“But, soft! What light through yonder window breaks?” – William Shakespeare, Romeo & Juliet
This past Monday, the S&P was down over 5% at its low from the FOMC meeting a few days earlier, 7% from its high. The bond market was in the ditch with a couple of black eyes, gold was breaking long-term trends, and even municipal bonds were getting beaten up. Emerging markets? You didn’t want to admit that you knew them. Nothing was sacred.
The headlines were filled with dark lamentations about triple-digit losses, Chinese credit, heavy redemptions and the general lack of safe alternatives. And let’s not forget the number of burned investors and media mavens who rushed forward to scold Mr. Bernanke and the FOMC for their communications skills. The gist of it, of course, was that the Fed should not be communicating tightening of monetary policy, not ever. Don’t even hint at it, unless of course you want to send us a confidential transmission ahead of everyone else.
Some predictable things ensued, some of which I had written about myself. Fed governors fanned out over the following days to reassure the masses. Bond traders moralized and shouted over the proceedings. And then some good housing news hit, and durable goods were okay, and GDP was revised downward for the first quarter to 1.8%. Goldilocks entered the house. The last day of June is often weak and Friday was no exception, or the market might have rallied one more day back to breakeven on the month.
There were some less predictable events too, in particular the sight of bonds being dumped. Treasury bonds haven’t been so unpopular since the Long Term Capital meltdown nearly fifteen years ago, farther back than many traders can go. Much of the damage was erroneously imputed to fear of higher rates, but the full effect of that was later, and mostly on the retail side. Much of the damage came from trading strategies that use Treasuries in one form or another, and some fear of higher rates rapidly translated into a lot of trades unwinding in a fashion that was both painful and hurried. Bond deals that would have sailed through the wickets six weeks ago were either amended or canceled.
Yet the market is likely to rally right into earnings season, so long as the jobs report doesn’t throw a wheel. Next week brings the ever reliable first-of-the-month rally, not to mention the usual rally that leads into the 4th of July holiday. Recent regional surveys suggest that the national ISM manufacturing number can recover past 50 on Monday. Housing news last week helped the market forget its troubles, and monthly auto sales on Tuesday could add additional balm. All we need is a jobs number similar to the last two months – even better, one that follows another ADP disappointment – and the “Goldilocks” paradigm of an economy neither too hot nor too cold will be ascendant.
Earnings season could very well be another story, but even if year-over-year comparisons turn up anemic, the market is usually able to keep going anyway through at least the third week of July. After that it may get dicey and often does, but next week and the week after could see stock indices add another percent or three, so long as there isn’t any serious trouble from abroad.
One overseas problem that is likely to ease for now is the string of scare stories about credit in China. It seems quite apparent that the central bank was determined to punish excess lending in the shadow sector this time and deliberately allowed a scramble for the quarter-end cash necessary to the balance sheets. Whether or not the lenders have to be cowed again next quarter remains to be seen, but next week at least conditions are likely to ease considerably, if for no other reason than the cash is less needed than before.
Another boost could come from automakers curtailing their summer shutdown, or even doing without it altogether. That’s likely to put a glow on jobless claims data and help out the next round of manufacturing surveys. A lot can happen over the next few weeks to throw things off, especially in the sphere of policy, but if the upcoming economic releases are anything like last week, you’ll start hearing some bombastic pronouncements about the second half recovery. That’s likely to be a sucker’s bet, but similar disappointments in the past have never stopped the Street from trying.
A reminder to our readers that Thursday, the 4th of July, is a US holiday and all markets and banks will be closed. Enjoy the break, especially those lucky enough to make it a four-day weekend.
The Economic Beat
The week was a study in contrasts. I had thought that the report of the week would be the personal income and spending report. In retrospect, it may have been the headline from the Case-Shiller housing report that reported existing home sale prices being up 12.1% over the previous year. It came shortly before a positive surprise in new-home sales, and shortly after the positive surprise in durable goods.
It’s probably safe to say that some of the increase in Case-Shiller pricing represents a mix shift, as the FHFA (federal mortgages) index, which excludes home prices that sold last year for over $750,000 (and less in most regions), rose only 7.4%. Both results are well above the long-term average.
Housing news was good across the board, really, with new home sales up to a (still-low) 476K annual rate and pending home sales rising more than forecast to their highest rate since 2006. It seems fairly evident that the uptick in mortgage rates is panicking some buyers off of the sidelines, so I would look for more strength next month.
That makes it a good time for my usual safe-driving warnings. One is that mortgage credit is still quite difficult to come by, and while it may ease up a bit this summer, the credit and currency markets have gotten sloppy enough that one can feel reasonably certain some sort of credit event-driven-fright is likely over the next twelve months.
In the second place, the housing market is about 2.4% of GDP. The actual dollar effect, with multiplier and confidence effects thrown in, is still well below the level of the paeans being written about it by Wall Street. It is also a market still very dependent on cash investors and government financing (over 90% of mortgages). Naturally one hopes that this will heal over time, but it isn’t going to be a straight line and any hiccup in credit markets will set it back for a period.
The Richmond Fed survey punctuated a decent string of positive manufacturing surprises that included New York (though new orders fell), Philadelphia, Dallas, and durable goods. The end of the week changed direction, with the Kansas City and Chicago surveys dropping well below expectations (the former a minus 5). Chicago is usually thought of as being auto-based, but Caterpillar (CAT) is based in Illinois and though it’s only speculation on my part, it may be that recent weakness in Cat and Deere (DE) was a drag on the two neighboring regions (the Kansas City region is tilted towards agriculture). In light of automaker plans to forego summer shutdowns next month, both the national and Chicago ISM readings might benefit.
The GDP revision for the first quarter took the market by surprise, falling from 2.4% all the way to 1.8%, but it was far enough back in the rear-view mirror that the rally was not only able to continue, but gain strength from the inference that the Fed would not, in fact, be able to begin tapering soon. More ominous to me was the trailing four-quarter rate in nominal GDP falling to 3.3% through the first quarter after averaging 4% for several years. I suppose the bright side is that another quarter like the first one is going to make it difficult to taper much.
The GDP revision was consistent with the Chicago Fed national activity survey, which fell again and brought the 3-month moving average to (-0.43). This chart is a bit scary when one looks at the divergence between the S&P 500 and national activity:
It’s especially worrisome when you look at the last time the current pattern developed. Perhaps the auto sector can turn the July reading around.
Consumer sentiment rose to new multi-year highs in the University of Michigan and Bloomberg surveys, though the former had a decline in current conditions. These things tend to peak just before bad times, though a high reading doesn’t guarantee a bad ending.
Next week is the first week of July, and it’ll be a big one as usual, what with both ISM surveys and the two payroll reports. It’s also good news, bad news for Street denizens, as the Thursday holiday tempts a four-day weekend, but that would mean being out of the office for the jobs report. The buy side should be at the beach in droves, with the sell-side and traders a little less lucky. Even so, look for Manhattan to empty out early.
The lineup is June ISM manufacturing and May construction spending on Monday, factory orders and auto sales on Tuesday, ADP payrolls and ISM services on Wednesday, and jobs on Friday. The ECB announcement is on Thursday, when all US markets, offices and banks are closed.