“And either victory, or else a grave.” William Shakespeare, Henry IV
The two-faced god Janus turned out to be looking down in the month named after him this year. In classical art, Janus appears to be looking to either side, because he is looking both forwards (presumably at the year to come, since January comes right after the winter solstice) and backwards at the past. In Wall Street mythology, though, he is either looking up or down, and this year he was looking down again.
But not straight down, if that’s any consolation. The 3% loss that the S&P 500 booked last month is not exactly huge, and is actually better than the (-3.6%) loss of January 2014. That said, back-to-back down Januaries have been inauspicious in the past, usually signaling either flat years or down ones. When the gains were positive, a lot of blood on the streets ran first as bear markets were running their course. Investing isn’t that formulaic, of course, but others will take notice and if things get tough later on, it could be another excuse for heading for the exits.
The chief culprits this week were earnings, the Fed, and GDP. When I think about it, the fact that markets were only down two or three percent could be a testament to its underlying strength, so disappointing was much of the news. Without Apple (AAPL) and Amazon (AMZN), the bloodletting might have been much worse. The blended (actual plus estimated) earnings growth rate now stands at 2.1% halfway through the S&P 500 roster, making me wonder if the final tally can get past a three-handle (i.e., less than 4%), as it usually rises through the reporting season. Earnings growth for the S&P 500 as a whole in 2014 looks like it can barely top 5% – if it even gets there.
The Federal Reserve’s Open Market Committee (FOMC), for its part, removed language from its statement about ZIRP (zero interest-rate policy) remaining in place “for a considerable time.” They opted instead for “patient,” but the markets sold off anyway. It’s been a long time since stocks sold off going into a Fed meeting and then again afterwards. I don’t consider the event as the end bell, but it is an warning on the increasing age of our bull market. I was also quite surprised to read one reporter suggest that prices fell because traders are impatient to get the rate increase over with, showing how badly journalists can be bamboozled when they talk to traders.
Finally, the first estimate of fourth-quarter U.S. GDP (gross domestic product) came in at 2.6%, well short of the prior week’s consensus of 3.4% and the last-minute cut to 3.2%. I cover the data in detail below, along with some of the misleading instant analyses, but what it appears to confirm is what I have long maintained – the second and third quarters represented a weather-exaggerated rebound from a weather-exaggerated first-quarter downturn, and the real underlying trend rate of growth in the U.S. has not changed.
With the Fed and ECB meetings in the rear-view mirror and potential trouble with Greece and Russia/Ukraine ahead, the immediate question is whether or not stocks can revive themselves, and if so why, or are they at the beginning of something more ominous? For what it’s worth, equity prices are oversold to levels that have typically resulted in at least brief rallies, but have also occasionally given way to more serious excursions down south. The S&P did rebound from its 150-day exponential moving average (EMA) last week, mostly because it usually does, but the 200-day level is not far off at about 1970. The market may need to try that out too before traders feel good about moving in again.
One factor that would help out is some stability in the price of oil; another would be a boffo jobs report on Friday (as usual, the Street wants good but not too good). There’s a lot of Fedspeak slated for the week, and the assorted governors may want to try to put the stock market back in tune with their various remarks, a practice that FOMC members have seemingly come to believe in. That kind of mere talk doesn’t work forever, as central banks may come to regretfully discover, and it feels to me like equities have started to become jaded in that regard, but prices could still be good for one or two more attempts.
Quarterly earnings have not been great, apart from Apple and Amazon’s surprise – laughably small to cold-blooded analysis, huge to its legion of fan-boys – and the end of earnings season could help in one of two ways – either there’s a late surge of improvement, or more likely, the season gets into the rear-view mirror and we can get back to the business of hoping for the better. At some point soon, low energy prices are going to boost the bottom lines of more companies than the airlines, and the talk should shift to isolating the energy sector from the broader outlook. The ECB will start its buy program in March, and hopes spring eternal in the spring. It’s too early to throw in the towel on this bull, but it’s also too late to think it’s going to another two years.
Congratulations to the new Super Bowl champions, the New England Patriots!
The Economic Beat
The economic highlight of the week was Friday’s release of the first estimate of fourth quarter GDP. A week ago, the estimate stood at 3.5%, the same number the Atlanta Fed’s unofficial GDP tracker had going into the report. A weak durable goods report two days prior had pulled consensus down to 3.2%, but the big miss of 2.6% helped put stocks in the penalty box.
Those numbers are seasonally adjusted, annualized rates, and a few billion dollars here and there can lead to substantial revisions to the rate down the road. With that in mind, what news there was, wasn’t exactly cheery.
