“And there upon the floor he swooning lay.” – Geoffrey Chaucer, The Miller’s Tale
One hundred forty two. That’s how many Dow points we have left to go to touch that magic 11,700 number, the low that many had hoped we had left behind. The March rebound has melted away completely, and we’re now in triple-bottom land. Will it hold? We’re only one weak day away from the test.
What got us back there? Well, let’s see. Apart from financials, the consumer, autos, housing, manufacturing, and inflation, we’re doing fine. Oil is up another 35% since March and food and energy inflation is rising around the globe. The bond insurers got whacked again, leading to more write-downs for the big banks, and leading indicator stock FedEx (FDX) lowered its outlook for the rest of the year.
Oh yes, Ford (F) opined that it wasn’t going to make money this year after all, leaving those sagaciously far-seeing rating agencies to issue blanket downgrades of the auto sector later in the afternoon. Having been asleep the last few years, they now seem determined to nail shut every empty barn door they can find. Where would we be without them?
Here’s another thing to think about – the 20-day, 50-day and 200-day moving average on the S&P 500 index are all sloping down again. That suggests that the short-term, intermediate-term and long-term trends are down. Of course, real events always trump chart formations, but the fact that the market has fallen significantly each time this event has transpired in the recent past isn’t comforting to traders.
It wasn’t any one thing that had the market sagging last week, just a steady accumulation of dreary tidings. Yes, there were more financial downgrades, but it was less the surprise element than the timing of events that had prices sagging. Nobody could have been really surprised that the domestic auto manufacturers aren’t doing well, or that FedEx is getting pinched by sluggish demand and rising fuel prices, or that the bond insurers are up against it.
The economic news (see below) had practically nothing good to say, the Fed governors are running around warning everybody about inflation and the weak economy, and foreign markets are sliding as well. This is the kind of confluence of events that we’ve been warning about, when the relief that we’re not descending into the maelstrom gives way to the depressing realization that we’re not going anywhere at all.
We’ve been saying that a retest of the lows is more likely than not, and we’re at that juncture now. Bear markets often take their final leg down between May and October, as springtime optimism about best-case scenarios for the economy and profits give way to more mundane outcomes, and company managements begin to lower their outlook for the rest of the year (as did Ford and FedEx).
Goldman Sachs (GS) reported earnings that were well above consensus and provided assurance once again that they are the cream of the Street, but then turned around and predicted that the regional banks wouldn’t recover until the first quarter of 2009. Not to be outdone for timely calls, after Fifth Third Bancorp (FITB) reported that it would cut the dividend, sell operations and try to raise another $1 billion in equity, Merrill Lynch (ML) then chimed in with its own daringly prescient call that the regional banks might still have more write-downs. Now you know why these guys get paid so much.
There is a positive side to this, and that is that we are getting into serious bargain land. The problem is that old shoppers dilemma: three weeks from now the 50%-off sale might be a 75%-off sale. To say that the market is worried right now is admittedly about as obvious as the latest rating agency calls, but the general deterioration in sentiment could easily carry us right down to the 11,000 level on the Dow, or even beyond.
Bottoms rarely overshoot as much as tops, but they do overshoot. A few more passes of the old one-two of lowered earnings estimates and increased inflation estimates could give us the hard landing that many have been waiting for (including us). It’ll be unpleasant for a while and there probably isn’t going to be an immediate rebound, but the valuations will be awfully attractive for those with strong stomachs and high cash balances.
We don’t think that the economy is going to the devil. The idea that it would quickly shake off the worst housing recession since the Great Depression will look foolish years from now (and to some it looked foolish all along), especially when set next to a credit market teardown and rebuilding process that just had to have been obvious, right?
But the economy is going to be limping below the level of this springtime’s hopes for some time. We think that the Fed’s projections have been in the right zone: unemployment is going to increase, housing won’t recover until next year, and there are downside risks to growth with upside risks to inflation. The urge to be first to call the turning point is a characteristic of every bear market, and the sign that we have bottomed is when everyone has thrown in the towel.
We’re getting near that point, but we’re not quite there yet. The last hard landing is still to come.
