“Seasons change and so did I, you need not wonder why.” – No Time, The Guess Who
by M. Kevin Flynn, CFA
As the changing of the seasons looms, it seemed like a good idea to review columns of years past written at this time of year. Though we are mindful of Mark Twain’s old admonition that among the months of the year, it is October and the eleven other months that are most dangerous for the stock market, September is certainly one of the odder ones.
For one thing, it’s the worst performing month of the year by a wide margin (June is the only other month with a negative average return, and just barely at that). It comes after the industry’s summer vacation month, August, a follow-the-leader type of month that tends to get stuck in a groove and keep going. That’s the safest course of action for those left behind on the desks – why take a chance by betting against the tape? Usually it’s up, as it was in eight of the last ten years.
This year the tape was down, of course, but take heart – it swooned in August of 2007 as well, and the year finished on an up note. The typical pattern for August to October, in fact, is a classic zigzag, with the August direction followed by a September reversal, and then October reverses again. Given how quickly the narrative has switched off the double-dip blues in favor of some September swing, it wouldn’t be at all surprising to see another zigzag.
We would say that it would be more surprising not to see another zigzag, but the fretful state of the economy and the precariousness of politics make it difficult to be too sure of any outcome. There is still the Greek debt problem waiting off in the wings, and it isn’t going to go away easily (cf. the very entertaining article by Michael Lewis in Vanity Fair). We believe the odds to be better than fifty-fifty that the situation will reach critical mass before the end of the year.
But it might not, either, although last week looked like the classic calm before the storm in that regard. On the one hand, there was the European Central Bank (ECB) talking about how great it was to embark upon an austerity program during a recession, because “positive effects on confidence [that the outlook is stable] can compensate for the reduction in demand” from budget-cutting. In other words, austerity breeds growth. Put more directly, the Germans are nervous, and won’t feel better until they are convinced that the risk of inflation has been reduced from 0.001% to 0.0001%.
Then there’s ECB president Jean-Claude Trichet, who last weekend reminded the Greeks of the sheer unthinkability of leaving the euro (despite most of the European financial community expecting exactly that). He wagged his finger even harder this week, suggesting that members who don’t meet their fiscal targets (could he have been talking about them?) would be reduced to non-voting status. If that threat doesn’t just cut Greek street protestors right off at the knees, we don’t know what will.
We advise our readers to use care in this matter, because there’s a fair amount of obfuscation going on about “default” and restructuring, some of it deliberate. It’s fashionable for some groups (such as the Norwegian state investment fund, buying up PIGS debt left and right last week) to say that default by the Greeks is never going to happen. What they mean is that the Greeks will not simply walk away from all of their borrowings and declare them null and void, a view that we think is quite correct.
But restructuring the debt is another story. We think that in time the Greeks will feel that the debt burden is simply too high, and the austerity program too onerous (second-quarter GDP was just revised another full point downwards, to (-6.4)% annualized), to take any more funds from the Bundesbank. What’s that? Sorry, we meant the ECB.
Technically, rescheduling and/or restructuring the debt (now $250,000 per person) would constitute default, however. So the term gets thrown around a lot, meaning sometimes one thing, sometimes another. We think restructure and reschedule will happen.
Our own political season rates to be quite a wild card this year too. Of late, we have heard and seen some ads that are some of the most vicious spots we’ve ever even heard of. We’re guessing from the calendar that they must be primary campaign ads, because the irony of them is that you can’t even tell whether the targets are on the left or the right! The one thing the ads seem to promise is that somebody belongs in prison (in our opinion, the people who made up the ads).
But as the review of our past columns reminded us, this is probably the craziest time of the year. We’ve certainly made a speedy about-face from August to September, and we could spin it around again. Don’t get too comfortable.
The Economic Beat
A week ago we were fretting that Europe might start to turn, which could turn the balmy prevailing wind from the previous week. The situation teetered for a moment, but the success of a Portuguese bond sale sprinkled sweetness and light for a couple of days and enabled us to get back to overreacting to small data points.
