End of the First

“If Jack’s in love, he’s no judge of Jill’s beauty.” – Benjamin Franklin (ed.), Poor Richard’s Almanack

As the first quarter of 2017 ended on Friday, the market has entered a holding pattern, more or less, that in the absence of geopolitical shocks (or something out of Washington) should follow a predictable pattern. Lacking strong reasons to buy or sell, we should keep wandering around until the spring rally arrives sometime after the beginning of first quarter earnings season next week.

Along the way, we might see a technical bump or two, like the one we had last Wednesday when the S&P 500 held around its 50-day moving average. We might also get the short, sharp correction that often precedes the earnings season rally, but that will depend in large part on the options position as we go into expiration on the 21st. That’s as late as the third Friday of the month can get (when monthly options expire), so the rally could be on hold a few extra days this time.

Last week offered more of the same of what we’ve been seeing, I suppose, with the defenders of the stock market digging for creative (or not) reasons that stocks might somehow be fairly valued, and wary bears and valuation counters wondering aloud how anyone can believe any of the former. It’s worth noting that even as the running GDP estimate for the quarter came down to the 1% region, you could see talking heads on the business news talking about how great economic growth has been. Sure it is.

But the stock market doesn’t trade on GDP or valuation, it trades on fear and greed. First-quarter S&P 500 earnings could be up over 10%, thanks to the roughly 50% increase in the oil patch. The latest FactSet earnings estimate is for 9% growth overall, an estimate that should come down somewhat as we get closer to the starting line. Given the padding built into the estimates, an 8% increase would mean actual expectations for about 11%, give or take a point. That should be enough to get the blood going again, along with the propaganda sirens. The fact that earnings will be scarcely better than three years ago will get short shrift – after all, the trend is your friend, not some old data point from three years ago.

The biggest potential monkey wrench – apart from the unpredictable administration – is the upcoming jobs report. I’m not looking for any nasty surprises quite yet. Weekly jobless claims have been stable, so if the hiring has plateaued – i.e., the labor force isn’t contracting but has stopped growing – we probably wouldn’t see any evidence until the April or May report, after the government has had time to process the quarterly survey. Until then, we’ll be going on seasonal adjustments and limited samples. The payroll employment number itself (that is, the unadjusted sample estimate) actually contracts every January by about 2% and then makes it up by sometime in the spring. I’m not so foolish as to try to call this month’s jobs number (or any other), but there isn’t much evidence in what data there is to suggest that the government has found any problems yet. The consensus guess of 170K-180K is modest enough, perhaps allowing for a weather payback from February, when balmy conditions probably contributed to the higher-than-expected number. We’ll see on Friday.

What happens after the earnings rally is quite another question: I would not at all be surprised to see a pullback of some sharpness when the season is over, but only after the equity markets have made fresh new highs. Though I don’t expect that a crash is imminent, keep in mind that stock market crashes only come from great heights – and we are quite high indeed.

The Economic Beat

A quiet week seemed to feature the latest consumer confidence report from the Conference Board as garnering the most attention: the result of 125.6 was the highest since December 2000.

I generally don’t write about consumer sentiment measures, as they are backward-looking and overly influenced by trends like recent stock market performance and changing gasoline prices. Employment levels do play a role, but they highlight the nature of sentiment indicators as lagging indicators – in fact, they work best as contrarian indicators at the boundaries. When confidence or sentiment are at multi-year lows, one can look ahead to years of strong employment growth, and at multi-year highs, they are telling you that employment growth is ending, along with the business cycle. Much has been made of the 16-year high in the survey, but I have yet to see or hear in the major news outlets a single observation that December 2000 – the last high – was also just a handful of months from recession, and a really, really good time to get out of equities.

The report of the week might have been the personal income and spending report for February. Personal spending was up only 0.1%, though personal income rose 0.4% on the month, increasing to 2.3% year-on-year. Spending eased to 2.6% year-on-year, the slowest such pace since August, taking down running GDP estimates for the first quarter. The GDP estimate for the fourth quarter was raised to 2.1%, largely on the strength of inventory accumulation – in recent years, this has meant payback in the form of destocking in the following two or three quarters. Four-quarter nominal GDP increased eight basis points to 3.55% after the revision, landing almost exactly on the trailing three-year average of four-quarter GDP: 3.55%.

Regional manufacturing surveys continue to pace well ahead of actual activity. The Dallas Fed survey’s latest result was a headline number of 16.9, down a bit from the previous month’s 24.5 but still well ahead of the energy slump of 2015-2016. The private Chicago purchasing manager index came in at 57.7, about the same as the prior 57.4. The Richmond Fed index rose from 15 to 22, its highest level in nearly seven years. Keep in mind that these surveys are all diffusion indicators, meaning that they measure breadth rather than depth (or volume), which may explain their recent strength. If everyone feels just a tiny bit better and checks the “higher” box, the survey results go up dramatically, even if “higher” might have been no more than one extra dollar of business – or just the feeling that business is a couple of bucks better..

In housing, pending home sales recovered from the previous month’s downturn with a sharp bump up of 5.5%, surely helped by weather that had first punished the prior month. The Case-Shiller home price index showed its year-year gain improving from a revised 5.5% to 5.7%, in January; it’s been in the 5.5%-6% range for most of the last couple of years. The U.S. trade deficit in goods narrowed somewhat as both imports and exports fell off in January, while weekly jobless claims remain steady.

The big report in the coming week is of course the March jobs report on Friday. Consensus is for a gain of about 180,000, but we’ll get the usual tip-off Wednesday when the ADP report comes out. The latter tries to anticipate the government number, but isn’t always quite spot on.

Monday brings the monthly ISM survey – expect another good number – along with construction spending for February. Tuesday has the complete trade report for January, along with factory orders, and Wednesday will bring the latest Fed minutes after the ADP report and the ISM non-manufacturing survey results are released. Friday also brings wholesale trade data for February.