“Boldly they rode and well, Into the jaws of Death” – Alfred Lord Tennyson, The Charge
of the Light Brigade
You know, you just can’t keep a good market down. Or as last week demonstrated for about the thousandth time, it can be pretty hard to keep a bad one down too. Despite a week that featured a Sam Zell bankruptcy (the Tribune), another pathetic display of how bad our current government is (the auto bills), massive layoffs from Sony and Bank of America (BAC), and the usual drumbeat of bad economic news, the cavalry thundered on last week.
Traders were feeling positively radiant by Friday’s close. Things had looked grim indeed, what with the automaker rescue being shot down first on Thursday night, followed by the news of Bernard Madoff’s peculiar investment withdrawal plan (you invest the money, he withdraws it). There are quite a few parallels there – both had once been pillars of their respective communities, both suddenly found themselves with few friends, and in an odd twist, Mr. Madoff seems to have lost just about the precise amount of money that the automakers need. Maybe they should help him look for it.
But Treasury came to the rescue, announcing before the open that unlike investment bank Lehman Brothers, for whom it unfortunately lacked the authority to do anything (it was a bank, after all) they would intervene if necessary to keep the car manufacturers afloat, as the latter so obviously falls under the purview of Treasury (before this is all over, we are going to run out of Alice in Wonderland comparisons).
If that wasn’t enough to warm traders’ hearts, it seems that the SEC didn’t have the foggiest clue what Mr. Madoff was up to. This despite any number of accusations written directly to the agency, a global rumor mill of many years standing, and his total lack of auditors or outside custodians in the face of annual inspections. If Madoff can make off with fifty billion so easily, clearly the average trader or broker has nothing to fear.
The market, you see, is Looking Across the Valley. As CNBC’s inestimable Bon Posani reported on Monday – and Bob is probably the best barometer there is of trader sentiment – we’re just going to have to get used to job loss announcements and bad data. Why? Because “they’re just going to be around,” that’s why. You can’t argue with that.
Two weeks ago, we wrote that at some point a sustained rally will be put together, pulling in fresh money and giving rise to important nods and knowing looks amongst the Wise that the market rallies before the economy turns. It looks like we’ve arrived. We also wrote that in the end, the rally gets wiped out.
The new Gospel according to St. WallStreet is that the economy recovers in the third quarter. With heaven’s approach only six months away, the odd broken leg should hardly matter now, should it? The divine revelations are based in part upon the recent news from the officiating National Bureau of Economic Research that the current recession actually began in December of 2007. Since the average recession is about eight to sixteen months, and we are already twelve months in, the calculus is that while sticks and stones may break my bones, stocks will never hurt me (or at least, not anymore).
Well, we’ve said it before, and we’ll say it again. Economies aren’t speedboats, they’re supertankers. They don’t turn quickly, though they can be made to sink faster than one would think. The stimulus program is nice, but it is probably at least three months away from creating a single job, and in the mean time we stand to lose a million or two more. The market’s upward bent is based on mostly on the belief of a second-half recovery that should begin probably not later than July 2nd. To our brave lads, bad news doesn’t matter anymore, because we’re going to recover in six months.
We can’t say for sure that that’s not the case, though to us it looks fifty-fifty at best. But one thing we can say is that the economy will keep getting worse before it gets better, and that in due time the accumulation of bad news is going to cause the market to lose its nerve and doubt its rosy scenario. More likely than not, we’re going to give it all back again.
One thing that really bothers us is that three-month T-bill rates are at zero. Yes, we know, it’s a flight to safety and the entire Treasury spectrum is overbought. Even so, the bond market tends to be right about the direction of the economy a lot more often than the stock market is. Zero interest rates are not encouraging.
We think that the economy is going to be slow to recover from its current situation –a lot slower than what the Street thinks or hopes. The market still hasn’t gotten it yet – the rejoicing in write-downs and layoff announcements is out of the old playbook that is looking for that recessionary pivot point. But this recession has the worst credit crunch since the Depression era, and the market has been consistently guilty of underestimating that damage since the August 2007 collapse of the Bear Stearns hedge funds.
The circle of layoffs begetting further cutbacks is still in the early stages. It wasn’t until the October debacle (courtesy of Treasury, the Fed and the Lehman fiasco) that companies began their cutting – we’ve quite a ways to go yet and many of the layoffs are still fairly well paid. In three months, we’re going to start seeing more of what we’ve started to see in retail – companies closing doors overnight and the remaining employees left out in the cold, with no severance and no job market. It isn’t going to help spending.
In the 2001-02 recession, unemployment rate peaked in June 2003, three months after the last market bottom. The S&P in that bear market rallied from 775 to about 950 twice, falling back to 800 in the meantime. In the 1980-1982 recession, unemployment peaked in November of 1982, three months after the August stock market rally set off by then-Fed chairman Paul Volker’s cut in interest rates.
