Breathing Spell

“They that stand high have many blasts to shake them.” – William Shakespeare, Richard III

That was a struggle. After the worst beginning ever for a new year in equities, a bit of dovish talk from European Central Bank (ECB) president Mario Draghi poured balm on a very oversold market and helped prices end a three-week losing streak.

There was help elsewhere, with a mostly benign economic calendar (see below) offering no fresh horrors, and mostly positive (relatively speaking) earnings reports, IBM prominently excepted (an earnings beat, but guidance was cut). The earnings estimate beat rate is currently running at about 75%, above average if not remarkably so, though the estimated decline for the quarter, which usually begins to rise as earnings come in, actually declined last week to (-6.0%), according to FactSet. Analysts must be feeling more pessimistic than usual.

The coming week is the biggest one for earnings, with only about 15% of the S&P 500 having reported thus far. It’s a curious and unusual thing that market commentary and chatter has remained largely focused elsewhere, with attention dialed in above all on oil prices, China, and central bank policy. The last is hardly any surprise, given the market’s preoccupation for the last few years. Worries about China may not seem new either, as anxiety over the Middle Kingdom’s “true” rate of growth has been building for months and may seem to many like another episode of undue worries about afar, the way markets have periodically obsessed over the state of the European Union (EU) and the chances of its more wayward members (Greece, Spain, etc.) wandering off into some form of Armageddon or another.

The real economic problems of Greece cannot be fixed by edict alone, but the questions of the country’s official creditor and membership status were indeed resolved (temporarily, at least) by political will alone, and the EU lived to fight another day. China’s problems cannot be fixed by edict either, though considerable hope remains here and abroad that just such an arrangement might be feasible. The country is hardly suffering and there is some justification for criticizing global reactions to its stock market turmoil and policy lurches as being overly dramatic. In another time and place, they might indeed be so, but in a world of slowing growth and elevated valuations, there is little room for error. People living in a dry forest are right to fear the mildest of sparks.

In 2008, when oil prices were inexorably headed towards $200 a barrel and the “peak oil” theory was all the rage (weren’t we supposed to be running out by the end of the current decade?), every minor event was fuel for the momentum trade. Refining oil is a dirty, dangerous business, with many shutdowns both scheduled and unscheduled for maintenance and repair, yet in the exaggerated summer of 2008, the mere rumor that a refinery worker may have called in sick seemed sufficient to stoke the rally.

In the event, prices never rose to $150/bbl. Some seven years later, “peak oil” is a sardonic joke, the globe is awash in oil and we are headed inexorably towards $20, with bankruptcies galore predicted. The latter has some basis in fact, as veterans can remember that the soaring oil prices in the wake of the 1973 OPEC embargo led to Texas banks first gorging on energy lending, then going belly up in the 1980s.

No doubt there is more pain ahead for oil people, and if the economy does slip into recession this year, as I expect it to do (though certainty is not a luxury I indulge in), it will only add further downward pressure on demand and prices. In the end, the old maxim about the cure for lower (higher) prices being ever lower (higher) prices should prove true, as supply and demand adjust and the pendulum reaches the end of its long arc. Perhaps they will approach $150 again in another ten or fifteen years.

In the near term, however, producer countries are going to feel some pain, and that includes the U.S., which is much more of a producer country now than it was in the mid-1990s, when oil last bottomed. Oil-related industrial activity was one of the few bright spots of the post-recession cycle (we couldn’t outsource it, fortunately), and oil-related contraction may be part of what tips the fading cycle into recession. All cycles must end anyway, but oil might be behind the final straw this time.

For now, the market remains quite oversold on both a short and medium-term basis. Some bounce is to be expected, though I wonder at its durability. Expect more central bank help at some point over the next coming months that should help revive flagging financial markets, but keep in mind that monetary policy cannot repeal the business cycle and at best will only cushion the fall this time around. If it’s any consolation, the final fall may yet be many months off.

The Economic Beat

The highlight of the economic tape last week was Draghi’s signal about increased monetary accommodation being in play. For economic releases, it was probably the existing home sales report, which beat expectations – not a common feat these days for economic data – with a very outsized December increase that was nearly 15% higher than the month before. Experience suggests a downward revision may be in store, but there was some good reason for the increase: Sales leading into December had been stymied for a time by new rules for closings and loans, and so a catch-up had been expected.

The big sales bump swung the year-on-year rate from a loss of nearly 4% to a gain of 7.7% (prices are up by almost the exact same amount), though some caution ought to be used before pronouncing the gains to be definitive. The blizzard of delayed closings surely had some effect on the initial estimate, though it ought to be acknowledged that the ultimate impact is still unknown – the possibility of upward revisions to November and December cannot yet be excluded either.

The report was part of a series of benign housing reports during the week, beginning with the homebuilder sentiment index that came in with a reading of 60 (anything above 60 is quite strong). It was followed by a report on December housing starts that showed starts a little below consensus and permits a little above; given the estimate error and the overall trend, I’d say starts remained largely on trend. The data get revised for some months afterwards, but the current estimates of gains for total (+10.77%) and single-family (+10.44%) starts in 2015 ought to largely hold up somewhere between 10% and 11%. Moderation in the rate of increase should be expected going forward, indeed the strength of 2015′s gain was built on a more modest 2014.

The Philadelphia Fed survey on Thursday beat expectations by being not as bad as expected, and that was of some help to the market’s mood. It would certainly be a mistake to call the January reading of (-3.5) a good one, and a fifth consecutive negative shouldn’t be overlooked, but it was still better than expected, miles better than recent New York Fed surveys, and at least pointing to leveling off in the pace of adjustment. New orders returned to a nearly neutral reading of (-1.4) and shipments had a positive response for the first time in months. December, unfortunately, was revised downward to (-10.5).

In other reports, the Chicago Fed’s national activity index 3-month average fell to (-0.24), which while not good, is still far from the recession level of (-0.7). The pace of weekly retail sales continues to soften, pointing to potential trouble ahead for the January retail sales report. Leading indicators actually declined, despite the artificial yield curve (which is why the market pays it no attention anymore), and weekly claims spiked upward. It was only one week and no disaster, but claims are far more sensitive than the monthly jobs report and many eyes are watching the report now for signs of any weakness.

The highlight of the coming week is without a doubt the FOMC meeting on Wednesday, and while no action was ever expected, market participants are now hopeful of seeing signs of a more relaxed stance, given the global market turmoil.

It will be a busy week besides the FOMC. The Fed banks chip in with regional reports from Dallas (Monday), Richmond (Tuesday) and Kansas City (Thursday), and another regional report comes Friday from the privately managed Chicago purchasing index. The rest of the month’s housing data will come through with price data on Tuesday, new home sales on Wednesday and pending home sales on Thursday.

Two big data points are the December durable goods report on Thursday and the initial estimate of fourth-quarter GDP on Friday. The Atlanta Fed estimates the current run-rate for Q4 GDP to be 0.7%, based on published data only (i.e., no estimate is built in) – the reports on new home sales and durable goods could push the first estimate in either direction. Presumably the FOMC will have had access to something very close to Friday’s figure. It’s hard to imagine it will be much better than 1%, but the final tally is still months away and could vary considerably from Friday’s release. Data on international trade round out the week that morning.