Wait for It

“Some very big things are going to be announced next week.” – Donald J. Trump, February 16, 2017

It is said that bull markets die in euphoria, which suggest that we ought to be performing last rites for it now. The stock market is very euphoric indeed and the pain trade has been ever higher. In my last report I opined that the back half of February ought to see some cooling off, but that outcome has yet to see any signs of beginning.

As to what is driving the market, it’s pretty much the same story it’s been in recent months – a widespread belief that the magic wand has been taken out of its sheath and is poised to wave in a fabulous spell of beneficence across the land. The steward of all of this is a guy who has filed for bankruptcy four times and won’t reveal his tax returns, presumably because he is worth much less than he claims to be (not proven, true, but if it walks like a duck and talks like a duck, the odds favor a certain outcome).

Lest you think I exaggerate, even Goldman Sachs (GS) has warned that optimism may be at a peak. S&P 500 earnings are currently estimated to have increased by 4.6% in the fourth quarter, according to FactSet, which also provided this interesting chart last week:


Note the dichotomy between actual earnings changes and stock prices. The way these things are resolved is that price returns to earnings, not the other way around.

The stock market has certainly been on a defiance binge. The more people talk about valuation, the more susceptible traders seem to become to any presidential promise to do something really big. If you are wondering if anything of substance happened last week to keep propelling the market higher, well, there was the January retail sales report beating expectations. It really was not such a great report (see below), lacking in breadth and owing much of its strength to rising energy prices and balmy weather. But to a feverish market, it was instant validation.

The other big event was of course the periodic promise out of Washington that something “big league” is going to be announced very soon. Although most of the leading investment banks have recently taken to warnings that both the implementation and effects of said bigness are likely to take longer and be less than expected, try telling that to investors who somehow feel liberated by a change in party (this usually happens with a Democrat-to-Republican handoff, and has always been a great time to cash out). One can see it in the manufacturing surveys that have produced soaring readings the last few months without any change in concomitant production (see more below). You gotta believe, right? Too bad for me that I’ve seen this movie several times already, and already know how it ends.

For now, I’ll repeat my short-term outlook: A pullback should begin any day now, but absent a major policy gaffe (which could also happen any day now), I don’t expect anything more than a 5% skim before the spring rally gets underway. The real pain trade looks set to come later.

The Economic Beat

After a slow start, the week launched into high gear on Wednesday with January retail sales and industrial production, the New York Fed manufacturing survey, and the latest homebuilder sentiment index.

There was good news in the retail sales report. January sales were up 0.4%, 0.8% excluding autos on a seasonally adjusted basis. Year-on-year sales were up a surprising 4.9% (unadjusted), some of which can be laid off to a favorable calendar and weather, but not all of it. However, the improvement was not broad-based, being confined almost entirely to autos, gasoline (i.e., higher prices), health care (ditto) and online retailing. Nevertheless, TTM spending rose to 3.6% (unadjusted), the best level since May 2015. This may seem like good news, but given that year-on-year disposable income only rose by 2.1% though December, such developments could mean trouble ahead. TTM sales for ex-auto, ex-gas spending are up 4.32%, compared to the three-year average of 4.26%, so the difference is not large. One can expect large exaggerations, however.

The New York Fed’s survey continues a pattern that has historically been resolved the wrong way more often than not. The overall level is at 18.7, the best in 2 1/2 years, and the category increases were mostly good. The Philadelphia survey the next day showed a similar outcome, 43.3, the best result in decades. But the industrial production report for January did not bear out either survey, a phenomenon that has deepened since the election. The total index fell three tenths of a percent (seasonally adjusted), leaving it unchanged over the last twelve months. Manufacturing is up only 0.3% over the same period, and both categories report lower capacity utilization than a year ago – 75.1 vs. 75.5 in manufacturing, 75.3 vs. 75.7 overall.

Yet regional business surveys continue to post stunning increases. If history is any guide, we are in for several months of disappointment as reality overtakes promises of “really big” events to come from Washington.

Homebuilding cooled a bit, though it is still fine on a relative basis. The homebuilder sentiment survey came in to 65 vs. expectations for 68, but 65 is still a very high number (it spent most of 2009 in readings below 20). Starts fell somewhat in January (-2.6%, seasonally adjusted) but December was revised higher and the year-year numbers look good – 11% for single family, 7.2% overall.

So far as inflation is concerned, the main story for the last 12 months is the uptick in energy prices. Producer prices rose a steep 0.6% in January, 0.4% excluding food and energy (“core”), taking the overall year-year rate to 1.6% overall and 1.2% core. Look for a slowdown in February, as oil prices have flattened. Consumer prices reported the same increase in January (+0.6%), taking the year-year rate to 2.5% and the “core” rate to 2.3%. It will be interesting to see the Fed-preferred PCE rates later on this month, as they were hovering around 1.5% at the end of 2016.

The coming week starts slowly again, with the President’s Day holiday slicing a day off. We’ll get home sales Wednesday, along with the FOMC minutes, followed by new-home sales on Friday. Mixed in will be some lesser manufacturing surveys, the federal home price index and the weekly claims report. Claims continue to be at a very low level and the next report has all the all-important 12th day of the month (used for the monthly jobs report).