Spring Leaks

“Joy to you, we have won!” – Pheidippides, proclaiming the Athenian victory at the Battle of Marathon

Hope, whose perennial springtime ascent I wrote about last week, began a speedy redescent last week. Weak economic data out of China combined with weak morning data and indifferent earnings on Monday morning to produce some tactical selling; when news of the Boston Marathon attack hit the wires later that afternoon, followed by speculation of possible terrorist involvement, the week was in for a rough time.

Earnings weren’t much help. Many of the largest companies in the financial and industrial sectors were light on revenue and/or earnings, accelerating flight into the consumer staples, utility and health care sectors. Next week will be heavy on tech stocks, and equities could use a jolt of optimism from them. Taiwan Semiconductor (TSM), the world’s largest chip foundry, reported decent results during the week and raised guidance, so there is still hope.

Indeed, having now bounced off its 50-day exponential moving average, it would be quite typical to see the S&P 500 index mount another charge back to the top of its trading range and the sacred 1600.

You may well wonder what might possibly be the catalyst, but the market has never required solid grounding for its forays into the stratosphere, just a bit of optimism and the failure of the earth to stop rotating. It could come from the resolution of the Boston situation (a very surreal week here), or perhaps some decent earnings (non-GAAP, of course) from the cloud sector, or good news from the slate of PMI “flash” releases on between Monday’s close and Tuesday’s open, including China and the EU. The last aren’t required to be positive, just not as bad as expected or as the month before. The first-quarter GDP estimate on Friday might look good.

If the above end up not looking good, then the spring sell-off could arrive early, unless the central banks spring back into action. Both Bundesbank (Germany’s central bank) President Jens Weidmann and International Monetary Fund (IMF) chief Christine Lagarde have hinted at the possibility of the European Central Bank (ECB) lowering rates soon. One could legitimately argue that ECB President Mario Draghi’s two infamous utterances of “unlimited” and “whatever it takes” last year were the main reasons the markets were up instead of down.

The preponderance of evidence certainly points to the global slowdown the IMF dialed up this week, lowering its forecast for global GDP growth to 3.3% and 1.9% for the US. The problems are still centered in Europe and China, both of which are saddled with piles of bad loans that they would prefer not to acknowledge. The Europeans seem resigned to waiting for a deadly crisis to persuade the Germans to change their minds about aiding in a continent-wide restructuring, while the Chinese leadership is no more anxious to admit to the size of its property bubble than ours was.

How the globe is going to somehow finesse its way out of the overhanging debt by ignoring it in the hopes that meager growth and time can cure it all isn’t clear to me. It seems to be asking an awful lot of US housing to lead the globe back to health, not with unemployment unlikely to improve much in the face of stagnating global trade. The improvement in jobless claims has leveled off considerably from last year, and we are still five million jobs away from 2008 levels. That’s a lot of houses to build.

The Fed can keep rates low, but only time and the economy can persuade still-reluctant banks to forget about their losses and start lending on reasonable terms again. We’re quite likely to get another credit-markets fright before that happens. Equities haven’t really focused yet on the economy – it’s still about the percentage trade, the calendar, and whether one should be optimistic about tomorrow or not.

The heavy volatility and seesaw action in recent weeks are a sign of a market getting ready for some subsea action. That doesn’t mean that the bottom is about to drop out, a process that could take many months, with lots of rebounds in between. But it does imply that tops could be profitably sold.

On a different topic, I would like to briefly note how difficult a week it was here in the Boston area. My sympathies to all directly affected, and my gratitude to all who expressed their concern.

The Economic Beat

The report of the week so far as visibility is concerned was housing starts. For myself, it was industrial production.

Housing starts broke over the one million annual rate (1.036mm) in March for the first time in many years. So why did the homebuilder sentiment ratio, reported the day before, fall back to 42 (50 is neutral)?

