Giddy Up


“You cannot escape the responsibility of tomorrow by evading it today.” – Abraham Lincoln

The whole drama last week reminded me of the animated film “The Incredibles” (if you have children under 20, you know what I’m talking about), whose central villain hatched a scheme to achieve hero status by sending a monstrous robot of destruction into a city, then staging a rescue from it. The plan worked until the robot’s artificial intelligence turned out to be better than expected, turning the hunter into the hunted. If that sounds like a metaphor for the markets and central banks, maybe there’s a reason.

The House outcome was in doubt as late as Tuesday afternoon, but Speaker Boehner permitted a vote that night and you know the rest. A two-month reprieve, followed by a wave of relief buying, short-squeezing, and sudden yearning for new price targets. Many traders are perfectly aware of the impending debacle over the debt ceiling, but trend-riding is trend-riding and problems are at least a week away, light years in trader time.

Now the market is in giddy-up mode, probably for one more week because the economic calendar is almost empty until the week after, and there’s nothing a momentum wave likes more than no news to disturb its narrative. No reality at all is best, if you really want to know. The biggest item on the dock is the European Central Bank (ECB) meeting, and any central bank meeting is itself a potential carrot.

Therefore, this giddy period is a wonderful time to start cashing out. Most won’t, because if there’s one thing the amateur investor hates, it’s not selling at the top. The most ignored axiom on the Street is also one of the most basic: It’s better to be on the outside wishing you were in, than on the inside wishing you were out. But if investors ever started heeding that rule, how could we have bubbles?

Another fundamental axiom is that the tape makes the news. Since the tape rates to keep rising next week, that will lead to a proliferation of fables about how strong the economy is and the broadening recovery. The fantasy will last until it’s contradicted by the data, much of which is a good six to eight weeks away.

I want to illustrate the real strength of the recovery with some quotes from the FOMC (Federal Reserve) meeting minutes three weeks ago:

“Participants observed that growth in economic activity continued to be restrained by several persistent headwinds, including ongoing deleveraging on the part of households and still-tight credit conditions for some borrowers, and that a major headwind facing the economy at present appeared to be uncertainty about U.S. fiscal policy and the outcome of the ongoing negotiations on federal spending and taxes… almost all indicated that heightened uncertainty about fiscal policy probably was affecting economic activity adversely.”

“..a few pointed out that an extended breakdown of negotiations could have significant adverse effects on economic growth. Other factors weighing on the economic outlook included the slowdown in global economic growth and continued uncertainty regarding the European fiscal and banking situation.”

I’ll spare you another slug of quotes from the review by the Fed research staff. Suffice it to say that nobody was talking about escape velocity; rather the discussion was what one would expect from people looking at hard data rather than today’s stock prices: No real change in the moderate pace, mixed conditions, and many challenges. For what it’s worth, GDP is decelerating from the third quarter into the fourth, and from the fourth into the first. Now that’s escap(ist) velocity.

The major indices are mildly extended, but there is certainly room to run higher before one can confidently start to take the other side. There’s the “break-out” target on the S&P 500 (1472), less than half a percent away and so invitingly close to 1500. The Russell 2000 has already broken out to an all-time high. The five-year high on the Dow is only two percent away. These kinds of targets are magnets for trading money, traps for the unwary, and matter more than reality at times like these.

The “other” January effect is that the second half of January is frequently a consolidation period, because the initial sprint out of the gates usually gets ahead of where earnings can really be. Unusually, we missed that in 2012, due mainly to the historically warm weather feeding the momentum the market had been riding from QE2. With revenue growth as weak as it is and more typical weather in store ahead, it doesn’t look like the odds favor a repeat.

When the budget battle begins in earnest, it won’t just be a matter of headlines, either. The new payroll tax starts to take effect for most people next Friday. It’s going to bite. It seems very likely that regardless of which side prevails in the battle, or whether it’s a draw, cuts will be coming somewhere. They may very well add up to a long-term positive – or not – but they will be a kind of anti-stimulus in the short term. Some kind of tightening is inevitable, even if it only comes as a by-product of a prolonged stalemate. The many who were unable to resist the lure of the new high are going to be wishing once again that they were already out.

