“And there shall be a great confusion as to where things really are.” – Monty Python, The Life of Brian
Yes, it was the best rally since whichever crisis had previously beaten up stocks – budgetary scares, the downgrade to the U.S. credit rating – and a pertinent question would be whether this latest “best rally” is a sign of an incipient bear market, as some have started to worry. Bear markets have the biggest reversal rallies. Or maybe it was just a rebound from an overexcited state of anxiety, the latter being probably the majority opinion.
It says here that the wild ride of the last week or so – which may or may not be completely over – was something in between. I don’t see it as the start of a bear market, mainly because I don’t think that the top of the current bull is in yet. That is admittedly more than a little bit of a tautology, so I will defend that thesis by asserting that while the business cycle is peaking, it is probably at least two or three quarters away from beginning its descent. True bear markets are birthed by the ends of business cycles, and while the stock market does tend to weaken a few months before an actual recession sets in, not every downward move is predictive of a recession.
The other side is that the both the bull market and the business cycle are getting old, and the kind of extreme volatility witnessed the last few weeks is something that typically signals that age and precedes the end of a bull market – though that end could still be many months away, even more than a year. Conditions for a change of market cycle can exist for some time before something finally catalyzes it, a catalyst that is always difficult to recognize in real time and always denied as such when it happens: Bear markets don’t begin with mighty crashes, but with slow, ragged declines over many months. The real blood comes towards the end.
The big rip-reversal was touched off the week before by first and foremost a market that was deeply oversold short-term and as oversold as it’s been on an intermediate basis in the last few years (oversold on a long-term basis only happens at bear market bottoms). Really, all that was needed was the proverbial match to the tinder, and one was provided by St. Louis Fed President’s James Bullard’s remark that well, you know, we could always just put off the end of QE. It wasn’t really the thought of having a few more months of very limited bond-buying that excited the markets, but the seemingly clear acknowledgement that the central bank intends to keep the market’s back.
On Monday of the week just ended, reports began leaking out that the European Central Bank (ECB) had been doing some bond-buying. The news didn’t do much to U.S. markets, but in combination with the U.S. rally on Monday, it seemed to electrify European markets the next morning. Along with a positive Apple (AAPL) earnings report after Monday’s close, the two helped inspire a big U.S. rally the next morning, one that nevertheless had regular observers scratching their heads for an explanation at day’s end. The ECB explanation actually came rather late to the U.S. party, but has managed to gain traction as the rest of the week’s trend continued.
Certainly the spreading sense of the return of the central bank “put” – i.e., any sharp price decline will be actively resisted by the central banks – helped the markets, even if the sense consisted mainly in thinking that everyone else was buying it, so one may as well go along for the ride. Anyone who has studied warfare knows that if you can get the 10% in front to go the right way, everyone else will follow because they think everyone else knows what to do.
The biggest unsung reason can be seen in the S&P 500 chart below:
The so-called “inverted head and shoulders” trade – basically, betting that an incipient “V”-shaped formation will complete and then move to a new high – has been one of the most reliable short-term money makers of this bull market. Once traders see it happening, it becomes virtually inevitable. The right Fed words this week could allow the market to run right back up to its previous high before taking a breather.
Of course, that might not happen, but you can expect that in the absence of fresh bad news, traders will be ready to charge ahead on Monday and Tuesday. Indeed, part of the reason for completing the “V” above is not just the lure of the impending Fed meeting, but the documented statistical tendency that shows most of the market’s performance can be attributed to the days before a Fed meeting. Everyone else is doing it, so you might as well do it too. The rally will give way to the usual chatter about “strong” corporate earnings somehow justifying it, pointing to two-thirds of companies beating estimates (it’s the long-term historical average). The overall earnings growth rate will rise every week of the reporting season, just as it does every quarter, because the estimate is always set about 200 basis points to the low side for just that purpose (the rate should end up between 6.5% and 7%). By next month, major brokerages will have thought of ways to recalculate earnings to show even better growth.
The aftermath of the Fed meeting could be the beginning of more volatility, though. Stocks usually sell off in the wake of an FOMC meeting, badly if they’re disappointed, a day or so later if it’s just profit-taking. But the week after has two major events that could turn the table again – the mid-term election, and the October jobs report. Traders, who tend to be seriously right-wing, will be strongly disappointed if the GOP doesn’t retake the Senate. Not so much as Obama’s re-election, which had an ecstatic Romney-is-going-to-win run-up in the days prior, but nonetheless.
