The Tax Man Cometh


“We must give Advice, but we cannot give Conduct.” – Benjamin Franklin (ed.), Poor Richard’s Almanack

It was more of the same last week – which is to say, not much – though one should allow that such meandering can at times be a good thing. The S&P 500 index closed last Thursday at just under 2330. It closed March 21st at 2344 and has drifted ever since, with my options-calendar-based guess being that the index will close this week – i.e., April 21st – at about 2350, barring any major unexpected developments. In short, it will mark one full calendar month of going exactly nowhere.

Help is on the way. While the combination of the three-day weekend (Good Friday is a traditional stock exchange holiday) and North Korean jitters led to some selling past Thursday, it shouldn’t last. The way bad news (in this case, North Korea) works on Wall Street is that it has to get worse every day, or the market gets bored with it. “Hey, it hasn’t killed us yet, so let’s move on” would be an accurate characterization. But April options finally expire on Friday (the 21st being as late as these things can get), with the most profitable dealer target currently 2350. After that, we are free to embark upon the traditional spring/first quarter earnings rally.

There will surely be some disappointments along the way, but I currently see no reason not to expect the usual estimate beat rate of around two-thirds, along with the usual professions of awe and wonder that go along with such unusual events (every quarter). Earnings are expected to come in with a year-on-year growth rate of around 10%. The estimate is for only 5.5% outside of the energy sector (which had a loss in the year-ago quarter), but even so, that implies an actual expected rate of 8%-10%, with the financial and material sectors expected to do most of the heavy lifting.

To be sure, most of that growth is already built into current prices, and many have argued that quite a lot more growth is going to be necessary to justify the post-election rally. So far any economic surge has only been survey-based, but the anticipation by the wealthy and those who came of age in 1980 isn’t going to go away unless and until tax reform completely founders in Washington. The latter possibility is real, but predicting policy outcomes is something of a fool’s errand that in this particular case I will avoid. For now.

As for North Korea, one shouldn’t make light of what could end up being a very ugly situation indeed. There are always hot spots somewhere in the world, but North Korea is a place where the lunatics are clearly in charge of the asylum and fanaticism runs deep. Here in the U.S., we too have a number of people who know what they know and don’t want to be diverted by the messy complexities of geopolitics. Many of them hold senior positions in Washington despite little or no foreign policy experience, and some of those wear that badge proudly. Too many people running about with the belief that the only way is the get-tough way is a very dangerous mix. Happy Tax Day.

The Economic Beat

The report of the week was the March retail sales report, though it engendered little market reaction by coming out on Good Friday, a near-ancient stock exchange holiday. That was probably a good thing for stocks, judging by the sell-off on Thursday, though the selling was mostly fear-based around issues like North Korea.

The initial estimate showed a monthly decline of 0.2% seasonally adjusted (SA), and perhaps more discouraging a downward revision of February from +0.1% all the way down to (-0.3%), an atypically large initial revision. At some point this will seen to be good (the Fed won’t raise rates!), but for now it’s having the effect of lowering everyone’s Q1 GDP forecasts to around the 1% level, with the widely-followed (but not infallible) Atlanta Fed GDP forecast coming all the way down to +0.6%. The initial Q1 GDP estimate from the Bureau of Economic Analysis isn’t due until the 28th of the month.

There were some better-looking numbers embedded in the report. Retail sales growth for the first quarter is at present 3.94% on a year-over-year basis (unadjusted), up slightly from the year-ago 3.77%. Year-over-year unadjusted March sales were up 4.8%, the best March showing in five years. Weekends helped. The Commerce Department survey estimated that Q1 sales are up 5.4% y/y on a seasonally adjusted basis, but I don’t believe it. Q1 2016 did have an extra day in February (leap year), but the department appears to be overcompensating: we haven’t had that good of a quarter on a year/year basis in around five years.

Some talked about bad March weather, but don’t buy it. There was some, yes, but there is always some bad weather in March, just as there are always weather excuses in retail. The weather in February was milder than usual and sales didn’t do much then either. Many categories still had strong year/year performances for the month, including autos (+6.1%), not a traditional outperformer when the weather is bad.

Higher gas and oil prices might have had some psychological effect. The trailing-twelve-month (TTM) rate for sales excluding autos and gasoline fell to 3.68%, the lowest it’s been since mid-2014. However, the TTM rate for total sales rose from 3.2% to 3.3%. Gasoline sales were up 14.3% y/y, probably all of it price-based.

On the inflation front, producer inflation remained on trend in March, edging down 0.1% on the month, but edging up from 2.2% to 2.3% on the year-year rate, with the core ex-food ex-energy rate moving to 1.6% from 1.5%. Consumer inflation fell a surprising 0.3%, taking the y/y rate from 2.7% to 2.4% and the core rate down to 2.0% from 2.3%. It could all mostly be monthly noise. Import prices fell 0.2% as well, though export prices were 0.2%. Higher energy prices have reversed years of negative y/y import-export comparisons, with import prices now up a deceptive 4.2% y/y and exports up 3.6%.

The labor turnover survey (JOLTS) for February had a familiar look: openings are up, making for the lead story in most reports, but hires were down, both on the month and year/year, on an absolute and rate basis, and rarely if ever noted. It makes you wonder about that BLS jobs total for February, already revised downward once. The Fed’s Labor Market Conditions index declined to 0.4 in March, making me want to make an additional crack about the BLS numbers, but the revisions can be substantial, so best to forbear. The estimate isn’t strong at first look, but it wasn’t negative either.

The coming week will feature industrial production on Tuesday – look for more Q1 GDP revisions in its wake – the housing market, and more industrial activity surveys, which will probably continue to run well ahead of actual industrial activity. The latter include New York on Monday and Philadelphia on Thursday, but the ideological split that has characterized the consumer surveys has undoubtedly been affecting the industrial surveys, which rung up some stunningly high numbers in the wake of the tax-cut election fever. Look for them to continue their steady decline – at what point will disappointment set in?

Over in housing, we’ll get the sentiment index Monday, starts on Tuesday, and existing home sales on Friday. The financial week should be dominated by earnings reports, as the season kicks into full swing.