December Dip


“Distinctly I remember, it was in the bleak December.” – Edgar Allen Poe, The Raven

Although the Dow Jones average did indeed just wrap up its worst week in three years, it was by no means the worst five trading days over that time. It was partly a calendar effect: Previous slumps this year have been worse, but bottomed out on other days than a Friday, in particular the October dip which turned around on a Wednesday.

Is the move the start of something bigger? Probably not, unless the Federal Reserve springs a surprise with its upcoming meeting, statement and in particular press conference with Chair Janet Yellen on Wednesday. As I’ve been writing for the last few weeks, December often has a rocky first half, despite its reputation of being a good month, indeed on a historical basis it is the second-best month after April. The rally that December thrives on often doesn’t get going until options expirations week or even the period beginning the Monday after. A “quadruple witching” is set for Friday, and right now an S&P 500 print between 2000 and 2020 on Friday is the sweet spot for options dealers, which would seem to limit the move in either direction (it closed at 2002 on Friday).

The markets are oversold on a short-term basis, but not so much as October or even August (one more down day could get us past either one). That said, it’s a rare event for stocks to sell off in advance of a Fed meeting. China is slated to issue another purchasing index on Sunday night, and recent weak releases have been a drag over here despite the fuzzy nature of the data (in China itself, they seem to be treating any weakness as a reason to buy stocks because, you know, more stimulus). Another weak report could still weigh on Monday’s trading here, but will run up against some important domestic data releases before its open. Only if all of the numbers are below estimates would one expect more selling.

It’s unlikely to get worse than that though, for two reasons: central banks, and the economy. The global economy is slowing down, and the US is not speeding up, but the domestic cycle hasn’t turned yet. A credit event could rattle it and the possibility of one has to be respected, but without one markets are unlikely to sell off in a really big way, not without a better reason that another downgrade to the forecast for oil demand. The International Energy Agency (IEA) did indeed help spook trading on Friday with its lower demand prediction for 2015. Energy stocks have been taking an unprecedented beating on supply theories, but to hear it could be demand as well is hardly a positive signal for global growth.

But central bank policy still trumps all. Be warned that it won’t always be the case, though many will count on just that, and I have a sense that some of the conviction is starting to leak in some quarters. Yet the bankers still retain enough market clout that should Monday and/or Tuesday prove problematic for prices, a sufficiently soothing press conference from Chair Yellen could spring a violent upside reversal and pave the way into the post-Christmas “Santa Claus” rally. I make no predictions of what Yellen and her brethren will say or do, but the evidence has been that the overwhelming majority of the members are fixated on maintaining stability in the markets. I fear that the practice is partly responsible for the punishing size of the last two bear markets – and the next one. But the members keep their own counsel.

A hint of what lies in store came from the silly reaction to the retail sales report (see details below). Though the main distinguishing feature of the report was that it beat estimates and was not otherwise exceptional, it led to some outrageous hype from Wall Street. The IEA’s demand outlook and the ensuing Friday selling put some of the helium back into the tank, but as soon as prices recover, expect the spin machine about the fourth quarter to restart immediately and feed any rally attempt.

The downward momentum for oil prices, however, has not yet been broken. I have no predictions to make on the subject, but the situation is ripening for at least a temporary reversal, one that might also be set off by any Fed-inspired trading reversal in the dollar. Should energy prices continue to plummet over the next couple of days, it will weigh on the financial markets. I’ll keep repeating it: falling gas prices will not increase retail spending. They only change the mix. What’s needed to increase real spending is real income, and that has been stuck in the doldrums. Over time, lower energy costs do benefit business considerably, and that could be a big plus for the economy.

Saturday was a day to go retrieve my freshman son from campus for winter break, and so today’s column is a day late. Where does the time go, I wonder – and the years.

The Economic Beat

The highlight of the week may have been the November retail sales report, very heavily promoted by Wall Street as being wonderful evidence that the economy is finally about to take off. How unusual.

The truth is that the report (+0.7% on the month, +0.5% excluding autos) was nothing special, but for the Wall Street born-and-raised phenomenon: it beat estimates. The year-on-year growth rate in sales declined and was identical with a year ago – which also announced an increase of 0.7%, later revised down to 0.5%. Looking at the trailing three-month and twelve-month sales, there is nothing new to talk about; the trailing twelve-month growth rate has been range-bound all year long at just under 4%. At any rate, the holiday season is like Easter and back-to-school in the sense that it’s the two-month totals that count. Last December was anemic.

One of the indicators that might have taken some of the shine off the report on Thursday was the price data for international trade. It’s a report that often gets overlooked and on its own would not have meant much on Thursday, but amidst a raft of weak reports from overseas and slashed estimates for oil, on this day it was fuel for the fire. Year-on-year export prices are down 1.9% through November, while import prices are down 2.3%. And it isn’t just oil, either – excluding petroleum, import prices are virtually unchanged at +0.1%. Not happy news for a market being hit by more stories about deflation abroad.

Deflation fears ran high during the week. The French CPI declined, German CPI was zero again, Italian industrial production fell to (-3.0%) year-on-year and Japanese machinery orders declined much further than expected, by (-6.4%) to drag the year-year rate to (-4.5%). When the US producer price index (PPI) printed Friday morning with a headline result of (-0.2%) and the goods component down 0.7% on top of disappointing Chinese results, it was not a happy scenario for markets.

In a fine piece of irony, consumer sentiment as measured by the University of Michigan spiked to 93.8, the highest since January 2007. It’s a backward-looking indicator that tells you mostly what stock market headlines have been saying, and if a rebound from last week’s losses ensues by year end, may stay above 90. Unfortunately it’s also something of a long-run contrarian indicator, making me wonder if rising back to the 2007 peak means we’ll be flirting with recession this time next year. The small business optimism index rose as well, reporting a November result of 98.1 – the highest since February 2007. Hmm.

Wholesale (+0.4%) and business inventories (+0.2%) for October both suggest that November-December could be destocking periods, with potential implications for fourth-quarter GDP. The time series for wholesale sales and inventories does suggest a downward pulse, but it’s too early to be sure.

The labor turnover survey (JOLTS) for October didn’t reveal much that was new, with both the openings and separation rates increasing by a tenth, while the hire rate remained steady. Claims were dead in line with the year-to-date trend, but Federal Reserve chair Janet Yellen’s “dashboard indicator” showed slowing momentum.

Next week will be centered on Wednesday and the Fed’s last meeting and statement for 2014, in particular Yellen’s press conference. It could send the market either way, but down would be a pretty bad (though not divinely so) signal. Just before going into the meeting, the policy committee (FOMC) will have November industrial production (Monday) and housing starts (Tuesday), along with word of the month’s business surveys from the New York Fed (Monday) and likely the Philadelphia branch (Thursday) as well. The week’s second largest event for domestic investors might be the quadruple witching on Friday, but there will be a raft of PMI surveys from abroad. Since they too are influenced by sentiment, last week’s market malaise may not show up until next month (if at all), but the trend of recent months has been a mild fade.