Expanding the Float


“Summertime, and the living is easy.” – George Gershwin

We’re not sure what was the bigger story last week – the Facebook (FB) float (amount of publicly tradable shares) expanding, or the helium under the stock market indices that seems to waft prices ever higher on ever lower volume. Or was it the float of German chancellor-turned-fairy-godmother Angela Merkel, who was able to lift European stocks -and so American ones – higher yet again by simply repeating the old standby formula of being “committed to doing whatever we can to maintain the common currency” (emphasis added).

Over the weekend her finance minister, Wolfgang Schaeuble, clarified the matter by stating that more aid for Greece was not part of “whatever we can” when he added that “we can’t make yet another new program.” It’s a familiar skit by now – Merkel promises good intentions, and her ministers come on a day or two later to add, “so long as it doesn’t cost any money.”

Madame Chancellor also repeated the key German prerequisite, which didn’t get as much airplay – “there has to be more responsibility shared politically.” In other words, German money comes with the price tag of German veto power on budgets. So far, that approach has gone down terrifically well in places like Paris, Athens, Madrid and Rome.

But what does it matter if the European train wreck is still on course? They’ll muddle through somehow, just like Paulson did, and anyway it isn’t going to happen this week. So long as traders believe there is no overnight risk, the robots are free to bid on the “positive” news flow. Which isn’t really positive either (see below), but what let’s not split hairs while the weather is nice.

The expansion of the Facebook float wasn’t so good for existing holders of Facebook stock, which saw it plunge again to half of its IPO price. It was enough to finally waken boy wonder CEO Mark Zuckerberg, who is being forced to confront the effect of a falling stock price on the gunslinger software engineers of the Valley. More lockup expirations await the remaining hardy holders, leaving their courageous venture capital backers with the inspired idea of dumping the stock at their limited partners. That way, whatever happens with the stock, the VC’s can shrug and say it was your decision to buy/sell, we just returned your investment.

The expansion of Chinese monetary policy hasn’t been so good either for the country’s crumbling property bubble and fading export sector. But what does it matter? Nothing bad is going to happen this week and anyway, they’ll muddle through.

From Lebanon comes the promise from Hezbollah of drastic retaliation if Israel takes out Iran’s nuclear program, which it is widely expected to do after the US presidential election. But what does it matter? Nothing bad is going to happen this week and anyway, the elections aren’t until November.

Only 40% of US companies beat lowered revenue estimates this quarter, and earnings are already predicted to contract for the third quarter. But what does that matter? Third-quarter earnings aren’t this week and anyway, maybe the Fed will buy more mortgage bonds. That should get earnings going again, and even it doesn’t, it’s summertime, and the living is easy.

We leave with you a little touch of irony. The Treasury appears to have rethought its approach with the two government mortgage giants, Fannie Mae (FNMA) and Freddie Mac (FMCC) and announced an amended payback schedule on Friday that sent the prices of shares of its preferred stock slumping. The Wall Street Journal observed in a school-masterly way that the fate of “an investment whose value depends on unknowable government policy outcomes is like a lottery ticket. And those usually end up worthless.”

Point taken. But doesn’t that apply to the entire European securities market, sovereign bonds included? Not that it matters, because nothing bad will happen this week and anyway, it’s summertime and the livin’ is easy.

The Economic Beat

The report of the week was the July retail sales report, quoted in the press the rest of the week as having risen more than expected. The catch is that retail sales didn’t rise more than expected – they fell.

In the earlier part of the decade, sales would rise from June to July. Since 2006, they have fallen, and so the seasonal adjustment factors have been evolving. The process weights recent years more heavily, and so this year’s July adjustment factor got an upward boost by the Commerce Department. July sales didn’t rise 0.8% in real terms, as the headline had it – they fell by about 1%. Had last year’s adjustment factors been used, the increase would have been at about 0.7%.

That difference of 0.1% doesn’t seem like a lot, and seasonal adjustment factors do serve a purpose, but corporate earnings are based on actual, not seasonally adjusted consumption. So is GDP. The idea that somehow spending regained momentum in July is a statistical artifact. Not only did retail sales decline by 1% in real terms from June to July, the better measure of year-on-year rate of monthly sales growth, which turned positive in November 2009, has been falling in recent months: using unadjusted data, in 2011 it averaged 7.9%, while this year has fallen to 6%. More ominously, it has fallen below 4% in the last two months and three of the last four, with the last two months showing the weakest improvement since January of 2010. August weekly data isn’t showing any strength yet either, despite the advent of back-to-school season.

On the manufacturing side, both the New York and Philadelphia Fed business surveys reported negative readings ((-5.9) and (-7.1) respectively) that were worse than expected. The data were not so bad as to be recessionist, nor were the underlying components, but the slowdown in manufacturing is clear. Industrial production for July rebounded from two months of going sideways with a 0.6% increase that was led by a reversal in utility usage. However, revisions have been substantial of late, so we’re going to be careful about drawing larger conclusions. It is hopeful that capacity utilization has crept up back over the 79% level and isn’t as far behind the long-run average of 80.3% anymore. However, manufacturing capacity utilization has stalled out this year, and still remains below its long-term average.

Housing had its own stories of phantom improvement. Starts fell slightly, instead of rising like they were supposed to, but the press preferred to focus on the improvement in building permits (mostly in the multi-family sector). In addition, the homebuilder sentiment index hit a five-year high, which isn’t as good as it sounds when one considers that the reading of 37 is still well below the neutral level of 50 and barely up from 35 last month. Builders also complained about tight credit. We don’t want to seem too negative, as we have said all year that the bottom in housing is in, but it is still the bottom and is still a slow improvement that is for the time being more fragile than thought. If all goes well, housing will continue to pick up strength in 2013-2014, but it could just as easily remain stuck.

Sentiment indicators were mixed, reflecting the confusing environment. The National Federation of Small Business confidence index fell, as did the Bloomberg Consumer Comfort index, but the University of Michigan sentiment index improved slightly. Leading Indicators did better than expected (+0.4%), thanks to weekly claims and strength in permits.

The calendar next week favors a continuation of the helium effect in stock prices. There is no major release until Wednesday (though we do pay attention to the Chicago Fed index released on Monday), when existing home sales are released in the morning, along with Fed minutes in the afternoon. A lack of news usually means a continuation of the existing trend.

New home sales are due on Thursday and durable goods orders on Friday. Equities are short-term overbought, but unless the numbers are quite weak we think the market has a good shot at floating higher. It’s August, which isn’t known for its attachment to reality.

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