Janus Looks the Other Way

“He that can have patience can have what he will.” – Benjamin Franklin (ed.), Poor Richard’s Almanack

We escaped, sort of. Friday’s bravura rally in equities removed the month of January 2016 from the “worst ever January” distinction, and it is now only the worst January since 2009, a lugubrious time indeed for equities. I’d call that cold comfort, but the warming trend in New England that accompanied the month’s final weekend makes the phrase seem somehow out of place.

When writing about the first month on the calendar, over the years I have often employed the metaphor of the ancient Roman god, Janus, the two-faced god who gave the month its name and is usually depicted as looking in both directions. This year seemed a very good fit indeed, with the market falling out of bed from the moment the page turned on the calendar, and then finishing the month with an outsized rally. The weather turned as well, with last weekend’s freakish snowstorm in the mid-Atlantic region giving way to fifty-degree temperatures in New York City at the beginning of February.

Okay great, you may think, a nice fit for the writers of investment letters, but what does it mean for the stock market? In that respect, it’s useful to reflect on the worse-behaving cousin of seven years ago, January 2009. That particular edition came in the final months of the last bear market, a most fearsome one, while the more recent January arrived in what may or may not have been the early stages of a new one – the verdict is still out.

One bad month does not a bear market make, but there are some interesting parallels to think about. The last bull market made its high in October 2007, but you would have found little support in the investment community for the belief that we were in a bear market until Lehman Brothers failed nearly a year later. Indeed, the last recession is said to have started in December 2007, but the summer of 2008 was marked by heated denials of any such thing. Bull markets die in euphoria, it is often said, but it might be better said that bear markets begin in denial, for the euphoric stage of equities usually comes many months before it starts to become apparent that anything is wrong. That phenomenon in turn feeds the denial stage – how can the bull market be ending if nobody is feeling euphoric?

I can’t argue with the euphoria part, since only people short the market are feeling that way these days. Better to forget such bromides, anwyay – nobody was feeling euphoric in September 2008 either, with the worst of the bear market still to come. Similarly, denial alone is no reason to buy or sell – the current bull market has been accompanied throughout by denials of its possibility, and bear markets are not brought into being by some conjurer’s trick of refusing to acknowledge that there could be one. If only investing were so easy.

Think about these few things instead, beginning with earnings. As of Friday, FactSet was estimating an earnings loss of (-5.8%) for the S&P 500′s fourth quarter, with 40% of its companies having reported. That number should improve as most companies inevitably beat estimates, but the deficit is too great to make up now that we are entering February. It will mark the first time since 2009 that we have experienced three negative earnings quarters in a row, an episode that came during a recession. The declines are far, far milder this time around, but they are still declines, and that is no foundation for a bull market in equities. Last week’s rally had more to do with short-squeezing and the Bank of Japan’s efforts (negative interest rates) than profits.

The second thing is the economy. The first estimate of real fourth-quarter GDP (about which more below) is 0.7%, a weak number that is weaker than it looks, with no bad weather available for blame. The rate of nominal GDP growth – that is, GDP measured in current dollars – fell throughout last year. Consider that the price deflator used to calculate Q4 output fell to 0.8% from 1.3% in Q3. Had it remained constant, real GDP growth might have been but 0.2% in the quarter. I have seen a steady stream of reports citing the 2.4% GDP estimate for 2015 as evidence that the economy is steady, unchanged from 2014 (also 2.4%), but the price index fell over the period from 1.6% in 2014 to 1.0% last year, masking the drop in nominal output. Indeed, the report itself called attention to the changes in the price deflators, along with the reality that the rate of growth in four-quarter real GDP was only 1.8%. No doubt I’m not looking in the right places, but I’ve yet to see reference to those facts.

0.7% is only the first estimate of the quarter, it could be revised in either direction, and the stock market doesn’t track GDP very well, often not at all. But numbers this weak this late in the cycle should cause you concern. The stock market does track recessions.

The final thing to think about is the current state of the market. Technically it is still oversold – obviously less so after Friday – and individual bearish sentiment is still high. Mark Hulbert, a well-known tracker of investment newsletters, wrote that the best-performing letter-writers are overall bullish, at least for now. Even if a bear market has started, there are grounds for prices to recover some of their losses. Markets rarely start bear markets by falling every month (though it can and does happen), and that terrible January of 2009 came in the final months of the last bear market, typically the time of the worst damage, a.k.a. capitulation selling. We aren’t close to that stage now.

More central bank dovishness cannot repeal the business cycle, but it could lift prices for a time. February’s empty Fed calendar will at least mean that the central bank cannot disappoint this month with a lack of dovishness, as it did last week. A lot of momentum will hang on Friday’s jobs report, about which I have no prediction, but a benign one would ease the way higher. Perhaps it’s best to emulate Janus for the time being and look both ways, for good years in equities rarely begin with a January so weak.

