Avalon's MarketWeek

Same As Always


“There is nothing new under the sun.” – From Ecclesiastes 1:9, the Bible

It’s a good time to remind readers of an old stock market adage: the tape makes the news. The same events look different under a flight of rising prices than a streak of falling ones, and get presented accordingly. Most news reporters work on the assumption that daily market reactions are wrapped around significant news developments (even the ones who don’t, by and large stick to reporting them that way), though the truth is that market moves often have little to do with what seems to be a high-profile piece of economic news. The moves still get explained that way, however, leaving a lot of investors and average joe’s bewildered when things seem to suddenly go the other way.

If you want to know the biggest single influence on last week’s rally, it wasn’t earnings, and it wasn’t retail sales (up 0.6% in June by the initial estimate, and absolutely rhapsodized about). If the market were as event-driven as they’re supposed to be, then Friday should have seen a big rally in reaction to the retail sales beat of expectations, rather than being mildly down (Turkey had nothing to do with it: when news of the attempted coup hit the wires in late afternoon, the tape barely flickered). No, it was the options market, as is often the case these days.

On an options expiration week (the one that includes the third Friday of the month), I will usually take a minute on that week’s Monday to look at how the SPYder (SPY) options are positioned. The SPY (the S&P 500 ETF) options are the most liquid and the least prone to being gamed by rumors of analyst opinions or corporate peccadilloes. I look for the maximal payout position for the dealers (the one where the most contracts will finish out of the money) and assume that barring some huge event that can stampede the markets, the SPY will finish very close to that price. On Monday, that strike prices appeared to be 216 for the SPY. It closed Friday at 215.83. Golly gee, what a coincidence!

One of the best ways to push the tape during expiration week is to load up on index futures during a quiet overnight session, preferably one without too big of a big news release the next day. Since the margin requirements are low, you can buy a lot futures for not much cash (buyer warning: you can also lose a lot of money very fast that way). The next morning, everyone gushes over the market being higher while portfolio managers scratch their heads and wonder what the heck is going on (occasionally they complain, but it’s usually written off as performance-related whining). Then the public news stations and headline writers will try to find some news event to pin the move on, even though the former may have nothing at all to do with latter. Nothing new about that – when prices are rising, bulls get interviewed, and when they are falling, the bears are on camera.

Lest you think I’m going to start ranting about dark global conspiracies, I’m not. There isn’t much that’s new going on here – in my lifetime, the public media has very rarely understood much of what goes on behind the curtains in the stock market. Even now, eight years on, I would be quite taken aback to meet a business reporter who actually knew much about the credit meltdown that came at the end of the last cycle, or the Lehman bankruptcy. People have their pet theories based on what they want to be responsible and stick to them.

There aren’t any secret wizards handing out secret orders to Wall Street for some nefarious political purpose either – the denizens of Wall Street are out to make money above all else, that’s all, and when you’re a professional options dealer, it doesn’t take a whole lot of brains or money to push the tape around during weeks like the last one. You don’t need to call up your options buddies to tell them to buy futures overnight – they’re all ready and raring to go anyway, and will jump in with their surfboards as soon as it looks like there’s a wave (or until the magic strike price has been reached). It’s legal, too – you can’t prohibit dealers from hedging their positions, or there would be no dealers.

In the long run, derivatives dealers and traders have little to no direct impact on prices, and frequently have little to none in the intermediate term either. The short term is another story, and those price moves certainly can play an important psychological role in building Potemkin villages of prosperous scenes (or despair, on occasion), however, as they did last week. Just don’t let that kind of casual news flow turn you into a sudden market believer or disbeliever. For the record, earnings were not great last week, with high-profile names like Alcoa (AA) or JP Morgan (JPM) beating expectations (trumpets, cheering) even as they reported year-on-year earnings declines (in Alcoa’s case, double-digit declines in both revenue and operating earnings). Roughly two-thirds of publicly traded companies are going to beat carefully managed expectations this quarter, the same as always. As the quarter winds down next week, so will the rally, same as always. And new highs (especially marginal ones) in the stock market do not signify new eras of prosperity – same as always.

