“Once more into the breach, dear friends, once more.” – William Shakespeare, Henry V
April managed to come through again. The markets wiped out most of last week’s losses, and while Friday saw the market go through its recent routine of running counter to the week’s trend, the damage was quite limited – with half an hour to go, the S&P was nearly unchanged on the day before doing a minor fade into the close. Considering the size of the GDP miss, that’s a respectable performance that can be counted as a victory.
It seems fair to add that the GDP miss wasn’t as big as it appeared. Although the consensus estimates were for something north of 3%, the weak durable goods report on Wednesday seemed to have convinced many that it was no longer in the cards. The very mild reaction to the print supports that conclusion, as futures barely moved in response. Though stocks did manage to fade about half a percent by lunchtime, buyers moved back in.
We could see 1600 on the S&P 500 by Wednesday, for the market will certainly be trying. Next week has a heavy data schedule and one can never be sure of such matters, but going into it the main events begin Wednesday, which not only has the first day of the month trade, but is the last day to position for Thursday morning’s European Central Bank (ECB) announcement.
The possibility of an ECB rate cut gained considerable traction during the week. To begin with, there was another collection of lousy purchasing manager data in the EU, topped off by the second monthly decline in a row for the German business investor confidence index. That seemed to convince the European markets of the likelihood of a rate cut, an event that has been increasingly favored in recent months as the economy continues to sour.
By the end of the week, two more events had occurred that pointed in the direction of the rate cut, at least to the eyes of this corner. One was an atypical weighing in on ECB interest rate policy by German Chancellor Angela Merkel, who steers clear of such matters as a rule. Madame Merkel opined that the bank was in “a difficult situation,” given that higher rates might be appropriate for Germany (in her opinion), while for other countries “it would need to do more.” Some read this as ECB opposition, but I see it as a pre-emptive apology for German savers up in arms about ever-lower rates (join the club).
At nearly the same time, the Bundesbank (German central bank) came out against the ECB bond-buying plan, a matter that many thought settled last year, but is still moot in the German court system. The motivation could be anything from camouflage to outright petulance, only the bank knows for certain, but it certainly has the appearance of a bank trying to maintain its bona fides in the face of a cut it knows is coming.
The ECB is indeed in a difficult situation. It’s no secret that bank lending in much of Europe is drying up, aggravating the downturn. What’s more, a twenty-five basis point rate cut will do little, if anything, to alleviate the problem in the current environment. But a rate cut does accomplish a couple of other worthy goals. The obvious short-term benefit is to rally equities – European stocks raced ahead last week – though that will probably come to an end within hours of the cut’s announcement.
More importantly, it will give the euro some breathing room against the yen, whose precipitous descent is cutting most of all into the sales of the EU’s biggest exporter: Germany, which derives over half of its GDP from sales abroad. With the US and Japan both pursuing ZIRP policies and quantitative easing, and China managing its exchange rate, the ECB can ill afford to sit around and simply twiddle its thumbs in the wait for everyone to balance their budgets. Germany needs to arrest the yen’s slide against the euro more than it needs another quarter-point for its savers. Let the Bundesbank grumble, it’s what they like to do.
So the signs point to a rate cut that is uppermost in trader’s minds and algorithms – for the moment. There are other hurdles to cross on the way there, including the ADP payroll report before the open on Wednesday and the ISM manufacturing report shortly afterwards. Monday and Tuesday are stuffed with data releases as well. They aren’t as high-profile, but a sufficiently juicy lemon could prevent the market from toasting 1600.
On Friday comes the jobs report, which could very well provide the inflection point for the spring correction, though I wouldn’t expect any straight lines. The report shouldn’t come as a complete surprise, given the ADP precursor two days before, but another report like March would probably provide the starting point for the process of bringing equities back to earth. A middling report could be sold as keeping both the Fed and some amount of growth in the game, while a strong report might set off a short squeeze and set new records with elan.
The weak March data in jobs, retail sales and durable goods weren’t enough to keep markets from rising in April (if you think it was about earnings, you certainly keep score differently than I do). It’s no secret on the floor that the market wants to take out 1600, and is hungry for an excuse to do so next week. That said, don’t underestimate the power of the turning of the calendar. Last week’s air pocket over a hacked AP tweet should be all the reminder that you need of the power of algorithmic trading. The default buy trade comes off in May, and weak news starts to matter again. Be prepared for the possibility.
The Economic Beat
The report of the week was the GDP estimate, though it didn’t move the markets very much. For once I can say that it was neither better nor worse than it looked, as there were several offsetting factors.
To begin with, there’s the deflator, or measure of price inflation, that determines what “real” GDP is, which is the number that gets printed on the headlines. It was reported as 1.2%, a result that I feared might come in a half-point lower, given that energy prices started falling in March. The fourth-quarter deflator, originally reported as 0.6%, has since been revised up to 1.0%. Revisions in this area are often significant, but it does feel like 1.2% is closer to the annual rate than usual.