The Economic Beat

The jobs report was virtually spot on the consensus estimate, though the ADP payrolls report a day earlier (+215K) had raised hopes for a higher number. In an odd sort of way, the actual number of +155K (168K for the private sector) may have been better for the market. That includes the miss on the unemployment rate, which was expected to fall to 7.7% and remained at 7.8% instead.

The reason is that the release of the FOMC minutes the day before had revealed that some members were questioning the length and extent necessary for QE-infinity. The notion that infinite easing might not actually be infinite shouldn’t have surprised anyone, nor the notion that some members were uneasy about printing money forever. It actually seems rather sound. But the press ran with the story and exaggerated its meaning (a first, I realize), and the trading boxes in turn sold on stories and words about “hawkish” and “early tightening.”

It’s quite conceivable that had the employment report been strong, something on the order of +225K, or a drop in the rate to 7.5%, the boxes would have sold in volume on the premise that the end of easing was now visible. That’s the kind of market we’ve had in the last year or two.

From the perspective of the economy, the number was decent, but not as good as appeared. Based on the preliminary, unadjusted establishment data, the percentage increase in jobs for 2012 was 1.43%. a bit above the average rate for the year, though not enough to consider it exceptional. Even with minor revisions, it’s the best rate of growth since the 1.78% of 2006, which was the peak rate of the decade. It’s also well below the two and three percent rates of the nineteen-eighties and nineties.

But there are revisions coming, and quite a tale could lay within them. To begin with, the November tally was revised some 16,000 higher, but that bonus was a complete product of seasonal adjustments – the unadjusted tally actually fell by some 4,000. Real jobs – that is, the unadjusted count – fall in December (usually) and January (always), so the adjustment process is huge. Biggest of all is the benchmark revision coming with the next report. We could gain or lose a considerable number of jobs, though historically stocks have not really been affected by the news. I suppose the black boxes don’t bother with such things.

Another revision area will come in manufacturing. ADP estimated a loss of 11,000 manufacturing jobs, while the BLS estimated a gain of 25,000. Something has to give. Though it’s not always the best gauge, the ISM manufacturing survey did report positive employment readings, so perhaps the BLS has the edge.

Thanks to two sharp gains in November and December, the aggregate payroll index ended up the year with a good 4.4% gain. Average weekly hours edged a tenth higher to stand at 33.8 versus 33.7 a year ago, and average weekly earnings were up 2.4%, again with much of the gain coming in the last two months. Yet recent weekly claims have shown nothing special in terms of labor strength – indeed the previous week was revised sharply higher – and while the number of long-term unemployed fell again, it did so at a lower rate than previous months. It may be that Sandy recovery work gave the data a temporary bump.

Some of the data was of mild interest – temp hiring was reported as a slight negative, the household survey reported a much lower gain (28,000) and government continues to shed jobs. What stood out to me the most was how flat the bulk of the data was. At first blush, there is no discernible change in trend. The New York Times headline ran “US Continues to Add Jobs at Slow Rate,” and I can’t argue.

That lack of change was borne out by the ISM manufacturing index and the November data on factory orders. The ISM reading was 50.7 (50 is neutral) with contracting sectors outnumbering growing, while new factory orders were unchanged from the previous month (though durable goods were higher). Same-store sales for December were fairly blah, with promotional activity cutting into margins (and remember, most of the struggling chains don’t report monthly data). Even Lululemon (LULU) was taken down by an analyst report noting the increase in promotional pricing on its website.

The ISM services (non-manufacturing) index was the bright spot of the week. I wouldn’t call it a roaring report, as many categories were flat or easing, but the headline of 56.3 was better than the estimate for a decline from the previous month’s 54.7. The comments seemed positive, and best of all the score of growing to declining sectors was 13-5.

The European news was unchanged too – recession. The main variation seems to be which country is surprising to the downside. Everything continues to contract, but there were no headlines about the EU breaking up, so markets rallied alongside the U.S., Spain most of all. Surreal.

Next week has a very light calendar. The small business optimism index on Tuesday and international trade data are the main monthly reports, though there is also consumer credit on Tuesday and wholesale trade on Thursday. Surely the biggest reports of the week are the ECB monthly statement on Thursday, and Wells Fargo (WFC) earnings on Friday. Alcoa (AA) officially kicks off the season on Tuesday, but the market doesn’t really think much about it anymore.

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