“Blessed is he that expects nothing, for he shall never be disappointed.” – Benjamin Franklin, Poor Richard’s Almanack
A commonplace event in January is the second-half fade. Stocks often burst out of the gate on a wave of new money and fresh calendar optimism. Halfway through the month, they get too far out over their skis and end up taking a tumble or two to a more sedate pace.
Given the lukewarm rise of the week just past, though, the fade is more uncertain. On the one hand, it’s clear that the market is trying to go higher. Mutual fund inflows were the highest they’ve been in a decade. The AAII retail investor sentiment survey is at an 11-month high. The S&P 500 hit a multi-year high (with remarkably little fanfare).
Yet there is clearly still worry in the market: A bear could claim with some justification that the market should have been stronger last week, given the previous week’s momentum and inflows. A market with no news usually keeps going in the same direction, yet it fell the first two days of the week.
Some of the decline might have been options related, as dealers sold off after the weekly expiration. Some of it might have been trading pros selling out to retail investors. Whatever the reason, a market that isn’t overbought is more susceptible to good news. A bull could make the reasonable claim that last week represented necessary digestion of the rocket-like previous week, which was really just the first day of the year. Much will depend on the dynamic of the earnings season that gets underway in earnest next week.
Not the sharpest of insights, perhaps, but bear with me. Next week’s results are heavy on financial names, where quarterly earnings growth expectations are high. The sector is a bit overbought of late and may be under net margin pressure (as was the case with Wells Fargo (WFC)). If prices struggle, the broad market is probably not going to make much upward progress – a so-so start with the financials should lead to the second-half fade syndrome. The S&P 500 is already up 3.2% this month, versus the long-term average of 1.1%.
The earnings bar seems low elsewhere. It’s always set to the low side, of course, but anticipation of a challenging earnings season this time around seems well built in to me. That lays the groundwork for the market to hack its way higher the next two weeks. Intel (INTC), for example, is a high-profile name that reports on Thursday. The stock has been under the cloud of declining PC use since the middle of the summer. The bar is set suitably low (consensus of $0.49 versus a year-ago $0.68), leaving plenty of room for upside surprise, which Intel has a good track record of doing.
I am not making any analytic prediction here about Intel’s quarter, but I do note that the company didn’t revise its previous guidance for the quarter, which seems to leave the door open for something good. A result of say, $0.55, would set up a classic Wall Street rally on earnings that declined from the previous year, but rides estimate beats higher anyway.
The reason I cite Intel is that it’s one of the early reporters and like many other large industrials, has had a declining stock price in recent months. Ergo, it’s ripe for a sentiment reversal. Positive “surprises” from this area could boost investor sentiment another notch on the earnings wall of worry. It hardly needs saying that disappointments will have the opposite effect; I for one am not expecting good earnings in an absolute sense for the quarter.
Two things to keep in mind, however: One, management is rarely pessimistic with the outlook in January. An acceleration of second-half earnings growth is one of corporate America’s favorite mythical beasts, much talked about but rarely seen. Two, while earnings may not compare favorably with the previous year’s quarter, they could compare favorably with expectations, and herd sentiment is what drives prices in the short run. “Better-than-expected” has been the marching song of many a silly charge.
Keep an eye also on the level of the S&P 500, one of the most talked-about themes on the floor. It managed to finish Friday at 1472, a semi-magical level and a five-year-plus closing high. Only the post-QE-infinity intra-day high of 1474.51 on September 14th remains to be taken out. At the same time, half the investor universe is expecting the index to top out at the 1500 level, including prominent technical strategist Tom DeMark.
The typical result for such high levels of expectation is that something else happens. Either we wouldn’t get there at all (or not until much later), or blow right through it and top out 25 to 50 S&P points higher. I have to admit that it’s difficult for me to see the latter happening this time out in view of the impending budget battle, but irrational markets are nothing new.
I still see the market headed for a good-sized tumble when the budget battle is joined, as both sides are digging in. While corporate earnings may succeed in “surprising” to the upside, flat-to-down revenues aren’t a solid base for later gains. Yet in one way the market managed the best of all technical moves this week, rising a small amount and keeping the overbought indicator lights turned off. Had we added another percent to 1485 or so, charts would be toppy and begging for a sharp reversal from the run at 1500. Now we could keep grinding higher – and suck the retail investor in just a little bit more.
