“On second thought, let’s not go to Camelot. It is a silly place.” – The Monty Python Troupe, Monty Python and the Holy Grail
Let’s see. Civil unrest spreading in Africa, check. Portugal downgraded, check. Spain downgraded, check. European debt situation worsening, yes, Japanese radiation levels rising, got it, and oil prices rising above $105 a barrel. Why, it must be time to buy equities!
Sometimes the stock market is a silly place. Sometimes, it’s embarrassingly so. Last week’s rally caught most by surprised, leaving even the traders on CNBC’s Fast Money at something of a loss to explain what was moving the market. Naturally, theories abounded.
Employment claims, said one (they fell by a mighty 5,000, probably 2,000 after revisions). The housing data is so bad (both existing and new home sales plunged) that the Fed will have no choice but launch QE-3, said others. Must be the bottom (again), said others. Or GDP was better than expected (a result from three months ago, with current-quarter GDP estimates coming down). Red Hat (RHAT) and Oracle (ORCL) earnings reignited cloud stocks. So either the economy was doing better, or worse, thereby guaranteeing higher stock prices.
Dreams were everywhere on the Street last week. Going by equity prices, Japan has already been reconstructed, with Caterpillar (CAT) Doug Oberhelmen exclaiming that the earthquake “could be a triggering event for Japan.” For what he didn’t say, but he sure knew what analysts wanted to hear (by eerie coincidence, Caterpillar had an analyst day last week).
Traders have bid CAT’s stock price up more than ten percent since the quake, apparently on the theory that Japan would generously give the reconstruction business to an American company rather its own native son and chief competitor, Komatsu. CNBC posted that Friday traders were focused on the “global reconstruction trade.” Apparently some of the radioactive water has leaked into the Exchange water supply.
Tiffany’s (TIF) announced earnings, guided its next quarter lower due to Japan, which represents 18% of the company’s sales, but observed that as it could not predict what might happen in Japan, it would proceed with unchanged guidance for the year, thereby hyping the stock and absolving itself from any Japanese shortfall in one go.
Jabil Circuit (JBL) agreed, saying that “the extent of the impact is not known at this time,” and therefore its guidance “excludes the impact of potential supply disruptions.” I mean, why spoil the party, right? The theme is being rapidly adapted by US companies, so expect to see more of the same: management giving GASP guidance (Generally Accepted Street Promoting), rather than the more boring GAAP (Generally Accepted Accounting Principles). GASP is an extension of the old EBBS system of the tech boom (Earnings Before Bad Stuff).
In fact GAAP should perhaps be called SAAP (Silly Arcane Accounting Problems) here in Camelot, because non-GAAP is almost all you read about in tech-land these days. We had to double-check Oracle’s earnings announcement twice before we finally were able to find a mention of GAAP results.
GAAP, after all, is so 20th century. Non-GAAP is more user-friendly, excluding things like giving away free stock rather than calling it compensation, or dismissing the endless stream of management blunders that result in “non-core” write-offs and “one-time” amortization charges as “non-core” events. That’s despite being on everybody’s P&L year after year. We are waiting for disgraced Lehman CEO Dick Fuld to demand a bonus for 2008 – after all, the company made good money excluding bankruptcy, which was indeed a one-time event.
We suspect funny money at work last week, partly because of the number of bewildered comments and conflicting explanations we saw in our email. Fast Money maven Joe Lavorgna was probably on to something when he said it looked like an attempt to sell the tape ran out of gas (prices were short-term oversold, certainly) and the black boxes took charge. Consider that about two-thirds of daily volume is program trading, the end of the quarter is coming up and all those expensive puts that were loaded up on in the first half of the month are now deeply out of the money. It was all neatly done on low volume no less. Throw in fear – the fear of being left behind in the race to quarter end – and you’ve got a good case for the market trying hard to ignore all non-supportive events at least through the end of next week.
As to all the demons raging on the edges – European debt, growth slowdown, Japan, slowing China, the end of QE2 – the market is perfectly capable of ignoring them all so long as there is liquidity. Attitude-wise, it reminds us of the 2006-2007 rally (which looks remarkably similar on a chart) that didn’t break until May. Don’t think the black boxes are unaware of that. There was no good reason for the rally in the first half of 2007 but momentum and the desire to be on the “right” side of the trade.
For ourselves, we would not be at all surprised to see April upset the applecart, because it’s supposed to be a good month for the market. Ergo, if we enter on a winning streak the subject will be on everyone’s lips and so the market, which tends to maximum perversity, will disappoint. The conclusion would seem to be that this is not the time to put money in and start betting on which irrational turn the markets will take. You’ll look smart for a very short time and then like everyone else, sell too late and your paper profits will vanish, along with the comments from the television traders.
Friday is the jobs report and laden with reports, so the week should be volatile.
The Economic Beat
Yes, wrong data was the story of the week. Perhaps the most infamous number was new housing sales, which reported an all-time record low of 250,000 units (annualized) in a series that goes back to 1963 – when there were about 120 million fewer people living in our storied land. Wall Street commentators were indignant and said, in effect, that the data just couldn’t be right.
We beg to differ. No doubt the data doesn’t jive with the wonderful-world theme song that the brokerage houses have been peddling lately, but it isn’t at all inconsistent. There is plenty of evidence to support it. To begin with, February is generally the lightest month of the year, or one of them. Snow and weather (the weather that was so warm it depressed industrial production, and so cold it depressed sales) were surely a factor – much of the Northeast was buried for most of February, and the sharpest regional drop came there.