One of the first things that stood out about the result was the negative deflator, quite an unusual occurrence. The price deflator used to calculate “real” (inflation-adjusted) GDP, the headline number, is usually overlooked and rarely discussed, but it has quite an impact. In the fourth quarter, nominal GDP was only 2.5% in the first estimate (compared to a year-ago 5%), and the negative deflator actually drove the headline number of real GDP up to 2.6%. Had the fourth-quarter deflator been the same as the 2014 deflator, or 1.5%, then the headline number would have been a measly 1.4%. Had it been the same as the ex-food and energy deflator (0.7%), it would have been 1.9%.
Oil prices fell a lot, and so of course the deflator did with them, but my experience with GDP is that big discontinuous drops in the deflator are suspect. Usually they get revised down the road – often substantially – though not always, but the main thing is that they remain one-offs – the deflator returns to a normalized level in the next quarter. Don’t expect such help in the first quarter of 2015, which enters without much momentum and a fair amount of heavy winter weather. Nominal GDP not only fell to 2.5%, the drop was enough to take 2014 down to 3.9%, just below the 4% average that has prevailed since 2010, and four-quarter nominal GDP growth fell to 3.7%. Despite some talk about the real number of 2.4% being the best since 2010, nothing has changed in the economy. No, not personal spending either, whose headline number also benefited from a negative deflator and careless analysis. The rate of nominal spending (PCE) slowed from the third quarter.
New orders for durable goods was the week’s first report to rattle the market. The headline result was a fall of 3.4%, seasonally adjusted, that took the year-on-year rate down to 0.3%: That’s negative in inflation-adjusted terms. Excluding transportation, orders fell 0.8% and the business investment category fell 0.6%, the third monthly decline in a row. Orders should rebound soon, and that may light a fire back under stocks again when they do. Weakness in energy will weigh on orders, though, as evidenced by the decline in the energy-heavy Dallas manufacturing survey, (-4.4) overall and new orders at (-7.7) in its January survey. The Richmond Fed district remained steady at 6 versus the prior month’s 7 (zero is neutral).
Housing wasn’t much help either, with the shine of on overblown new-home sales report being rubbed out by a disappointing pending home sales report. Weather had plenty to do with both figures. A cold November helped set up a warm December for a little burst in new-home sales that was exaggerated by the seasonal adjustment process to a 481,000 rate. But the Census bureau has released 500K+ rates around the turn of the year the previous two years, rates that were later revised downward and more importantly, were not portents of any change: sales for all of 2014 are currently estimated at 437K, a minor improvement (1.9%) over 2013′s 429K. December existing-home sales were alright, but pending home sales fell by 3.7%. If the latter number improves much in January, I’ll be surprised. Case-Shiller reported that comparable home prices were up 4.3% in November from a year ago, the same as the October rate.
The Federal Reserve’s Open Market Committee (FOMC) statement was of some disappointment to the market when it traded the “considerable time” clause for “patient,” but threw a bone by characterizing the economy as “solid.” I took that as a tip that committee had seen a GDP number that was closer to the Atlanta Fed’s tracker of 3.5%, which didn’t exactly pan out. I can guess they were trying to position it instead, or less likely, they just hadn’t seen it after all. Stock market mavens remain firmly entrenched against any rate increase that might upset the equity party, but the Fed’s problem isn’t that short rates of fifty basis points would upset the economy – it’d be near-meaningless from a practical standpoint – but that the business cycle isn’t going to last forever. If the central bank gets to the end of it with ZIRP still in place, what recourse will it have to cushion any blows?
Clues that we are in the last stages of the cycle come from consumer confidence numbers that are at cycle highs, as the Conference Board’s reading of 102.9 9 (the highest since the last cycle peak year of 2007). The number is obviously influenced by falling gasoline prices, but these numbers correlate poorly with spending. A look at weekly chain store data suggests we are headed for another weak month of retail sales in January. There aren’t any hard-and-fast rules about this kind of thing, but objective looks at past data keep suggesting that we are in the last year of the expansion.
The employment cost index remained steady at a 2.2% year-on-year rate in the fourth quarter. I don’t know how we are going to get past 4% nominal GDP with that kind of trend. The Chicago PMI rose to 59.4, but that number has been so asymmetrically high since it was taken over by Deutsche Bors that neither I nor the Street give it much heed anymore.
The national PMI, or purchasing index, comes out Monday from the ISM, along with December construction data and personal income and spending data. It’s a busy week, but the focus will be on Friday’s jobs report. Claims data showed no evidence of weakening from the recent 200K+ trend, though there is more to the headline number than that factor alone. Consensus is for a net add of 230K, which seems quite reasonable to me, but whether or not the unemployment rate moves a tick is less important than the caveat that jobs are a lagging indicator.
The week is rounded out by factory orders on Tuesday – largely signaled in the red by last week’s durable goods report – the ISM non-manufacturing index on Wednesday and international trade on Thursday. As is their wont, Fed governors will be all over the place speaking in the wake of the latest statement, so we could see some volatility from various claims and counter-claims.