Heading Home for the Holidays

“But I heard him exclaim, ‘ere he drove out of sight, “Happy Christmas to all, and to all a good night!” – ” ‘Twas the Night Before Christmas,” attributed to Clement Clarke Moore

No, last week wasn’t much of a Christmas present, but no, it didn’t mean all that much either. After the obligatory rally in response to the Fed’s monumental raise of the funds rate to a staggering one quarter of one percent (0.25%), stocks sold off sharply the next two days.

However, the selling had less to do with the market’s verdict on the Fed and more to do with a generally feeble market running into selling from Europe. Most European institutions were closing their books for the year on Thursday – little to no work happens on the old continent next week and Thursday was a good day to get a head start on vacations – and were quite happy to take advantage of the bounce in prices. Selling begat selling just as buying begets buying, and the day wiped out all of the prior day’s big gains, though the down volume was less than the up volume had been. That changed on Friday, when a modestly heavier day of selling administered the coup de grace to the week.

Going into last week, the options positions had favored a close of either 200 or 210 for the widely traded S&P 500 ETF, the SPY. Based on the Fed meeting and outstanding positions, I had thought 210 more likely, but Thursday’s selling seriously weakened that case when the SPY closed just below 205. When further European selling hit on Friday morning and left the SPY narrowly above 200 at the European close, the path of least resistance was down and the last fifteen minutes magically moved towards the 200 mark.

Such selling doesn’t occur in isolation, though it is something of an annual event – December expiration moves tend to be large and somewhat trend-independent. Still, one cannot claim that there was much buyer enthusiasm to greet the selling. Such enthusiasm hasn’t been seen a lot lately, in keeping with the lack of growth in profits and the economy. Keep in mind, however, that trading desks tend to go with the flow at expiration time rather than fight the tide, so I would not be surprised to see the SPY right back at 210, possibly higher, by New Year’s Day. Just as there weren’t many buyers around last week to face the selling, in the last two weeks there won’t be many sellers left to greet the buyers. Stock indices may yet finish the year on a positive note, even if prices have to be dragged across the finish line.

Oh yes, there was a Fed meeting last week and the long-delayed rate increase, the first in nearly nine years, finally came to pass. I found Janet Yellen’s Q&A meeting with the press to be interesting for its contrasts. On the one hand, the Fed chair stood stolidly behind the economy, projected to rise next year (as usual) from a GDP rate of 2.1% this year to 2.4% next year, proclaiming it to have “shown considerable strength” and blaming weakness on the dollar and trading partners abroad.

On the other hand, the chair made several references to the need to have some more ammunition on hand, e.g. “with interest rates at zero, we have less scope to respond to negative shocks than to positive shocks.” That stood in contrast to remarks only a few days prior by former Treasury Secretary Larry Summers, the one-time favorite to succeed Ben Bernanke as Fed chair, rather than Janet Yellen. Summers’ candidacy, once seen as a sure thing, sank when a groundswell was reborn about remarks he had made about women as perhaps not quite as suited overall as men at mathematics (it was one of several off-the-cuff speculations he made on the subject, including lack of encouragement and interest). Those remarks cost him the presidency of Harvard and then his shot at the Fed chair (and people wonder why coach Bill Belichick never says anything of substance at all), and you can be sure that Janet Yellen is very aware of both the remarks and his days-earlier ridicule of the notion of raising rates. Indeed, Summers kept up his criticism in the aftermath, calling both the raise and the premise a mistake.

It’s an interesting topic of discussion – personally I favor the reload position, though it should have been done a year ago and I don’t know if either course could have succeeded in freeing the Fed from taking the blame for the impending end of the business cycle. But end it will, and the rate raise will have had nothing to do with it. I am at least partly in the same camp as veteran floor trader Art Cashin in believing that the Fed will be back to zero before it ever gets to one percent.

Even so, the Santa Claus rally should still arrive, though the true period begins the day after Christmas and runs until two days into the New Year. Whatever it does,I wish all and sundry a very Merry Christmas!

The Economic Beat

While the event of the week was the Fed’s little rate bump, the news from manufacturing shouldn’t go unnoticed. The New York Fed manufacturing survey started the week off on Tuesday with its fifth down reading in a row, this one at (-4.59), though it was actually above consensus and not as low as November (-10.74). The internals of the report included continued weakness in new orders (-5.07) and employment (-16.16). The New York report is not given the same attention as the older Philadelphia survey, which followed up two days later with its own negative reading of (-5.9), below both November (+1.9) and consensus estimates for a slight positive. New orders continue to show weakness, at (-9.5).

The Markit purchasing “flash” surveys also showed weakening, with the manufacturing number edging down to 51.3 and the services index fading to 53.7. The Markit indices are relatively new and don’t have the market impact of the long-established ISM surveys, but they have also been running consistently higher, leading some to interpret the numbers as harbingers of weaker ISM readings for December. On Friday, the Kansas City regional survey dropped sharply back into negative territory, from +1 to (-8).

All of the surveys are diffusion numbers, so we don’t know how much depth is behind the drops in activity. The industrial production report for November wasn’t good either, however, with a broad decline of (-0.6) that reflected big weather-related drops in utilities (-7.6) and mining (-8.2). However, other important categories were also weak nearly across the board, including manufacturing (unchanged) and consumer goods (-0.5). The only bright spot was business equipment, at +0.2. The year-on-year comparison for the total index is (-1.2), with manufacturing at only (+0.9). Ah well, it’s only transitory factors at work, right?

Inflation data did provide a bit of support to the Fed rate raise, as the latest consumer price index (CPI) shows a year-on-year increase of 2.0% for the so-called “core” rate that excludes food and energy. The total change is only 0.5% year-on-year and 0% in November, reflecting lower energy prices (which also bleed into the cost of food production). Still the 2% reading lines up nicely with the Fed’s target inflation rate (also 2%) and had to provide some comfort for the committee.

The news from housing was positive, with a drop in the sentiment index to a still-strong 61 belying a good report on housing starts that had both starts (1.173mm annualized adjusted rate) and permits (1.289mm) above consensus. The year-on-year rate for starts is still north of 10% and may gain a little bit with the warm weather, despite the lower reading in the sentiment survey that would normally have me expecting a downward revision to the starts data. The latter led to an upward revision in the estimate for current GDP to 1.9%.

The December 21st week starts slowly and ends early, with the stock market closing at 1 PM on Thursday for a long Christmas weekend. Most of the data is packed into Tuesday and Wednesday, with the first report of note being the latest revision to third-quarter GDP on Tuesday. Little change is expected. Existing-home sales arrive on Tuesday morning followed by new-home sales on Wednesday.

On the factory side, the Richmond survey is Tuesday morning and the initial estimate of November durable goods data comes on Wednesday, along with an estimate of the month’s personal income and spending. Christmas Eve will feature the weekly jobless claims report. Have yourself a merry little Christmas!