So far, most of the attention has been on the fact that we didn’t go over the fiscal cliff, or at least not yet. The only permanent change, though, is that payroll taxes went back up and most people didn’t start seeing the good news until Friday. Some won’t until the end of the month; many will have gotten a raise that exactly offsets the tax hike. It isn’t going to stimulate spending, in any case. The other change that’s most likely to come this quarter is more fiscal tightening, be it in the form of taxes or spending. Like its fiscal-cliff cousin, the tightening could get overlooked at first in the wave of relief over any deal being done. But it won’t get overlooked for long.
The Economic Beat
It was the lightest of weeks on the U.S. calendar. Small business optimism rose a fraction, though you could reasonably say it was unchanged. The ICSC-Goldman report on weekly retail sales was at odds with the Redbook weekly report, as has often been the case for some months, in this case with the former sounding hopeful and the latter pessimistic. Guidance has been on the low side for some retailers of late, including Kohl’s (KSS), Best Buy (BBY), Tiffany’s (TIF) and Aeropostale (ARO) .
Weekly claims seem to be running normally again on a year-over-year basis. I had some concern in December that they might be heating up, but the calendar makes comparisons tricky at times and now it looks as if they’ve settled back into a broad pattern of roughly 10% year/year improvement. November trade data continued to show price weakness, along with a relative import surge that is going to weigh on fourth-quarter GDP.
A series I do follow closely is wholesale trade. There was little in the way of exceptional news in the release of November data, though. Sales fell on an unadjusted basis and rose on the adjusted one. The three-month moving average of unadjusted sales fell for the fifth time in six months, though the decline was quite small (-0.59%) and arguably cliff-related. The growth in trailing-twelve-month sales slowed for the fifteenth month in a row and is now down to 5.6%. The adjusted inventory-to-sales ratio is still low, at about 1.2 (unadjusted 1.19), and only slightly higher than a year ago.
The European Central Bank (ECB) didn’t cut rates, which sent the euro and European stocks soaring. Here in the U.S., stocks rally when they cut rates. I guess it’s a big world. In the European case, it seems to have been taken as a signal of confidence in the European economy. In addition, a higher euro is the last thing that the EU needs, so it was only natural to bid up its stocks.
The student loan bubble, bulge, mountain or whatever you want to call it continues to rapidly expand, as evidenced in the latest consumer credit report. This is going to come back to haunt us, but as usual we will wait until it’s past critical mass to react.
French industrial production was a little better than expected in November, German a little worse. The former is down 3.6% year-on-year, the latter 2.9%. A visitor from another planet might conclude that if only the declines would accelerate, European stocks could really take off. It just goes to show the value of sophistication. The EU will report its December production estimate Monday morning.
China’s trade balance was better than expected and so its market rose (global growth!), but inflation was worse and then it fell (no stimulus!). The country is scheduled to report industrial production, GDP and retail sales data this weekend.
Next week has both the economic and earnings calendar heating up. The highlight for the former should be the January retail sales report, scheduled to be released on Tuesday. The bar is low: consensus is for a gain of only 0.2%. In manufacturing, we’ll get the Industrial Production report for the same month on Wednesday, bracketed by the New York Fed survey on Tuesday and the Philadelphia Fed survey on Thursday. The Fed’s Beige Book of regional reports is Wednesday afternoon.
Housing, which has very much been on the market’s mind, reports the homebuilder sentiment index on Wednesday and housing starts on Thursday. Inflation, which hasn’t been at all, reports the Producer Price Index (PPI) on Tuesday and the Consumer Price Index (CPI) on Thursday.
Some of the bigger Dow companies start to report next week, which could set the tone for the latter half of the month, in particular for the financials. After Wells Fargo’s report on Friday, featuring lower net interest margins, the other Gang of Four banks report on Wednesday (JP Morgan (JPM)) and Thursday (Citigroup (C), Bank of America (BAC)). The two big investment banks, Goldman Sachs (GS) and Morgan Stanley (MS) also report on Wednesday and Thursday respectively.
On the industrial side, there’s Intel after the close on Thursday, followed by GE, Johnson Controls (JCI) and Schlumberger (SLB) on Friday before the market open.