“Let us learn from the past to profit by the present, and from the present to live better in the future.” – William Wordsworth
October 2015 showed a mighty rebound indeed, of 8.7%. For bulls it was validation that nothing was ever really wrong, and indeed CNN-Money ran a raving report with quotes of “a banner month for bulls” and bears being in “hibernation,” or so apparently said Merrill Lynch. It was the best-returning month since October 2011.
And therein lies a big difference. October 2011 was a couple of years into the recovery, springing back from the August 2011 downgrade to the U.S. credit rating and gathering rebound strength from Ben Bernanke’s newly-minted QE program. Most of all, it was early in the cycle. In October 2001, the S&P also had a banner month, up 7.5%, not as good as February 2000, up a whopping 9.7%. Those rallies came very late in the business cycle – in fact, the recession had already begun by October 2001, though few thought so at the time. If you sold both of those rallies, you’d have been much better off a year later. Better yet was to have shorted them, as the S&P was down 23% a year after its great showing in February 2000, and down nearly 18% in the year following October 2001. Clearly, great Octobers are no guarantee of future performance.
Another commonality between the October 2001 and October 2015 rallies is that neither of the big rebounds returned the index to its high on the year. Stocks are in fact quite overbought at present, and once the usual first-of-the-month rally is out of the way on Monday, I expect some weakness to follow that will probably last up until Thanksgiving, give or take a day or two.
The number one reason is earnings, which I still see as finishing the quarter with roughly a 1% year-on-year decline for the S&P 500. Equally bad is that estimates for the fourth quarter have finally given up the ghost and analysts are no longer projecting a positive quarter, but a negative one of (-2.7%). That’s only on a to-date basis – typically estimates will fall another 300 basis points or so by the time reporting season rolls around in January. Despite the usual parade of estimate “beats,” we’ll still be left with a third consecutive quarter of earnings declines.
Many excuses can be made – as they always are – including the dollar, energy, China and doubtless at some point the weather again. Consider that while negative currency comparisons may indeed begin to fade in 2016, the only factors that would weaken the dollar next year are economic weakness (and further money-printing by the Fed) and a surge in oil prices. The demand in oil isn’t increasing, so a price spike would have to come from a supply disruption. Sudden surges in oil prices have not led to U.S. prosperity in the past – recall that the 2008 spike helped deepen the nascent recession.
The main thrust of the Fed’s non-statement last week can be summed up as status quo: Maybe the FOMC (monetary policy committee) will raise rates, maybe it won’t. The fact that the statement offered no immediate obstacles seemed to be all that was sufficient to allow chart-chasers to keep betting on closing the gap below:
But once that gap is closed and stocks retreat again, it won’t be a good technical sign (though some will bet on the “cup-and-handle” pattern that should come about from the year-end rally). In the meantime, there is little comfort to be had from the initial estimate of real GDP as 1.5% (annualized, adjusted) for the third quarter. Despite the usual stock market excuses that if you only look at it this way, it’s really not so bad, nominal GDP decelerated from 1.5% in the second quarter to a measly 0.68% in the third. However it’s much better to look at the year-on-year numbers, which showed nominal GDP falling to 2.93% (year-on-year), the first time it’s been under 3% since the second quarter of 2013.
Profits falling, GDP declining, the cycle is eight years old – what’s to worry about? How about very elevated valuation ratios that leave no room for error? Valuations themselves don’t make prices go up or down, but they do provide an excellent guide to how much road has to be traveled to regress to the mean – and they always do. Right now the price-to-value gap is large. I don’t think stocks will decline all the way into year-end, I still believe in the year-end rally, but don’t mistake this October rebound for anything more than what it is – a chance to trade out of stocks for a few weeks until stocks are oversold again.
The Economic Beat
The event of the week was the Fed’s statement, though it said so little that it may not be right to call it the data report of the week. There’s a lot of economic ground to cover before the central bank’s December meeting, now a slight favorite to include a tiny, yet momentous bump in the funds rate. The move or lack thereof won’t matter to the business cycle, though many will blame the end of it on whatever the Fed does – or doesn’t do.
One item that puzzled me in the FOMC report was the comment that “business fixed investment… (has) been increasing at solid rates in recent months.” Excuse me, what was that? New orders for durable goods are down 3% year-on-year, (-5.3%) excluding transportation, and the business cap-ex spending category has comped negative every month this year, with the result being a year-on-year loss of -7.3% (all numbers are seasonally adjusted). The regional Fed manufacturing surveys have all been marching negative across the board, with Dallas reporting a lugubrious (-12.7) on Monday and Richmond at (-1) the day before. The national ISM purchasing index has been languishing near 50.
So where is the strength? Well, the third-quarter GDP report did show that durable goods added 0.48% to the quarter, a figure which came in for no little skepticism in light of the weak monthly data from the Commerce Department. The two agencies do use different methods. It’s only an initial estimate, but I found it odd that the FOMC would highlight the area as a source of strength. Perhaps it was just a glossing of the BEA release, which did highlight the sector as a positive, yet decelerating contribution, but the September durable goods report the day before had not been cause for optimism. It showed a substantial downward revision to August, from (-2.0%) to (-3.0%) and a decline (-1.2%) that was somewhat larger than expected. On the plus side, the mercurial Chicago purchasing index leapt back up to 56.2 in October, its first good showing in months.
The sales rate for new homes fell much more than expected in September, to a 468,000 annualized rate (seasonally adjusted) with a big downward revision to August (552K to 529K). The September number may get revised as well, yet year-to-date sales are still up 16.7%. The actual number of homes over the trailing twelve-month period did fall from 496K to 495K, the first decline since last fall. Pending home sales also fell by 2.3% in September. The two reports were in contrast to the last week’s more optimistic data on starts and existing home sales. Case-Shiller pricing data showed steady prices, a 5.1% year-on-year gain next to the previous month’s 5.0% (revised down to 4.9%, but then this month may suffer the same fate).
Consumer sentiment measures have little value as leading indicators, but the October decline in consumer confidence did suffer a sharp decline, from 102.6 to 97.6, while the University of Michigan sentiment measure eased from 92.1 to 90, the latter continuing a downward trend from its summer peak. The surveys might point to trouble for the October jobs report that is due this Friday (consensus 190K), as well the weakness in the personal income report for September, 0.1% versus an expected 0.2%, with identical results in consumer spending – and yet strategists up and down the street are talking about how strong consumer spending is, so don’t worry about GDP!
Next week has the all-important jobs report on Friday, as noted above, along with the ISM manufacturing survey on Monday and the non-manufacturing survey on Wednesday. Construction spending for September is alongside the ISM report on Monday, factory orders are Tuesday, along with October auto sales. Jobless claims have been steady, but everyone will be curious about revisions, if any, that come in the October jobs report, along with the usual obsession over the headline total.