One reason is that the rates for both single-family starts and new building permits declined. The headline starts number got a huge boost from multi-family construction, a bulge that is probably going to recede by next month, two at the most. That leads to two inferences, the more obvious one being that the rate of housing starts will decline next month, at least on a seasonally adjusted basis.

The other is that credit continues to be tight for individual homebuyers. The rise in multi-family construction is being helped along by better conditions in commercial lending and investor pools. So far as single-family purchases, though, banks are still plagued by their past lending practices, having to cough up relatively large sums on a periodic basis to atone for sloppy practices. Before anyone rushes to blame the regulators, I would observe that banks have been repeating this cycle since deregulation began in the 1970s: chasing some lending fad in the hopes of getting some of big money, booking nice paper profits for a short amount of time, then becoming reckless in pursuit of same. Afterwards they are stuck with a hangover that lasts much longer than the party ever did.

Some of the refinancing news of late is suggesting an inflection point in the remaining number of homeowners able to profit from doing so, and successfully wade through the hundreds-of-pages long agreement moat. It’s getting to the point that you might snagged on the qualifying bar if you tipped a waiter only 10% back in the nineties. That tightness is present in the new home sales segment too, where the qualified buyers are predominantly sellers of other homes, those able to obtain FHA financing, and investors. That pool may not be able to sustain the growth rates we have seen in the initial months of recovery. Commercial mortgages and loans, by contrast, are experiencing easy times.

Industrial production in March was weaker than expected. The headline number of +0.4% exceeded the 0.3% estimate, but the beat was all due to autos and an uptick in utility production (March was cold). Manufacturing actually fell (0.1%). That was echoed in both the New York and Philadelphia Federal Reserve surveys. Both were short of estimates, with New York at 3.05 and Philadelphia at 1.3, and both readings were the lowest April observations since the recession. New orders weakened to barely positive in New York and slightly negative in Philadelphia.

Two-third of the Philadelphia respondents cited demand uncertainty as an obstacle to hiring, with only 17% (about 1 in 6) citing regulatory uncertainty. The spring slowdown certainly seems to be here, and the main problem is centered in Europe’s recession. It is likely to deepen, going by the latest data from Germany, if the yen continues to weaken and make German exports less competitive. The Chicago Fed national index is on Monday, and I’m curious to see what it has to say about March.

The latest batch of price indices revealed benign pricing conditions, perhaps too benign if you’re worried about deflation. The Consumer Price Index (CPI) fell to a 1.5% rate over the last year, not far from the 1.1% rate logged by the Producer Price Index (PPI). Recent drops in energy helped out, with the CPI “core” (excluding food and energy) at 1.9% over the last year and the PPI at 1.7%.

There was an interesting contrast between the Leading Indicators, which fell by (0.1)% where a gain had been expected, and the Fed’s Beige Book, whose comparatively upbeat tone helped out stocks on Wednesday. The Book authors wrote that “outlooks…remained optimistic across sectors and Districts,” and the report cited “robust” conditions in oil and gas, along with tight housing markets. The Conference Board (authors of the Leading Indicators), by contrast, commented on “weak demand” and that the March data “reflect an economy that has lost some steam.”

In the midst of all of this good news came the revelation from Bloomberg that its consumer comfort index had leapt to its best level in five years. Perhaps taxes weren’t as bad as people had feared.

Next week brings the rest of the latest round of housing news, with March reports for existing home sales on Monday and new home sales on Tuesday. Durable goods for March are on Wednesday, providing the last chance to rework first-quarter GDP estimates before its initial release on Friday. The market will be ill-placed to withstand disappointment in any of them, though as I wrote in Seeking Alpha, the first-quarter deflator measure may come to the rescue for the GDP headline print. The latter needs to be at 3% or better to comfort the market.

There will a full slate of earnings as well, with the beleaguered Apple (AAPL) reporting on Tuesday and a number of high-beta high-fliers reporting during the week, including Amazon (AMZN) on Thursday. The tone of those reports will decide if we make another attempt at 1600 this spring, or a trip back to 1450 first.