The Economic Beat
Not surprisingly, there was almost nothing good to report from the week’s batch of economic data. The New York Fed set the tone for the week on Monday when its monthly survey of regional manufacturing conditions produced a disappointing number of (–8.7) versus the consensus estimate of (-0.5) (zero would mean no change from the previous month). New orders and shipments fell also, with prices received up sharply. There was some consolation in that prices-paid and employment indicators were unchanged.
The weakness in manufacturing was confirmed on Tuesday with the release of the monthly industrial production report for the nation, and then again on Thursday with the Philadelphia Fed’s regional survey.
Industrial production reported a May decline of (-0.2)%, pulled down mainly by a drop in utility output (can you say, “demand destruction?”), versus a consensus that called for a 0.1% gain. Manufacturing was flat from the month before, and the year-on-year reading was (-0.1)%. Feeble, but not calamitous. Capacity utilization, which has been falling steadily for the last year, checked in at 79.4%, at the low end of estimates and below the consensus. There isn’t any inflation coming from industrial demand pressures.
The Philadelphia survey, which has been declining for months, reported another discouraging decline on Thursday of (-17.1) against the mean estimate of (-10). New orders fell sharply again, shipment and employment indicators were down while prices reported were up. I would think that all of this deterioration would have to feed into the corporate outlooks due to be reported soon, but the six-month outlooks remain resilient. That’s less cheery than it appears, however, because the six-month outlook tends to be inversely correlated with actual results.
Housing didn’t offer much that was positive either. Starts declined 3.5%, a little bit more than expected, and permits fell too. The improving weather in the Northeast, though, did lead to a strong rebound there, so not all is lost. Credit conditions aren’t helping: mortgage rates jumped again, applications fell and the supply of fresh write-downs from the banks appears to be limitless. A couple more large private builders filed for chapter 11; perhaps a public company filing is near.
Those inflation worries got a boost from the PPI data, as the total number jumped a very scary 1.4% from the previous month. This is double-digit stuff, folks, the nightmare of the seventies. As usual, the increase was led by energy and food respectively. Soaring oil prices also helped fuel the inflation of the seventies, but unlike that time, it still isn’t feeding into core inflation (+ 0.2%) or wages. That’s good as far as structural inflation is concerned, but it does present a problem for corporate and consumer bottom lines.
Jobless claims were a mixed bag. The reported number of 381,000 is fairly high, pulling up the four-week moving average to higher levels. It’s also the survey week for the jobs report, so the May report due out in two weeks looks to be a little shaky right now. Continuing claims did decline, however.
Leading indicators rose 0.1%, but that was helped along by a rise in stock prices and a widening yield curve. Both look set to reverse right now. That won’t change the real verdict: we’re flat-lining, and we’re going to be to the weak side of flat-lining for the foreseeable future.
Next week could be tumultuous. Nothing is on tap for Monday, but then the fun begins. We’ll start slowly on Tuesday with another consumer confidence reading and the beginning of the FOMC meeting. Then on Wednesday we’ll get some real action, with durable goods before the open, new home sales shortly after the open, and then the FOMC statement in the afternoon. No action is expected by the Fed, but if they do act it’ll set off a tsunami in the markets.
More likely, though, is that the Fed will take no action other than to recalibrate its policy statement, and that alone ought to trigger a few million stop orders. Suppose that durable goods are weak, as are new home sales (our view), oil inventories disappointing (ditto) and the Fed taking no action. Then the dollar is down, oil is up, inflation worries are up, the economy looking down and stock prices, well, they won’t be up.
Thursday ought to keep things moving along. The press will start us off with opinions that the Fed is between a rock and a hard place, and that we’re basically stuffed. Then we’ll get a report on corporate profits, the final GDP estimate for the first quarter (final until it’s revised again), existing home sales (the most important of the various housing reports) and the usual claims data.
First quarter GDP just might be better than the 1.0% consensus, though in the end it hardly matters whether it’s 0.9% or 1.1%. It could prove psychologically important for a day, especially as we expect existing home sales to be better than expected. The price component of the GDP report may well be the most important bit, especially if it misses the consensus. Research in Motion (RIMM) reports after the close, and judging by last week’s price action, big things are expected.
The week will wind up on Friday with the personal income and spending report (including the Fed fave, PCE components), another consumer sentiment report, whatever momentum the RIMM report may have generated and a report an hour before the close that could get a lot more attention than usual: farm prices. We just might get one more swoon for our weekend travels.