It’s true that in the 1990-92 recession, unemployment peaked long after the stock market bottomed in October-November of 1990. But we think that this credit-driven deleveraging recession is going to resemble 1980-1982 a lot more, and we have a long ways to go before unemployment peaks.
The current rally had its genesis in a pause in forced selling that began a couple of weeks ago, combined with a drive to mark up month-end prices. It could continue a bit longer, despite somewhat overbought conditions. There is a keen desire by many traders and asset managers to push end-of-year prices higher, if only to alleviate the pain for a bit. Even skeptics feel performance pressure. The “new new” thing that bad news doesn’t matter anymore still hasn’t had enough time to take on sufficient water to sink.
Despite last week’s gutless posturing against the automaker bill, led by Southern Republicans who, safe in the knowledge that the administration would rescue them from their “no” votes, felt free to pander to their home base, some kind of bill is likely to pass and keep up market spirits. Oddly enough, the senators were emboldened during the week by the lack of reaction on Wall Street, whereas traders were feeling emboldened by the certainty that Congress would do something.
It’s arguably the best outcome for the bailout to take at least another ten days, allowing the market to keep rallying on the rumor rather than selling off on the news. Yet the news around the globe is unmistakably bad, as evidenced by the monthly trade figures. The markets are rejoicing in the global rush to cut interest rates to zero, without stopping to think too much about why it’s happening – the worst economic conditions in seventy-five years.
Unemployment is still only at 6.7%, and is expected to top out north of eight percent and possibly much higher. All of that unemployment is going to lead to lower trade and fewer imports, yet people are already talking up commodities. The market is a discounting mechanism, you see. That leads us to wonder exactly what commodity markets were discounting last June.
The markets have dialed in a third-quarter recovery, but a CFO survey released last week showed that a little more than half didn’t expect any recovery before the fourth quarter of 2009 and the rest not before 2010. The survey is supposed to a reliable indicator. Traders have already have written off this quarter and raised whisper estimates to unbeatable levels, but if still unscathed we’ll never get past the barrier of the next quarterly earnings season in January.
When companies universally cut their 2009 outlook and say they have no idea when conditions are going to improve, that’s going to shake newfound convictions in the six-months-from-now theory. Yes, we had all the bad news priced in – at 750 on the S&P 500 index. At 900, it isn’t priced in. By all means trade this rally, but don’t fall for it.
The Economic Beat
Last week’s economic releases were useful in two respects: there wasn’t much, which helped the market to get on with its business of rebuilding castles in the air, and what there was didn’t taste too bitter. It was far from being good medicine, but like any good rummy, the market figured out a way to get its buzz.
The first notable release of the week was pending home sales data for October. The decline from the previous month was a modest (-0.7)%, which was much better than the consensus. The National Association of Realtors made some hopeful noises about stability in the housing market. We would like to remind you of some important reasons to be cautious.
In the first place, as far as the pending home sales report itself goes, the October report showed the best strength in some of the hardest-hit areas, such as Florida and California. That seems to shout, “foreclosure sales!” In the second place, despite all the talk of “pent-up demand,” mortgage-purchase applications fell back sharply again last week and are at very low levels, despite the fall in interest rates to 5.45%.
As our modern Cassandra and banking analyst Meredith Whitney pointed out last week, even rates of 4.5% aren’t going to matter when financing is unavailable, when 20% of homes are underwater (the current value is less than the mortgage) and when people don’t have a job. Her very real fear is that the five major banks that now control 70% of credit card issuance (a dangerous situation indeed) are going to pull $2 trillion of credit over the rest of the fourth quarter and 2009, leading to devastation in consumer spending and hence the economy and employment.
Sam Zell was taking the opposite tack, suggesting that at the current run rate we would begin to run short of housing in the middle of 2009, thereby turning the situation around. As much as we respect Mr. Zell, who has made many a mighty move in real estate over the years, he didn’t foresee the credit crunch of the fall that doomed the Tribune deal. Not that we can blame him, because we didn’t foresee it either – who could have predicted that the government would set fire to the house they were supposed to protect?
But the credit crunch has happened, and that is going to make the current recession different than 2001-02, or ’90-’92, or ’80-’82 or even ’74-’75. If the banks do follow through on the plans that Ms. Whitney fears, we can guarantee that we won’t be seeing any turnaround in housing prices this year. Not in real terms.
The trade data for November weren’t good, but they weren’t bad either, for the straightforward reason that they were awful. The deficit widened instead of narrowing, exports decelerated at an alarming rate, and the following records were set for the largest single-month drops: a) import prices; b) import prices excluding petroleum; c) petroleum prices; d) export prices and e) non-agricultural export prices.
