“You cannot pluck roses without fear of thorns.” – Benjamin Franklin, Poor Richard’s Almanack
Yes, it’s springtime and the classic first-quarter earnings season has gotten underway. I’ll give last week’s price rebound a “B” for its gains of better than one percent, but not quite as good as two or more. Whether the bounce runs all the way through the end of next week or not will depend on how dovish the markets think the Fed is being with its statement this Wednesday, a sentiment that in turn depends on what color of glasses the markets happen to be wearing next week. Global markets are a bit goofy about stimulus as a panacea these days, so if the initial Q1 GDP estimate earlier that morning comes up short of 1%, the odds are good that the glasses will be rose-colored.
April rallies typically come in the second half of the month and last about two or three weeks; it’s the rare ones that don’t that are grounds for distinction (and cause for real concern), the equivalent of Sherlock Holmes’s dog that won’t bark in the night. You should sit up and take notice if markets don’t make new highs next week.
In case you missed it, even the Nasdaq finally got past its old highs, a mere fifteen years after the last one. No doubt Jeremy Siegel will soon be citing the event as further proof that you can’t beat buy-and-hold investing (though on an inflation-adjusted basis, the index still has a ways to go). Fair enough – if you live long enough, most bad purchases will eventually regain their old value. I don’t consider that to be proof of great investing, but I’m just a cranky skeptic.
Why the all-time highs? First off, it’s the spring, and springtime rallies happen even in recession years. Second, every cycle brings its own cure for the business cycle and this one is no different. In the late nineties, the “new economy” paradigm of perpetual growth was eagerly devoured. That was followed by the mantra that housing prices never decline, thereby supplying a perfect, endless source of financing, credit and supplement to lost income opportunity. Now it’s central bank stimulus, whether foreign or domestic. In the U.S., it’s “lower for longer” and the widespread fallacy that the business cycle only ends when the Fed “jacks up” interest rates high enough (in the words of one business writer) to choke off the economy, an event that hasn’t happened since 1980.
In China (and elsewhere), it’s the belief that the country’s growth recession is a marvelous stroke of fortune for investors, who have only to throw their money into the obligatory stimulus pot to witness fortunes emerge. Meanwhile all the clever-boots are shifting money to Europe, where “valuations are cheaper” (barely, and with less growth), and more importantly, QE has just begun (so who cares about growth?). I mean, those stocks have to rise another 30%-50% or so, right? Just look at that German business confidence index, which rose to its highest level since last June.
I’ll tell you what, the Western world’s most export-oriented economy certainly isn’t going to suffer from having its currency devalued by 25% in six months. Other European export businesses should benefit as well, though within the eurozone itself it will matter less. Falling oil prices aren’t going to hurt the oil-poor continent of Europe either. But the economy is still weak, austerity still isn’t going to fix it (however much it may satisfy the Germans), China is still going to pay for its bubble, and the U.S. business cycle is still going to end, sooner than most people think (which is invariably some years from whenever today is).
But the cycle isn’t ending quite yet. The second and third quarters should still see a better quarter than the first, though the rebound will not be as good as the one last year. The dollar’s rise against the euro is nearly over. As for the Fed, who knows – the bank has been deathly afraid of upsetting the trader applecart the last couple of years, but you can go broke trying to predict policy decisions. Vice Chair Stanley Fischer has been persistent in a message that rates will rise, but that doesn’t mean his view will prevail when Janet Yellen has to close her eyes and throw the switch. If she does.
In the meantime, the financial economy will continue to distance itself from the real economy: Earnings are “better than expected” this quarter, sayeth the pundits. Of course they are, if they weren’t we’d be in a full-blown recession. The estimated decline in S&P earnings growth for the quarter has risen from (-4.6%) to (-2.8%) with 60% of the index to go, meaning we can hope for an eventual decline of only 1%-2%. The latest rumor is that the Fed may move in mini-increments of an 1/8 of a point, a development that could drive markets wild with (short-lived) ecstasy. Of course that will all mean new all-time highs in the index – until it doesn’t. Just keep in mind the one maxim that does have a perfect track record over time – the higher the rise, the farther the fall.