The Economic Beat

As noted above, it was a economic week of misleading reports about the company, with scattered beats of monthly consensus figures getting major it’s-all-good validation from the options-fueled stock market rally.

The Econoday write-up on June retail sales called it “a fabulous month for the consumer,” the kind of fluff that keeps the investing public insulated from the truth. June’s bump (+0.6%) gained most of its percentage strength to a big downward revision to May, from +0.5% to +0.2%. Yes, it turns out that the same May that Econoday had earlier rhapsodized over as being “very solid” and “a pleasant surprise” was in fact nothing special at all, being only +0.2%. Given that the revisions to retail sales data have been consistently downward of late, one might expect rhapsodists to hesitate before acclaiming initial looks at seasonally-adjusted data.

The trailing-twelve-month (TTM) growth rate for retail sales on an unadjusted basis fell from May to June, from 2.7% to 2.67%. That’s a pretty small difference, admittedly, but a) it may widen further post-revision; and b) it’s not what I would call a fabulous episode. In fact, year-over-year June sales were the weakest in five years (+2.1%) and half the rate of 2015. In sum, retail sales for the six months of 2016 are up 2.6% over the first half of 2015, on a seasonally adjusted basis, exactly the same amount as weekly earnings were up over the last twelve months in the latest jobs report. Not a coincidence.

June industrial production came in for some of the same so-much-better-than-expected hype, but once you eliminate the monthly noise, there is nothing to write home about. Production has been showing a saw-tooth pattern on a monthly basis, with May revised to a decline of 0.3%, while June has an initial estimate of +0.6%. The real number to watch in this series is the year-on-year number, and that is at (-0.7%). It’s an improvement from last month, but is still running negative and will need some more big boosts from utilities to get back into the black.

The notion of manufacturing strength took a hit from the New York Fed manufacturing survey, with a preliminary result of +0.55. Zero is neutral for this report, so it essentially shows no pickup in activity. New orders were slightly negative (-1.82) while employment data was somewhat worse. The only good category in the report was prices paid, steady at plus 18.68. Wholesale trade showed more sales weakness in May with the 17th consecutive month of year-on-year declines. At 1.35, the inventory-sales ratio remains stubbornly high.

While we’re on the subject of employment, there were two more reports this week warning of softness. The Fed’s own Labor Market Conditions Index was negative for the six month in a row, at (-1.9). It ought to be noted that revisions can be large in this series – May went from (-4.8) to (-3.6) – and that the Fed doesn’t seem to know what to make of its new series. Certainly the markets don’t pay much attention. The index was calculated after the June jobs report, so don’t look for more help there, but might yet be revised upwards. Maybe the markets will pay attention then? The labor turnover report (JOLTS) showed a notable drop in the May job openings rate, from 3.9% to 3.7%. The hire rate remained stable at 3.5%, a tick below the May 2015 rate of 3.6%. The June report might bring better news, but I wouldn’t look for any surges in hiring.

Higher oil prices raised up May import-export prices, with estimated increases of 0.2% for imports and 0.8% for exports. The year-on-year rates are still negative at (-4.8%) and (-3.5%) respectively. Producer prices in June got similar help with a monthly increase of 0.5%, leaving the year-on-year rate at a still-subdued 0.3%. Excluding food and energy, the latter is at 1.3%, a tick up from May’s 1.2%. Consumer prices also rose, though by much less (+0.2%). The year-on-year rate for consumer prices is 1%, about the same as the producer index. The U.S. ten-year bond yield is at record lows, reflecting no concern over inflation.

Next week is mostly housing and earnings. The former kicks off with the homebuilder sentiment index on Monday, followed by housing starts on Tuesday. Existing home sales and existing home prices are on Thursday. The other report of interest is the Philadelphia Fed business survey on Thursday.

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