The Fed’s Beige Book on Tuesday contained the revelation that growth had moderated, a fact apparent to anyone who had seen a newspaper or news site in August. Nonetheless, it sent the market spiraling lower until the July consumer credit report came along an hour later. It showed a decline less steep than feared (thanks to auto sales), and although card credit continues to contract, the headline was enough to arrest the market’s slide.
The report that is probably still getting the most play was the weekly claims report. Although it doesn’t seem as if the mainstream press is aware of it, actual (non-seasonally adjusted, or NSA) claims declined for the third week in a row to a third post-Lehman low. The declines haven’t been very steep, but they’ve been steady and it looks to us as if the pattern should continue. The NSA rate of about 380k has been running well below the headline adjusted rate of 450-475k for those weeks.
The bad news is that although claims were rising before the Lehman debacle, there’s a big gap of about 50,000 to get back to pre-Lehman levels. However, the possibility that claims generally trend down over the near future will help both the market and business confidence.
Claims typically rise going into the end of a quarter, though, so expect to see another rise down the road. It won’t show up until we’re into October. Since the cutoff period for the jobs report should fall next Friday, the next two claims reports (covering this week and next week) will help set expectations for the last jobs report we see before the upcoming Congressional election in early November (the elections are on the 2nd, the jobs report is on the 5th).
The recent string of declines in weekly claims has dramatically shifted published sentiment away from a double-dip recession since the month began. If the trend continues over the next two weeks, however mildly, that could lead to a continued shift towards equities and set the stage for a much-improved jobs report (emphasis on “improved,” as we doubt very much that the report would show genuine strength).
On that score, we were rather appalled to observe that some of the faces on CNBC did a poor job the previous Friday of concealing their dismay at the better-than-expected last jobs report. We would like to hope that the situation wouldn’t repeat itself, but given the current poisonous political atmosphere, we’re not going to hold our breath.
The July trade and trade inventory report was the kind of stuff that puts a smile on the face of us econ geeks. Strong domestic demand in the second quarter (domestic final sales rose at a 4.3% annual rate) meant that imports rose faster than exports, and since imports are subtracted from GDP, the second quarter number was revised downward as domestic demand was revised upward (if your eyes are glazing over at this point, you have our sympathies).
In July, domestic demand weakened and imports fell faster than exports. But that counts as a plus to GDP, so economists started hiking their third-quarter estimates back up again. Wholesale trade inventories rose in July as well, and that too would provide a boost to GDP (though it is only the first month of three and might not last).
The inventory data provoked very different responses. Some celebrated that the inventory rebuild wasn’t over, while others bewailed a buildup as indicative of weak demand. Sales rose also, though not by as much, and the inventory-to-sales ratio rose from 1.15 to 1.16 (compared to 1.29 a year ago). Despite the very small increase and an IS ratio near the bottom of its historical averages, some headlines played up that it was the “highest level since February”. The truth is that the series has been in the narrow range of 1.13 to 1.16 over that period.
It looks as if the topspin on the data is only going to increase between now and the first Tuesday of November. One of the key data points next week will be retail sales data for August released on Tuesday, though it really doesn’t deserve to be. Despite the back-to-school part, August is less of an indicator than you might think, and with the weather patterns on the two coasts stuck in apparel-unfriendly patterns (cold and damp, hot and humid), we’d be reluctant to read much into it.
We would look more closely at the New York and Philadelphia business surveys released on Wednesday and Thursday, the former coming shortly before August industrial production is announced. With the latter, we’ll be interested to see if capacity utilization continues to improve. If the producer and consumer price indices (PPI & CPI), released Thursday and Friday for August, manage to hit consensus expectations for overall increases of 0.3%, you’re going to see Treasuries take another hit. The first consumer sentiment reading for September from the University of Michigan will round out the week on Friday.