“But I heard him exclaim, ‘ere he drove out of sight, “Happy Christmas to all, and to all a good night!”" – The Night Before Christmas, popularized by Clement Clarke Moore
In the end, last week’s decline-and-rally show was another edition of the 2014 mid-month “V” spectacular. The October sink-and-soar move that had the indices falling around 10% at their intra-day lows gave way to a ferocious rally that surprised even traders expecting a rebound; last week the pattern repeated itself in milder form.
The principal catalyst in both instances was the equity market fixation on central bank policy, often summarized as “the Fed put.” Neither earnings nor the economy really play much of a role in these affairs, though stock market boosters often try to peddle them as substitutes for the less dignified reasons of charts and Fed-mania. While both of the former factors do require some sort of minimal positive perception as a backdrop, the real catalyst is the Fed’s exaggerated protectiveness towards the equity markets.
As to the trading, the formula isn’t complicated. Take an oversold market, an important support point on the charts, in this case the 120 day moving average, an options expiration week, throw in soothing words from the Fed and leaven with a bit of spice. In both October and December, there was an extra dose of buy-the-dip fever after it looked like the chart had turned, a goodly amount of short squeezing and a shot of you’re-being-left-behind desperation. The latter episode included a positive calendar effect: on Thursday and Friday, the phrase “Santa Claus rally” was being bandied everywhere. In short, it was a herd stampede.
I would love to tell you the exact upside to the current move, but that would require divine insight. What I can tell you is that in the absence of some fright from abroad, the market believes that it’s safe to push on past 18,000 on the Dow (nearly there already) and the previous highs on the S&P 500, perhaps followed by the all-time high on the Nasdaq. The year-end S&P 2050 level – my own likely target for the end of 2014 – that may have seemed next to impossible as recently as Tuesday, has already given way to a new target of 2100 and indeed the momentum is such that something in the neighborhood of 2125 is more likely.
As I frequently remind my readers, the tape makes the news. The global slowdown fears that the recent plunge in oil prices precipitated are based in reality – the US has definitely increased the supply of oil, but the demand for oil abroad isn’t falling because we’ve taken up fracking here. However, as the tape mounts higher over the next few weeks, you can expect to hear less talk about the slowdowns in China and Europe and more talk about Fortress America, another variation on the failed theory of decoupling that will similarly fail in the end – but not before it’s first roped in the rubes.
The 2006 stock market rally lived on global growth and decoupling, much as the 2014 one has survived on US decoupling and highly exaggerated claims about its economy. 2007 ran on hopes of Fed rate cuts until those actually came and went without changing anything, and I suspect that stimulus dreams for both China and Europe will work the same illusion as we head into 2015. For how long is as yet unknowable; we are in the fourth quarter, but the last period of bull markets doesn’t run on official time. It could end anywhere from six to eighteen months from now, a little bit less with a credit tremor (think Russia), a little bit longer with a credit mania (think greed and stupidity).
Just don’t fall in love with the tape. The Fed’s Janet Yellen seems to be trying to have it both ways by signaling that the first move could come sooner than mid-year while leaving in the “considerable time” language, the latter part being the boost the market didn’t expect and really loved. It doesn’t change the business cycle.
Next week is Christmas week, I need hardly remind you. U.S. equity markets will close early at 1PM on Wednesday and remain closed until the Friday open. Though volume on the last day of the week will be very light, prices could be quite volatile as various positions are um, “adjusted” as we head into the last few trading days of 2014. Merry Christmas to all!
The Economic Beat
The report of the week was the strong U.S. industrial production report for November. At the time it couldn’t offset selling fears fueled by falling oil prices and downward momentum, but strong performances from autos and utilities boosted the year-on-year rates to 5.2% overall and 4.8% in manufacturing. It was unquestionably a good month, but be warned that utilities are going to take a hit in December, the auto boom is at its peak and oil-related activity will soon begin to fade. We are most likely at or very near the peak, partly signaled by the New York and Philadelphia Fed manufacturing surveys.
Take both surveys with a grain of salt, of course, as they often correspond weakly with actual output, but New York did drop into negative territory (-3.58) with a slight decline in new orders (-1.97). The shipments reading was negative – barely – for the first time in eighteen months. Over in Philadelphia, the reading was still well above average at 24.5, though that was about half of November’s result of 40.8. New order and shipment results were also about half of the previous month. The real indicator to watch is the six-month forecast, which peaked above 60 two months ago; the history of these peaks is that activity results will grind back to zero over the ensuing months. For what it’s worth, the “flash” purchasing survey result for manufacturing also eased from November.
In the meantime, inflation is painting a contrasting picture. The consumer price index fell (-0.3%) in November, due largely to falling oil prices, but still only rose 0.1% excluding food and energy. The recent import-export and producer price data were also quite weak.
Homebuilder sentiment was unchanged, declining trivially from 59 last month to the current 57. Both starts and permits, however, declined and came in below estimates. Neither are falling apart by any means, but the growth rate in 2014 is less than half of 2013 and 2015 looks like it will be more of the same trend. Existing home sales are due this Monday, followed by sales of new homes for November the next day.
Janet Yellen mistakenly referred to the fall in oil prices as a tax cut that puts more money in consumer’s pockets, but it isn’t and it won’t. Total consumer spending grows with income, not deflation; it’s only the mix that changes. Up to this point, December retail spending is weak, though the biggest two weeks are still to come.
Next week will also see durable goods data on Tuesday, along with November personal income and spending and another revision to third-quarter GDP. The Chicago Fed’s national activity index is Monday, and weekly jobless claims wrap up the week with an early holiday release on Wednesday.