April Showers

“Year after year, spring can’t help seeming younger.”- Wang Wei

Stock prices seemed to be walking through the park last week, but it wasn’t quite May yet and the rain came. A combination of so-so data, profit-taking and Carl Icahn’s warning about stocks (not comfortable) and Apple (APPL), which he no longer owns, ended the month on a two-day sell-off. That isn’t so unusual for April, but it did lead to a weaker-than-usual performance for the month. It took a patently contrived move in the closing hour on Friday to bail the S&P 500 and Dow Jones out into barely positive returns – the Nasdaq didn’t quite make it.

Oddly enough, the market had already worked off its overbought condition, setting it up for a run to the old highs. It’s a run that would make a lot of market watchers (and investors) uncomfortable, because the higher the altitude the farther the descent. However, Icahn’s warning was the signal profit-takers were waiting for, and the calendar had shifted away from green light to yellow light.

When markets are climbing a wall of worry, they are usually anxious over externalities or their own ascent – that something bad or vaguely bad might happen. geopolitical events, earnings slowdown, buyer fatigue and so on. When geopolitical disasters fail to materialize – and most of them don’t – then the markets can feel justified and rally further. The same goes for earnings season, which sometimes sees outsized rallies on any earnings growth at all. The catch is that they need to be showing some growth. Let me reemphasize that – some growth. It can be weak, so long as it is properly beating lowered expectations. An outstanding example of this was the end of 2006, when the economy was beginning to slow. The market worried about third quarter earnings and they did indeed come in weak with domestic revenues showing no growth, but earnings were positive, they did beat expectations, and so markets took off again on the chant of “global growth.”

When it’s early in the business cycle, worries are usually buying opportunities, so long as there is no double-dip recession. However, it’s quite late in the cycle now and the current wall of worry has been the usual late-cycle stuff: The patient may be dying, but so long as there is a pulse a kind of defiance can reign, even more loudly when there have been a couple of cardiac arrests along the way (we’ve had two 10%+ corrections in the last two quarters).

Think back, if you can, to the year 2000, when the S&P 500 defied the collapsing Nasdaq for months – after all, the latter was just undergoing a healthy correction – healthy, mind you! – in the dot-com sector (so the conventional wisdom went). In August 2007, first the Bear Stearns credit hedge funds blew up, and then Bear Stearns itself was thrown to the wolves the following March. All during the year, housing was undergoing a healthy – healthy, mind you! – collapse. Ergo, there was no market anymore for the mortage-related paper the credit hedge funds were holding. Despite the huge warning, the stock market rallied to new highs in October – after all, the Fed cut rates so what was there to worry.

There won’t be any credit hedge funds blowing up this time, there isn’t a dot.com bubble and the national mortgage market isn’t insane again, so what’s to worry? Plenty. Sectors in the financial economy are overextended, we are drowning in a sea of government debt around the world, central banks have run up massive balance sheets, and in our real economy the business cycle is ending. Manufacturing has been declining while consumer spending has come to nearly a halt. The last nail in the coffin will be employment, a lagging indicator showing indications that the growth is nearly over. When employment changes this cycle, I suspect it will change suddenly and be accompanied by the usual denial. Some sector will come apart and of course the market will say it is healthy until everyone knows it isn’t. Hang onto your umbrella and don’t buy into this rally.

The Economic Beat

The Fed did nothing again and issued another statement that seemed to say the same. Two days on, you could find plenty of disagreement over whether the statement was more hawkish (inclined to raise rates) or dovish (inclined to bury heads in sand). In short, the Fed deferred further action until some magic moment, worried a shade less about the global economy and a shade more about the domestic one, and proclaimed itself ready to move quickly in a data-dependent day if the data are ever clear enough, which of course they aren’t. Many are betting that the Fed isn’t inclined to move until after the election, and they may be right, but it ought to be allowed as well that a 0.5% annual rate of GDP in the first quarter – released the next day, but surely available the day before to members of the FOMC – is hardly good grounds for raising interest rates.

The GDP rate was immediately set upon by bulls as being subject to the usual first-quarter weakness and dismissed in favor of the second quarter rebound. Yet the four-quarter rate of nominal GDP has been stable the last three quarters now, running between 3.0% and 3.2%. During the last two years, we had grounds for expecting a weather-related rebound, but the winter just past was a mild one. In fact, the milder weather has contributed to much better start for new housing construction this year compared to the last couple of years. That doesn’t necessarily imply a drop-off in the current quarter, but there is no reason to expect a sharp rebound either – there isn’t anything for the sector to rebound from.

New home sales for March and pending home sales data for April were both quite steady. The trailing-twelve-month (TTM) rate for new home sales has slowly climbed to about 500K and has remained there for the past four months, with the latest rate 502K (pre-revision). Pending home sales were up about 1.5%, in line with recent existing home sales. Home price appreciation has also been stable, at least as measured by the Case-Shiller index, which has been in a range of about 5.4%-5.6% for months. The latest rate is 5.4% through February, though the spring selling season should push the rate back up a couple of ticks.

Some of the early April manufacturing survey data looked hopeful, but then tailed off in the latter part of the month. Dallas (-13.9) and Kansas City (-4) continued last week with contracting readings, while Chicago (50.4) disappointed with a neutral reading. Only Richmond (+14) was good. The national survey (ISM) is due on Monday.

International trade in goods for March reflected imports (-4.4%) falling faster than exports (-1.7%), actually a plus for GDP but a warning about consumer spending, up only 0.1% in the March personal consumption expenditure (PCE) category tracked by the Fed. Income was up 0.4%, with real disposable income up 3.1% year-on-year and real spending up 2.6%. Income jumps around a bit with 3.1% about the middle of readings over the last six months, but spending has downshifted from the 3% level. Weekly jobless claims remain stable at low levels.

Next week begins May and so is a busy one, with the ISM survey kicking things off on Monday. It’ll be accompanied by March construction. Wednesday is full, beginning with the ADP payroll report and March international trade (includes services), productivity for the first quarter, and then factory orders and the ISM non-manufacturing survey. Friday has the all-important jobs report, with consensus sitting at an easy-to-beat 200K.