Safety in Numbers

“If everyone is thinking alike, then somebody isn’t thinking.” – Gen. George S. Patton, Jr.

Risk on, risk off. Is it time to sell, or time to buy? Was that a head-fake up, or a head-fake down? It’s all very much end-of-cycle behavior, as an overvalued stock market advances solely on multiple expansion (another way of saying prices are going up while earnings don’t). The markets retain a hard core of loyalists, but as the number of prominent doubters grow, the real support for prices comes from an aversion to looking silly by selling early. Better to look silly later for not having sold, because then everyone else will be looking silly at the same time.

An enduring feature from cycle to cycle is the proliferation of articles from asset management firms that reluctantly acknowledge that times could certainly be better, but you never know, maybe someday they will get better and so we better stay fully invested (e.g., this latest quarterly from Russell Investments). You want to be able to say after the fact that of course we knew stocks were expensive sir, why just look at this report we issued before the fall, but we had no reasonable way of knowing that (fill in the blank) was about to happen.

And so we soldier on, one bad report away from the beginning of the end. There are plenty of candidates, starting with the possibility of a weak jobs report this fall and stretching across fears about banks (last week and Deutsche Bank (DB), for example), countries (China, Great Britain, Italy, Greece, and so on), central banks, elections et cetera. The irony of these known fears is that each time one is averted, or doesn’t visibly and quickly end in disaster (e.g., Brexit), prices will rise in reaction because the worst hasn’t happened yet.

Over the weekend I was chatting with a high-net-worth portfolio manager who was of similar mind – acknowledging that the warning signs are all around us but observing that these nothing periods can go on longer than one would expect. It’s not uncommon. Then there’s the new clever little word ploy that involves quietly redefining “trend” growth as something between 1.5% and 2%, so any blip above that is “above-trend” growth. When did this happen? Maybe when the FOMC shifted its 2016 GDP projection last week to 1.8%.

I still see rosy predictions that Q3 growth will be above 3%, yet retail sales have been running at stall-speed for most of 2016 and it looks like September is going to be another down month, with an implication that third-quarter year-on-year growth will be the lowest since 2007, when it was the last quarter before the last recession. Third-quarter growth forecasts have already come down from over 3.5% at the beginning of the quarter to 2.2% (both the NY and Atlanta Fed), and that is before the September retail spending data is known. It looks to me like we are headed for another below-2% quarter, so maybe anything above that is trend. But remember, if it’s 1.9%, it’s still “above-trend,” because the Fed said 2016 looks like 1.8%, so that’s the new trend, my friend. Hey, have you seen the emperor’s slick new robe?

I’m sticking with my volatility forecast for the month of October. It will doubtless be influenced by election developments, Brexit developments, Deutsche Bank developments, and then in about ten days we will get the beginning of third-quarter earnings season. Buckle up.

The Economic Beat

The week led off with August new-home sales, with the sector continuing its good showing this year, up about 13.6% (unadjusted) year to date. The annualized adjusted rate fell to 609K from 659K in July. The market for existing homes continues to ease, with the year-on-year gain in the Case-Shiller index slowing to 5.0% in July from 5.1%, and pending home sales in August declining by 2.4%.

The manufacturing sector continued its struggles, though not without one minor bright light: although the Dallas Fed survey turned in another negative number overall, (-3.7 with a neutral level of 0), a rare positive number was in production, rising from 4.5 all the way to 16.7, doubtless in response to firming oil prices. Richmond was also in negative territory, with a minus 8 reading for September coming after minus 11 in August. Like Dallas, employment readings were negative. Chicago, a private sector survey, did turn in a positive number, rising to 54.2. Finally though most importantly, new order for durable goods in August were unchanged, though down by 0.4% excluding transportation, (-1.0%) excluding defense, and posting yet another year-year decline in new orders for business capital goods (-1.3%), making it 13 months in a row. Somehow the last category became positive when seasonally adjusted.

The final stand-alone revision for second-quarter GDP was released, with the real GDP rate rising to 1.4% from an earlier 1.1%. As has often been noted here, very small dollar amounts can lead to big swings in the annualized adjusted result – the important number to know is that four-quarter nominal GDP rose from 2.43% all the way to 2.57%, or 14 basis points. The difference is close to negligible, though it won’t stop the usual gang of spin merchants from trying to milk the data for signs of some sort of pivotal turning point that will rescue us all for years to come. The decline in corporate profits in the second quarter was revised to (-1.7%) from (-2.2%).

The initial estimates of August income and spending were that income rose 0.2% as expected, but spending was unchanged, below expectations, and actually fell in inflation-adjusted terms (the initial estimate is a decline of 0.1%). The year-on-year rates stand at 2.4% for disposable personal income, and 2.6% for spending. It’s the third month in a row that annual spending growth has outpaced income, suggesting people are turning to credit to maintain their spending.

Next week brings the all-important jobs number, though it will begin with the national purchasing manager survey for manufacturing (ISM). The weekly claims numbers have been good, with the insured unemployment rate hitting an all-time low of 1.3% in recent weeks. Survey data has shown consistent declines in hiring, though, so we should probably expect another middling to low number for jobs. I have noted previously that there could also be a catch-up effect soon if it turns out that low layoff rates are not equating to elevated rates of hiring, as I suspect may be the case.

Other data next week include construction spending on Monday, along with September auto sales, and then two somewhat important reports on Wednesday, the ADP private-sector payroll report, and the ISM non-manufacturing survey for September.