The measurement period for the October jobs report is now complete, and after crunching the jobless claims for the period, it looks to me like the stage is set for a blow-out jobs number. Unless the model has changed, it will probably be above 300,000. I couldn’t tell you if the stock market would rally that day or not on such a number – traders can be capricious with jobs reports – but the bond market definitely would not. Fears of accelerated Fed tightening after all would set in Monday if not Friday. The early-to-mid-November period often sees seasonal bottoms for the stock market, partly because of the post-earnings season letdown, so if we happen to get one extra catalyst, another retest of the lows could well ensue. The good news is that it’s exactly the kind of thing that sets the stage for the historical November-to-May outperformance. The bad news is that we may first need to go down again one more time before we can go up.
The Economic Beat
The report of the week was probably the Apple earnings report, followed by the story of ECB bond-buying, in a week that was heavy on earnings and light on economic releases. The regularly-scheduled economic report of the week would probably be September new home sales, released on Friday with big revisions to previous months.
I wrote last month that the new home sales report would likely be revised downward, in particular the outlier data point for Western region sales. Both came to pass, and so for the second time this year the “best month for new sales since the recession” claim disappeared after a large revision downward (the last time was January sales). The latest seasonally-adjusted annual rate now stands at 467,000 (467K), up from the August rate of 466K but down from the originally-announced August rate of 504K. July and June were also revised downward, and the actual total of new homes sold in the last 12 months is now estimated to be 437,000, up 5.3% from last September’s 12-month total. That improvement from the June year-year rate of only 1.7% may ease as we get later into the calendar, due to the big dip in August-September 2013 sales from the impending budget crisis and government shutdown.
The existing-home sales report came out a few days earlier, with a bump-up in September sales (2.4%) mimicking last year’s bump. The year-on-year sales rate is still negative (-1.7%), mortgage-purchase applications are still down 9%, yet October might see a mild lift from the recent drop in mortgage rates, which did have a big impact in refinancing applications. As the story about Ben Bernanke’s application denial illustrates, credit remains tight. With the larger banks especially guilty of trying to do local lending with a one-size-fits-all template that ignores the real rule of knowing your customer, and the higher cost of getting loans-for-sale into compliance (remember the quaint notion of banks living off their loan portfolio interest?), don’t expect to see any changes this cycle.
Brighter news came from the Chicago Fed national activity index, where the 3-month average moved up to 0.25 (0 is neutral, the range is minus one to plus one), and jobless claims, where the 4-week moving average reached its lowest level since early 2000. The downside to the former is that the index values get revised for many months afterwards, such that the only thing I feel safe saying is that the final number should be positive. The downside to the latter is that we have about touched bottom for claims levels. Those bottoms rarely last as long as a year and have not preceded years of additional expansion – they’ve generally come about a year or less before the business cycle started to turn downward.
Other news of note included the 50.2 reading for the HSBC version of China’s purchasing manager index. Last month was 49.9, the consensus was 50.4, and the differences are really meaningless apart from the psychological effect on traders. Third-quarter Chinese GDP was released earlier in the week as showing a 7.3% annual growth rate.
That came as something of a surprise to me, as the country tends to print what it wants to print (and never revises it) and so I believed it would stick to its previously announced goal of 7.5%. Notwithstanding, it did beat the consensus for 7.2% (naturally), making me also realize I must have missed some informal signaling that the rate would come down. As I’ve written in the past, it isn’t the absolute number so much as the change of direction that matters with Chinese data, so they are telling us that the growth rate has declined. Supposedly industrial production rose and retail sales declined in September, but I have less faith in those, as it’s entirely possible the country would simply not want to show all three declining at once.
Next week has the all-important Fed meeting, with the statement coming Wednesday afternoon. Presumably the FOMC (monetary policy committee) will be in possession of the first estimate for third-quarter GDP scheduled for release the next morning. It will also have seen pending home sales (Monday) and durable goods for September (Tuesday), along with the consumer confidence report and the Case-Shiller home price index (both Tuesday). Regional business surveys come from Dallas on Monday, Richmond on Tuesday and Chicago on Friday, which will also have the September personal income and spending report (largely known from the GDP report the day before).