A 250,000 rate may be a new low, but it isn’t breaking a 48-year old record. The old record of 274,000 was set only last August. The rate went below 300k on three separate occasions last year, generally blamed on the expiration of the tax credit. The latter surely played a substantial role, just as the weather did in February, but to continue blaming such spectacularly low numbers (less than half the original rate of January 1963) on one-off factors is delusionary.
Let’s look at some of the other evidence. The number of new homes for sale is also at an all-time low – 186,000. Existing home sales fell nearly 10% last month, setting a record for all-cash sales (33%) in the process, with distressed sales rising to 39% of the total. Tight credit was cited by both the president (“remains a challenge”) and chief economist (“unnecessarily tight”) of the National Association of Realtors. Building permits fell a hefty 10% in both January and February. Pending home sales fell for February as well.
Take fire-sale pricing, little supply (the months-of-supply is creeping up due to the low sales rate, but the number of houses for sale is going down), little building, little motivation, very tight credit – without their financing arms, the big homebuilders would have trouble selling anything. It’s a recipe for a broken market.
The primary driver of rising prices during the housing boom was the supply of credit that resulted in an ever-widening river of money flooding the sector. Keep giving the bidders more money, and the prices in an auction will go up. It’s that simple. Now the supply of money is continuously shrinking. Take money away from the bidders, and the auction prices will keep going down.
Our beloved Gang of Four banks (Bank of America (BAC), Wells Fargo (WFC), JP Morgan (JPM) and Citigroup (C)) have nearly two-thirds of the market. They are all sitting on wads of bad paper – just look at the dividend news last week. Citi announced the most token of all dividends (one penny a share after a one-for-ten reverse split), and Bank of America’s attempt to raises its own dividend (and by extension, its share price, and thus executive compensation) was rebuffed by regulators.
More problems in the sector include still-falling home prices: (-3.9)% year-on-year through January, according to the latest federal lending agency data. Banks don’t like to lend money to buy assets with falling prices. Another is that Gang of Four operations aren’t suited to the current environment – their massive assembly lines are best suited for volume batch processing during benevolent periods of rising prices. Loose documentation procedures from the boom years and a structure too unwieldy for genuine loan-by-loan work have generated a stream of fumbles, poor execution, negative headlines and new regulations.
The result is that the banks are predictably responding with an ocean of new paperwork and suspicion, making a mortgage harder to get than it’s been in anyone’s lifetime. The intent of the new oversight is laudable, but really the problems are timing and scale – banks hate to lend to any sector that still has bad loans on the books, and trying to tune the behemoth banks for know-your-customer lending is like trying to outfit the Titanic for pond fishing. It may be a boat, but it ain’t gonna float. The only cure will be time and envy – the time to write off and forget the bad loans, and envy of the profits that someone somewhere will eventually make.
The next chapter of the saga will come next week, with pending home sales for January on Monday and the Case-Shiller home-price index for the same month on Tuesday. Mortgage-purchase applications did recover a bit last week, but remain at very depressed levels.
Another data release that must have been wrong was durable goods for February. They fell instead of rising, with ex-transportation orders down (-0.6)% and business investment falling for the second month in a row. It’s supposed to be wrong because the ISM surveys were strong that month. But the surveys only measure breadth of sentiment, a limitation we have frequently pointed out, and sentiment always peaks as business slows. That said, we do expect a positive revision to February next month, but even if pulled all the way up to neutral, it still leaves investment down for the quarter.
Unemployment fell slightly last week, and the rising market seized upon the minor drop as some justification for its madness. They remain elevated, however, and we fear that the markets are setting themselves up for disappointment again. Next week will bring the March jobs report, and the consensus estimate is for 200,000.
The jobs report has been disappointing very month since the fall. Will this month be any different? It’s subject to a lot of seasonal factors. State data indicates that construction has been picking up in some of the warmer states, especially California. It’s typical for the time of year and the numbers might have appeared tame as recently as 2008. However, with 2009-2010 layoffs running at very elevated levels, a mild increase could get significant seasonal boost. If so, the market may simply implode with hype.
Two Federal Reserve surveys were released last week, with the Chicago Fed’s National Activity Index edging down for the second month in a row and the Richmond manufacturing survey easing a bit from 25 to 20 (0 is unchanged). The Bureau of Economic Analysis (BEA) announced its latest revision to fourth-quarter GDP, and this time the BEA reversed field from its earlier estimate and raised it back to 3.1% from its second estimate of 2.8%.
Part of this revision depended on the price deflator being revised down to a 0.3% annual rate from 0.4%, a rate we already thought too low, given that the PCE rate (the Fed’s preferred measure) ran at 1.2%. One result was that the weekend press suddenly became excited again about the boffo American recovery, despite the Bureau’s comment that the revision “primarily reflected a sharp downturn in imports,” or the fact that real domestic purchases fell 0.6%.
Consumer sentiment dropped sharply in March, though the second reading was only slightly lower than the first. Doubtless the market correction and rising gasoline prices played the biggest role. Though the result was below estimates, we sat and literally counted the minutes until the market would reverse its drop and decide it was okay to rally again. It took three minutes.
Besides the all-important jobs report next Friday (important, that is, if it’s a good number, else it won’t matter so much), there is also the ISM manufacturing survey, February construction data and March motor vehicle sales. It could be quite an April Fool’s Day.
Leading up to that will be the Chicago PMI the day before, along with February factory orders. The latter should give a clue on the revision for durable goods. The week will begin with the aforementioned pending home sales, along with personal income and spending for February. Tuesday will bring the Conference Board’s consumer confidence survey, which is taken more seriously by the market – unless it’s wrong, of course.