leading indicators, once a major market report, are also out on Thursday, though they hardly raise an eye anymore. Another third-quarter GDP revision is released earlier that morning.