“At length the Man perceives it die away, and fade into the light of common day.” – William Wordsworth, Ode: Intimations of Immortality
I‘m afraid I have little that’s new for you this week. The highlights of last week were a market that did nothing in a very not volatile way, and a speech by Fed chair Janet Yellen that had the same effect. Yellen’s speech – which you can find here - was successful on one count, at least, in that it seemed to spawn an about equal number of analyses that triumphantly announced that the central bank was determined to raise – or not raise – rates for as long as necessary. Both options were hardly unreasonable, given the amount of waffling in the speech.
Another quarter of profit declines is in the books, spending and investment rates of all sorts are down, but none of that is going to matter until one of two things happen: the jobs reports begin to further sink, or the Fed raises rates. The Fed and the stock market both are clinging to the notion that job growth is strong and is all that really matters. I fear that said growth is being overstated, and that few (as usual) are heeding the admonition that employment is a lagging indicator, but the good news is that it may yet be a number of weeks or even months before the game is up.
Ms. Yellen’s speech said very little, despite all the articles that tried to extract some hidden meaning. The economic outlook is for more of the same. If things stay on course (presumably that means jobs reports and not GDP), then the Fed may raise interest rates one day. On the other hand, if things don’t start to get better, they may not (yes I know that’s a contradiction, but that’s the way it goes these days). At any rate, everything the Fed has done in recent years has been perfectly correct.
All of this torpor and prolonged accommodation by the Fed and other central banks has contributed in a different way to a recurring phenomenon, that of investors and traders becoming more and more aggressive with exotic ways to make money as a business cycle ages. Negative and ultra-low interest rates have led to all sorts of exotic combination trades involving currencies, swaps, derivatives, etc,. and as they succeed they attract more and more imitators. But there is no new plateau of eternal stability, and when some instability does come, as it always will, these trades get upset. Leveraged trades that were heretofore the work of genius quickly become spectacular losses and the rush for the exits gets ugly.
Such behavior is one of the main reasons the Fed has raised rates as a cycle gets old, not to kill it off – because that takes a very high level of rates – but to keep crazy trading from getting out of hand and thus creating a bigger disaster when the cycle ends.
In this cycle the central banks have been paralyzed with fear of upsetting markets, and one unintended consequence of the accompanying prolonged accommodation has been the gradual rise of a another mountain of positions that will collapse in a very ugly way when bad weather comes. The Fed thinks a very richly valued stock market is an endorsement of its success, so long as the richness doesn’t start to become another tech bubble (a monster that will not reappear in our lifetimes). Today’s stock market levels in the face of a prolonged skein of declining earnings and profit growth that comes from a listless economy are actually a huge warning that things have gotten quite out of hand in the financial markets – but each Fed board never seems to understand the problem in front of it until it’s too late. Enjoy the last days of August.
The Economic Beat
The report of the week might have been the first revision of second-quarter GDP, but for the fact that at 1.1% (seasonally adjusted and annualized) it was exactly on consensus and showed very little change from the first read of 1.2%. The decline was not in nominal output, virtually unchanged at a seasonally adjusted and annualized rate (SAAR) of $18.436 trillion from $18.437T in the first estimate, but in the price deflator, revised upward from 1.9% to 2.0%, and thus lowering the headline real (inflation-adjusted) number for GDP. The latest estimate of second-quarter profits was a decline of 2.2% following a 2.3% decline in the first quarter. Yes, Ms. Yellen, the economy is booming.
The reaction to new orders for durable goods in July typified the kind of schizophrenia that dominates the market these days and the dogged determination to avoid noticing the fact that the emperor is indeed without any clothing. Here’s how Econoday summed it up, “the factory sector…is now definitely showing some life” and “the strength includes core capital goods, where orders jumped 1.6%.” Overall new orders rose 4.4% on a seasonally adjusted basis.
But all of the positives were in seasonal adjustments, and when one looks at the year-on-year trend the news is definitely worse. Last month’s year-year total was revised downward from (-6.4%) to (-6.6%) and the prior month down from (-4%) to (-4.2%) on a seasonally adjusted basis. The big swings in the headline numbers are due to orders for commercial aircraft, orders that take years to ship and that often get cancelled in the next downturn. Business capital goods orders were not at all good: July 2016 was 2.4% lower than July 2015 (not adjusted), down from a 2% y/y decline for June, and the year-year rate swung substantially lower from (-3.5%) to (-4.9%). The trailing twelve-month rate is (-4.1%) on an unadjusted basis.
As for new life, well, the New York Fed manufacturing survey had already been negative the week before, with an unchanged reading for Philadelphia and new orders negative in both surveys. Last week Richmond (-11) and Kansas City (-4) reported similar results, with new orders posting eye-popping declines in Richmond (-20) and (-7) in Kansas City. That factory sector is really humming along. Next week will bring the final verdict, with Dallas on Monday, Chicago on Wednesday and the national survey (ISM) on Thursday.
The big report of next week will of course be the August jobs report. Weekly claims data have been steady and although JOLTS data has showed some hiring weakness, I suspect that the August report will be at or above the consensus (175K). The seasonal adjustment process involves more guesswork than usual at this time of year, so there may be payback waiting for us down the road. That said, if the number is over 200K, don’t expect anything but adulation from the stock market.
The rest of the week kicks off with July personal income and spending on Monday, the ADP teaser report on Wednesday and construction spending on Thursday. Housing chips in with Case-Shiller price data on Tuesday and pending home sales on Wednesday. The only report that will matter to prices for stocks in the S&P 500 is the one on August jobs.