“A little learning is a dangerous thing.” – Alexander Pope
In 1996, Alan Greenspan had the temerity to wonder if traders might not be prone to “irrational exuberance.” He didn’t actually accuse them or the markets, but coming from the normally sphinx-like Fed chief, it was like a lightning bolt to the stock market.
Traders never forgave him. The damage was shaken off, the markets climbed to ever-more irrational heights three years later before going over the cliff, yet traders were still bitter over it when he stepped down 10 years later (I thought then and now that one result of the incident was that Greenspan, the most market-attuned Fed chair of my lifetime, was subsequently too timid during 1999′s madness, though I don’t expect he plans to ever admit it).
In this week’s semi-annual testimony to Congress, Janet Yellen tossed a spanner into the automated buy-works (it’s a Yellen hearing, she’s a dove, ergo buy buy buy – the action started Monday). It was a no-look throw too, because she didn’t actually say anything upsetting aloud. She did seem a tad less dovish than usual in her remarks and answers – and was probably dying to tell off some of the grandstanders in the House – but the offending object came in the print version of the Fed’s monetary policy report, which was signed by Ms. Yellen. The writer theorized that “in aggregate, investors are not excessively optimistic regarding equities. Nevertheless, valuation metrics in some sectors do appear substantially stretched–particularly those for smaller firms in the social media and biotechnology industries” (emphasis added).
The immediate effect of the dastardly words – after all, the Fed’s real duty is to support the stock market at every turn (isn’t it?) – was to cause a sell-off Wednesday in those sectors. When Thursday saw a general rout in equities (the first 1% down day for the S&P in 62 trading sessions) sparked by the combination of the Ukraine-Malaysian Air tragedy and the Israeli army moving into Gaza, doubts and fear lingered, despite a parade of biotech and social media stock analysts appearing on the tube to deliver the shocking revelation that people should still be buying their sectors.
Friday was a different story. The market opened up because things hadn’t gotten worse – one of the most reliable bull-market trades there is – then climbed almost throughout the day, fueled by options expiration, short-covering, and a bit of reckless abandon. As trading came to a close, rally-emboldened CNBC “personalities” began jeering and snickering over Chair Yellen’s amateur status as sector analyst/stock picker. They looked very much like a clique of high school adolescents swapping can-you-believe-it japes over some outsider’s feckless attempt to join the inner circle of cool. Personally I am not the world’s biggest fan of Yellen as Fed chair, but this was an embarrassing display by a group that displays little to no market intelligence of its own and often betrays the opposite.
Whether Yellen herself did indeed select the sectors as being overvalued – I for one doubt it – is something we may not learn for some time, if ever. One thing you can be sure of is the pervasive sense of immunity that is spreading throughout Wall Street. Every day I hear a new face tell me that the monetary authorities aren’t going to let anything bad happen to stock markets anywhere. It’s the kind of hubris that precedes a fall. A big one.
But not an immediate one. Experience suggests that once firmly established as a mainstream, everyday credo, this kind of magic talisman usually takes about a year to dislodge. Usually. The odd thing is that in this particular case, the talisman has a say in the matter, unlike the last two pre-crash fads of globalization and the new economy. The magic lamp dropped multiple hints in recent days that it does not want the equity markets to rely on it anymore, ranging from the overvalued sector remark in the above-noted report – a warning shot if I ever saw one – to Stanley Fischer’s (Fed vice-chair) observation that markets can decline without causing a financial meltdown, to Richard Fisher’s (Dallas Fed president) Thursday enthusiasm for ending QE and raising interest rates as soon as possible.
Time will tell. Despite Friday’s bravado, the market appears to be running mainly on rhetoric and momentum, and the fuel is getting a bit thin. It’s perilous to predict the stumble point of such a run – the market is quite capable of going up every month for the rest of the year, and people went broke fighting the tape in 1999 – but my nose tells me times are going to get interesting soon.
The Economic Beat
The fact that the principal reports on the economy were below consensus had little effect on the robot-driven trading that assigns more weight to Fed testimony. Nor does that kind of thing matter to options trading (last week was expiration week). The main report was the June data on retail sales, a mixed bag at +0.2% that was well below consensus for 0.6%, though the miss was mitigated by May being revised upward two ticks from 0.3% to 0.5%. Revisions and the initial estimate nature of the data tend to make proclamations about month-to-month changes a doubtful business anyway.
Better indications are found in the year-on-year changes for the quarter and year-to-date. The second quarter is provisionally sporting a 4.9% improvement compared to its 2013 cousin of 4.5%, but the rebound nature of the quarter explains the difference: The first six months of 2014 had a 3.6% growth rate over the same period in 2013, compared to the year-ago rate of 3.8%. Even with potential revisions, there appears to be little to no difference in retail spending.
Once again, the economy is failing to accelerate as promised in December and January; once again, the stock remains more concerned with the prospects for easy money. June housing starts were a bigger disappointment than retail sales, falling over 9% from May after a 7% drop the previous month. They’re still up over 5% year-to-date, but single-family starts are barely up at 1.3%. The homebuilder sentiment index enjoyed a sharp rebound over the neutral level (50) to 53, making the starts data all the more surprising, given the usual close relation between the two.
Industrial production for June was also below consensus (as I wrote this, I heard yet another prominent bank strategist talk about how good all the economic news was this week), coming in at only +0.2% where 0.5% had been expected, this time with a downward revision to the previous month (0.6% to 0.5%). Manufacturing was up an estimated 0.1% on the month. But the market has gotten so used to weak data that as long as it isn’t outright negative, any positive number seems not only to suffice, but to count as more good news.
Manufacturing and business surveys were indeed positive. I frequently remind readers that with the exception of long periods, diffusion surveys are not good measures of the strength of economic activity. They measure breadth, not depth. May PMI surveys in Europe were positive, for example, but subsequent industrial production declined. The New York Fed survey produced a July reading of 25.6, which reporting services emphasized as being the highest number since 2010. I didn’t see any mention made that the 2010 figure did not correspond to any generalized strength in activity. In fact, it was followed by a series of declining current activity readings, and in that respect one ought to pay attention to the Philadelphia Fed survey data.
The venerable Philadelphia Fed activity index produced a well-above consensus reading of 23.9 versus the prior reading of 17.8. The salient part of the report for me, however, was the six-month outlook. It is a very good contrarian indicator, one that I wrote last month should peak this month, and the first leg (the increase) has now likely come to pass. Expect the activity readings to begin a months-long decline shortly.
The prices of goods and services continue to show very modest upticks from last year’s very low levels of increase. Much of it is energy-related, but what rises there are of late have attracted strong attention from critics of the Fed. Yet the central bank’s purchases are circulating mostly in reserve accounts or the asset markets and don’t seem to be gaining a lot of traction in the real economy. The potential may be there, but it still seems to be a case of “pushing on a string.” The latest data for producer prices showed a year-on-year increase of 1.9%, 1.7% excluding food and energy. However, the initial monthly read was for a gain of 0.4%. Tuesday’s CPI reading will no doubt be in focus.
Import prices for May were revised higher, leaving the June increase lower than expected. On the one hand, the year-on-year increase for import prices is a very undramatic 1.2%; on the other, 2013 was a year of declines so there is movement higher. Export prices did fall an estimated 0.4%, leaving the current year-on-year rate at a paltry 0.2%.
From a market point of view, the emphasis next week should be the first peak week of the second quarter earnings season. There is more housing news on the docket, including existing home sales on Tuesday and new home sales on Thursday, and more regional surveys through a week that will be topped off by June durable goods on Friday. The highlight of overseas data is apt to be the China “flash” PMI survey on Wednesday night.