Springing Sideways


“Deserve’s got nothin’ to do with it.” – Clint Eastwood in The Unforgiven

The market fell three of five days last week, despite a big mid-week jump on Wednesday to commemorate the Fed not predicting the end of the world in its March statement (after all, they could have raised rates much higher, right? But they didn’t, so buy!) That left the indices mixed, with the main results being an increase in the number of articles on why the bull market isn’t finished and the dimming of bright red technical indicators.

The former is more telling. While technical indicators are fairly reliable guides to shorter-term developments in the markets, broadly overbought conditions can persist for long periods. Even sharply overbought conditions can be worked off with a bit of sideways action, and the current sideways pattern (going on three weeks of very mild decline) may accomplish no more than working off oversold conditions sufficiently to allow the eager faithful to jump back in.

One thing I have seen that doesn’t occur as regularly as oversold or overbought conditions is the proliferation of articles explaining why you cannot and should not ever think that getting our of an overvalued market is a good idea. The articles will explain that nobody can time the market (in the short term, this is reality), piously talk about Warren Buffet-style investing for the long term, and point to the detritus of those who wrongly predicted the end of the bull market. You just can’t know when the end is coming, and anyway it may not end. Even if it does, it might not be so bad.

Such thinking markets the end of every bull market. We can know that this kind of thing, combined with the long age of the current market, means that the market has run out of reasons to buy other than the fact that the market has been up. Ergo, it must go up some more. But the current bull market only went sideways for the two years going into the election, and the recent bout of euphoria does show signs of fading.

That said, while it is possible to say when stocks are hopelessly overvalued, it isn’t possible to say when the process of taking fright from such lofty levels will begin. We may later point in retrospect to the current period as when the Trump trade finally ended and the beginnings of reality began to seep in, but it may also just turn out to have been another bump in the road before the final cyclical peak is achieved. The spring rally will hit soon, and not even bear markets can derail those. Whether we are higher in June than we are now is impossible to say. Whether we deserve to be higher is easier to say – no.

A series of logistical issues held back this week’s edition, but MarketWeek should be back on schedule this weekend.

The Economic Beat

The report of the week was probably the February retail sales report, though it was overshadowed by the Fed’s decision to raise rates to a lofty 75 basis points. The data was just okay, with the small 0.1% gain overall (seasonally adjusted, or SA) held back by weakish auto sales, though ex-auto, ex-gas sales themselves were up only 0.2%. Looking at the unadjusted data, the year-on-year sales were up only 1.7%. February 2016 had an extra day, so the comparison was bound to suffer, but February 2017 weather was much better for shoppers. In any case, the seasonally adjusted estimate wasn’t much different. Trailing-twelve-month (TTM) sales slowed from 3.6% through January 2017 to 3.2%, about the average for the last four months. The TTM rate for ex-auto, ex-gas sales slipped to 3.9%, the first time it’s been below 4% since January of 2016. You would never know from most of the casual assessments of the economy in the business news, which mostly talk the same vein of ever-expanding growth even as it’s slowing. After all, the stock market is up the last few months.

The event of the week, judging by the market reaction, was the Fed’s decision to raise the target on the federal funds rate to a range of 0.75%-1%. Perhaps the most interesting part of the universally expected move was that the central bank left intact from December nearly all of its economic projections for the year – 2.1% real GDP, 4.5% unemployment being the most prominent, while edging up its forecast for core PCE inflation to 1.9% from 1.8%, leaving the forecast for overall inflation unchanged at 1.9%.

The stock market, of course, has been acting as if something quite different is going to happen. In fairness, while the preponderance of bullish commentary (and trading) has focused on the stimulative effects of tax cuts and infrastructure spending, there is also a widespread, less-spoken belief on the Street that corporations will use most of any benefit from a tax cut not to hire workers – why raise costs and hurt margins? – but to increase dividends and stock buybacks. After all, it’s what corporate America did with its repatriation tax holiday in 2004. Companies don’t lack funds for investment anyway, not with profit margins near all-time highs. That will support a multiple expansion even if earnings don’t do much.

The inflation news elsewhere was mixed, with the producer price index posting a big monthly gain of 0.3% (SA), taking the year-year rate to 2.3%, although the ex-food and energy rate is still only 1.5%. The markets might be more alarmed if it didn’t already look like the oil rally has stalled out for the time being. The consumer price index, or CPI, rose a tame 0.1%, but the year-year rate does stand at a relatively high 2.7%, with the core rate at 2.2%. The year-year rates for oil and gasoline are quite steep, so the effect may fade as the months go by unless the energy rally can discover fresh footing.

Manufacturing surveys remain quite strong, though the breadth did ease from February in the two most widely-followed regional surveys from New York and Philadelphia. New York slipped to 16.4 from 18.7, Philadelphia to 32.8 from 43.3, but both readings are still quite high. The two surveys are showing multi-year highs for new orders, but I still question the validity of these numbers as reflecting more hope than reality, and the surveys don’t measure activity volume anyway. New order survey results have been strong for months with little to no increase in real activity.

Industrial production was unchanged in February, but the underlying news was a bit better, as the warm weather penalized utility production and held back the overall total. Manufacturing was up a healthy 0.5% (SA) and is now up 1.2% year-on-year, which is better than it’s been in months. The report was careful to highlight the impact of lower utility output on much of production, but the warm weather also gave a big lift to construction and mining (read oil and gas extraction). If the flattening of oil prices continues, the manufacturing bump we’ve seen from increased oil production should quickly level out.

The little-noticed Labor Market Conditions index from the Fed rose by 0.6 (0 = unchanged). It isn’t much, but it’s better than the long streak of small negatives the index posted last year. The labor turnover report (JOLTS) reported an uptick in the hire rate in January, from 3.6% (where it’s been for many months) to 3.7%. The rate of job openings actually fell from 3.8% a year ago to 3.7% in January 2017. I don’t consider either tick to be of much importance, especially not with one month of data, but bulls focused on the “acceleration” in hiring. Uh-huh.

The coming week will mostly be about home sales, with the latest existing home sales rate on Wednesday, followed by new home sales on Thursday. Durable goods orders are due on Friday, and I certainly won’t be alone in looking at them to see if any of the wonderful survey numbers are showing up in hard numbers. The warmer first quarter is going to help, but in the end weather’s effect is transitory – what it takes or gives in one quarter typically reverses in another.