An upward revision could come from imports. Goods imports got a January boost from the catch-up after the December port strike in Long Beach, California. Yet the February data weren’t as strong and unless March sees a significant boost, which I doubt, the import estimate number will be revised downward. March 2012 saw a significant uptick in imports, partly energy-boosted, that was probably modeled into the estimate. As imports are a subtraction in the GDP calculation, any cut will boost GDP.
Some tried to blame government spending cutbacks for the shortfall, but there wasn’t any particular area of strength elsewhere to justify that line. The data are all initial estimates and shouldn’t be taken as gospel, but with that in mind, domestic final sales fell from a 1.9% rate in the fourth quarter to a 1.5% rate in the first. Nominal GDP was reported at 3.7%, and it’s going a take a big revision to catch that number up to 2012′s first quarter rate of 4.2% (the deflator can’t help, though imports might). If current GDP stays below a 4% rate, it will be the first time since 2009 that the first quarter has done so, making for a less than auspicious start.
PCE, or personal spending, was supposed to have recovered to a 3.2% annual rate, though that number seems high to me in light of the first quarter’s retail sales. Some of it is due to auto purchases, but a good part of it is also due to energy costs and a cold winter. Despite some of the usual inane talk of late about how moderating gasoline prices are going to rejuvenate the economy, after going from very expensive to very expensive minus five bucks a week, February gasoline prices were at an all-time nominal high for the month. Let me assure you that heating oil wasn’t cheap either. Not to be left out, natural gas staged a sharp rally that began in mid-February and roared throughout March, a month that was not comfortable in the middle of the country so far as the temperature went. Possibly revised spending data will come out Monday.
The durable goods number (-5.7%) that effectively knocked the 3% GDP number off its perch wasn’t entirely bad, but it was a long way from good. Television tried to blame it on Boeing (BA) orders, but the ex-transportation category was also a big miss, at (-1.4%) versus estimates for +0.5%. The most redeeming factor was that the business investment category, non-defense capital goods excluding aircraft, was given an initial estimate of +0.2% (the next revision comes out this Friday). However, orders in the category were down from last year for both the month and quarter. The rolling 12-month rate of change was negative for the 3rd month in a row, which hasn’t happened since oh, 2009.
New home sales were on the bubble, as television reported them slightly above estimates and other media below, but existing home sales were definitely short. Nevertheless, the former result seem to reinvigorate markets, as did the talk of the ECB rate cut. For all that, if you had told me the S&P would regain nearly 2% during the week, I would surely have guessed that the GDP and durable goods data had beaten estimates, not come up well short.
Assorted Federal Reserve banks reported data in tune with the rest. The Chicago Fed National Activity Index reversed from an upward revised +0.76 in February all the way down to (-0.23) in March. It’s been volatile lately, with the three-month moving average hovering around the flat line. The Richmond Fed and the Kansas City Fed both reported survey results in the negative mid-single digits. The Markit “flash” PMI result declined, with the regular ISM result due Wednesday. The Chicago survey comes out the day before and should give us one last clue to what the national number will be – and perhaps more important from stocks’ point of view, what the market expects it to be.
Weekly claims data continues to be quite volatile. California apparently keeps reporting estimates and then catch-ups, helping to create big swings (the state makes up about 1/6 of the national total). Then there are holiday effects, April school vacations, and so on. The declines in adjusted claims during the first half of March, when the jobs report data was collected, did not translate into a good number, so it may be that the increase in the first half of April won’t translate into another weak number. Barring further revisions, the total number of initial claims for the first quarter fell 4.3% from the first quarter of 2012. That’s less than half the rate of decline from 2011 to 2012 (10.4%).
Claims and survey data don’t indicate a hiring boom, but the Consumer Confidence survey on Tuesday and ADP payrolls on Wednesday ought to prepare the market for whatever is coming. I suspect an upward revision to March, but beyond that I won’t guess.
Personal income and spending for March comes out on Monday, though they ought to track the data from the just-released GDP report. It’s followed by the last of the monthly housing data, with pending home sales (for existing homes) on Monday and the Case-Shiller price index on Tuesday. Construction spending comes out Wednesday, which is not only the first day of the month, but also has the ISM manufacturing report, auto sales for April, and the FOMC announcement in the afternoon. For what it’s worth, the markets tend to trade more sideways than anything else when confronted with such a heavy barrage of data.
Thursday has the ECB announcement and trade data. Friday ends with the jobs report, factory orders and the ISM non-manufacturing survey. The focus of earnings will shift to health care and energy, which may balance each other out. The week is going to be a lot for the market to digest.