The Economic Beat
In a rather quiet week for data, I’m not sure what should be called the report of the week. Perhaps the biggest takeaway from last week is one of a sideways economy. Home sales, for example, are doing alright (by post-crash standards) with existing home sales rising in March by 6.1% (seasonally adjusted, or SA) to a 5.2mm annualized rate, and new home sales posting a 20.7% year-on-year increase (not adjusted, or NSA) for the first quarter. The latter category saw a pullback in the seasonally adjusted rate for March to 481K, but upward revisions to the last three months were helpful. The trailing-twelve-month (TTM) rate for new home sales now stands at 461K and is slowly creeping towards the 500K level. Price increases for existing homes in the National Association of Realtor’s survey – which has a somewhat higher price mix – are 7.8% (SA) for the year-on-year median (March), while the federal agency price database showed a 5.4% year-year increase through February. The Case-Shiller same-home-sales index reports its own February data next week.
Manufacturing data was less encouraging: although new orders for durable goods showed a 4.0% increase for the month (SA), orders excluding the lumpy transportation component fell again, this time by 0.2% (SA), dragging the year-year rate for ex-transportation down to (-1.9%) (SA). Total orders are barely changed for the year, and business cap-ex orders were weak again, with March orders 4.5% weaker than March 2014. The year-on-year rate for the category eased to 3.7%, the lowest in 16 months.
Business cap-ex spending has been a white whale for a couple of years now, with investment managers trotting out surveys at the start of each year promising increases that don’t materialize. The year-on-year rate has wobbled before, and the TTM rate went negative in 2013, an unusual event that usually happens at the onset of recessions. But it recovered back to a 5.7% rate last fall – undoubtedly helped by energy patch spending that is now contracting, before subsiding to the current 3.7% rate. Longer-term growth rates continue to weaken, however, and that will mean some payback down the road. As GE’s recent announcement made plain, corporate CEOs see more value in stock buybacks. It may be job-security value rather than long-term business value, but it’s hard to argue that it isn’t rational self-interest for the executive.
In a similar vein, the Chicago Fed’s national activity index recently reached another trough, with the 3-month moving average provisionally declining to (-0.27). However, the danger zone (-0.70) is still far off, and the coincident index has simply rebounded off of every intermediate high and low the last few years. Some data, such as retail sales and others, also hint that the cycle has crested, but they are as yet only hints, perhaps rhythmic pulses rather than trends.
It’s easy enough to say what the economic report of the week should be next week – the initial estimate of first-quarter GDP. Tracking estimates are all over the map, from the Atlanta Federal Reserve’s 0.1% to private-sector guesses at 1.5% and up. Consensus is for 1%.
However, that report will take a back seat to the holy of holies, the FOMC (monetary policy committee) statement later that day. If the GDP report is on the low side, plenty of market mavens are going to strenuously argue – and not for the first time, with the noise level rising of late – that the Fed simply cannot raise rates this year, an event that might by pure coincidence curtail the equity party. By and large, the market will want to agree, for similar reasons. Whether or no, the business cycle will end nevertheless. One school of thought is that the Fed will raise rates in 1/8 of a point increments, rather than the traditional quarter point. Ultimately it would only make the central bank look foolish in retrospect, but it may well do it.
Other reports of interest include the national purchasing manager index on Friday (a.k.a. the ISM manufacturing survey), which will be preceded by two regional surveys, Dallas on Monday (probably rotten) and Chicago on Thursday. The latter has plunged in recent months, so it looks ripe for a rebound.
Pending home sales are Wednesday, Thursday has March personal income and spending (mostly known from Wednesday’s GDP report), along with the quarterly employment cost index. In addition to the ISM on Friday, there is construction spending and the second of two consumer sentiment measures, both of them only telling you about where the economy and markets have been last year and nothing about where they are going the next.