The Economic Beat

The week led off with a regional Fed report that doesn’t often get much attention, but did on a day when oil prices were sinking again. The energy-centric Dallas Fed survey has been putting up negative numbers ever since oil began tumbling, but the January reading of (-34.5) was spectacularly low (0 is neutral), the lowest reading in nearly seven years (April 2009). Equally stunning was the pronounced flip in the production index. It had not been negative for some months, unlike the general index, but collapsed from +12.7 to (-10.2). The outlook also fell into negative territory for the first time in seven years, though it ought to be said that being a measure of sentiment, the outlook tends to lag changes rather than lead them (consumer confidence rose again last month). Fears of oil-related bankruptcies and credit-market damage took center stage again.

The Dallas survey was echoed somewhat in the Kansas City Fed manufacturing survey, which reported a second consecutive reading of (-9) in January. It isn’t widely followed and was overshadowed anyway by a miserable durable goods report that showed a 5.1% decline in new orders from December. Ex-transportation, the loss was 1.2%, ex-defense, down 2.9%. Business cap-ex spending had the lowest (-7.7%) year/year comparison (Dec. 2015 vs Dec. 2014) since 2009. Shipments dropped by 2.2%, weighing on the first estimate of fourth-quarter GDP the following day.

That report wasn’t exactly robust, with the initial estimate coming in at 0.7% seasonally adjusted and annualized (SA), just below consensus estimates of about 0.8%. The number was helped along by the drop in the price deflator from a 1.3% annual rate in Q3 to a 0.8% rate in Q4; the estimate for the quarterly nominal rate was only 0.38%, the lowest rate since the weather-beaten rate of Q1 2015. Four-quarter GDP fell to 2.9%, which – if it holds – will be the lowest rate since the ice-bound second quarter of 2013. There’s no weather to blame this time around either, except for disappointed winter clothing retailers (skiing is down in New England, but it is well up in the Western states).

A little after GDP on Friday came the volatile Chicago purchasing manager index. When the report was in the public domain, it was widely followed as perhaps the best precursor to the national number due this Monday. Since it’s been private (it was purchased by an investment bank), the data are not only not readily available for analysis, they’ve been all over the road. Last month the index plummeted to a very low 42.9 (50 is neutral), but in January it staged a spectacular rebound to 55.6! The increase is surely good news, but the market just isn’t taking the numbers as seriously anymore.

The housing market is fine (it certainly helped Q4 GDP), with home prices showing no distress, Government and private surveys are showing annual gains of just under 6% for existing homes. Pending home sales showed an easing off with a meager gain of 0.1% and a downward revision to the previous month, but the pending data hasn’t been matching up well of late with the older sibling that it’s supposed to predict, existing home sales.

The pace of new home sales took a jump – maybe – in the December estimate, to a seasonally adjusted, annualized rate of 544,000. I say maybe because the initial estimates around the turn of the calendar year have been prone to big swings and big revisions later for several years now. The rate has been gaining steadily notwithstanding, and the actual annual rate was nearly 500K (499K) after the December estimate. That’s still low by historical standards, but improvement is always welcome.

The weekly data on retail store sales has been getting worse every week in January, leading me to think another low reading is in store for the month’s retail sales report in two weeks time. The employment cost index came in with a high reading (+0.6% for the quarter), but the year-on-year rate is still only 2.0% and is very likely within a quarter or two of its cyclical peak. Weekly claims settled back to a 278K rate (from 292K), but the report had an ominous note: it was the first week in about five years to show a year-on-year gain, rather than decline. I will be scrutinizing this report in coming weeks.

Next week leads off with the aforementioned ISM (national purchasing) manufacturing survey (personal income comes first, but the GDP report has already estimated the headline numbers). Last month’s number was 48.2, but should it follow the direction of the Chicago survey back over 50, it would give stock prices a lift. Given the volatility of the former and the weakness in regional Fed surveys, though, it’s probably best to eschew any predictions. We’ll also get the monthly construction spending report. The ISM non-manufacturing, or services report, follows on Wednesday.

The main release will be the jobs report on Friday, with the ADP report on Wednesday making last-minute adjustments to expectations. Forecasts have been moving back down to the 200K level and below (from last month’s 292K), and the slightly higher run-rate for weekly claims (year-on-year) might be an influence in that direction. The January number is a highly adjusted one and the BLS report is slow to capture changes in hiring patterns, but the markets hang on them anyway. Consumer confidence rose to a very high 98.1 in the Conference Boards survey last month, a positive indication for jobs but not one to bank on – the University of Michigan sentiment survey eased slightly.

In between we’ll get factory orders on Thursday, which should provide more clarity on which industries were getting hurt the most in last week’s data on new orders for durable goods. New-car sales for January will come out the first few days of the week, and the December international trade report is due on Friday. The goods portion of the report last week showed exports falling as imports stayed flat, pointing to more pressure on Q4 GDP estimates.