Those reports were bad enough, but set beside the weekly claims number they were almost cheery. Claims roared higher to 573,000 – a small matter of fifty thousand over consensus – in the worst week since the early 1980’s. Ditto for the four-week average and for continuing claims, with the latter having only recently crested three million. They are now at nearly four-and-a-half million, after the biggest weekly jump in thirty-four years.
The market shrugged it all off, of course, because in the parlance of the floor, “we already know that.” The weak opening was overcome and our lads bravely leapt forward again, ignoring the cannons, until JP Morgan (JPM) Jamie Dimon stopped the charge in its tracks with his observations on the deteriorating credit markets. That led to the day’s selloff.
A very grim-looking pre-open Friday morning – the Dow futures were down three hundred points at eight o’clock – was rescued by a series of serendipitous events. First of all, retail sales data came in negative, but slightly better than consensus (-1.8% actual versus –1.9% forecast). Even better, excluding motor vehicles and gasoline, they were actually up 0.3%.
A few minutes after nine o’clock, the Treasury department made its announcement that some kind of backup funding would be found for the autos, and the futures improved a lot more. When consumer confidence came in above expectations with a bounce from the previous month, that was enough to keep the market happy the rest of the day. Never mind that the bounce was from a record low or that the level is still very low, because the current conditions index improved and anyway, it beat the whisper number.
The Producer Price Index (PPI) number was also released Friday morning, but it was almost completely ignored. The overall numbers fell more than expected, but the core pieces were right on consensus with 0.1% increase for the month and a 4.2% increase year-over-year, continuing a deceleration that began last month.
We’ll caution that the retail data may not be as good as appeared, however. A lot of seasonal adjustment went into that non-motors-and-gas boost, and the model may be off by more than a little this time around. In addition, while Black Friday gave a boost, it was less than expected and came at the expense of heavy discounting. Sales indicators fell again the following week, the three-month trend is deteriorating and LCD panel sales – a key indicator of willingness to spend – are bleeding.
In sum, the data point to continued demand destruction, but the market is busily insulating itself from reality by managing expectations. A few weeks ago we were writing that economists were beginning to project a drop in GDP of over four percent, but now estimates as high as six percent are being whispered around. Presumably those estimates will be modulated as necessary to avoid surprises, but even if they creep up to seven percent it won’t really matter to our wise men, for they are wisely looking ahead to the third-quarter rebound that has become an article of faith – or is it an article of imperial clothing?
There’s a lot of data next week, but we don’t know if it’ll be enough to unhorse the optimists. The main reports should be the FOMC policy statement on Tuesday afternoon and the earnings from the banks formerly known as investment banks Goldman Sachs (GS) and Morgan Stanley (MS). The Fed is expected to come out with a cut of fifty to seventy-five basis points, although we don’t see why that would do any good.
We’re hoping that Dr. Bernanke sticks to twenty-five points – that’s about where the effective rate is, and it might actually boost confidence while leaving an extra bow in the quiver. We’re also keen to hear about any plans that the Fed might really have to issue its own debt, a prospect we find disquieting.
As to our banking chameleons, neither has pre-announced and the expectations meter was set quite low by week’s end. An “everything including the kitchen sink” quarter is expected, so anything short of a major meltdown with tears and shouting on the conference call might be digestible to the markets. Unless, of course, one hears that things are even worse than Mr. Dimon let on. That could start some fireworks.
The Consumer Price Index is due out on Tuesday, but it’ll have to be dreadful to bother anybody. Expectations are low and the market isn’t worried about inflation. A big enough drop might spur deflation worries, but probably not for long.
We’ll get a good look at the output side of the economy, beginning Monday morning with the New York Fed’s December survey of regional conditions, followed shortly thereafter by the Industrial Output report for November from the national Fed. The Philadelphia Fed’s business survey for December will round things out on Thursday.
Absent special factors, industrial production was estimated to have fallen by about 2/3 percent in September and October, so the consensus for November is for a drop of (-0.8)%. Even a fall of one percent or so shouldn’t faze our boys, because “they already know that,” though if the European banks are in Madoff trouble Monday morning, it may matter. Estimates for the regional surveys are deep in the root cellar.
We’ll get an update on the housing market with the release of the housing market index on Monday afternoon, and data on housing starts Tuesday morning. Our feeling is that the current reports probably aren’t going to reflect what the 2009 trend will be. At any rate, expectations are for declines, so any stabilization may be welcomed.
Leading indicators are due out on Thursday, and as you might expect they are forecast to be down, though not by as much as the month before. We suspect that they haven’t yet bottomed. Finally, for those of you who are tired of the market volatility, you have our sympathies because Friday is a quadruple witching day. Good luck.
StockWatcher remains in hibernation until the auto bill passes. If the current rally continues, use the occasion to lighten up on equities.