Avalon's MarketWeek

All’s Well That Ends Well


“But I must attend his Majesty’s command, to whom I am now in ward, evermore
in subjection.” – William Shakespeare, All’s Well That Ends Well

Someone won the battle between the EU and Greece last week, but I’m really not sure who it was. Perhaps the real winners were equity fund managers – they have en masse perfected their routine of treating the Greek situation with a shrug and a knowing smile. Nothing bad is going to happen, you know, and it didn’t. As they like to say on Wall Street, a trade works until it doesn’t.

You certainly don’t need me to tell you that the Greek-EU crisis cycle repeated itself yet again, finishing with the same ending of kicking the can down the road. The latest iteration had a bit more drama, a reasonable amount of volatility and quite likely will have some serious long-term repercussions, but – so what? Mr. Market only gives a nod (if that) in passing to that kind of thing. Greece will make its payment – the one that was really serious – on Monday, and the U.S. stock market can go back to its normal rhythm of reducing the far-off silly affair to chit-chat status while concentrating on the real fundamentals: the current rebound on the charts, the perennial second quarter earnings rally (regular as clockwork, including the “surprises”), and obsessing on Fed chair Janet Yellen. Not that anyone says they want to obsess on Yellen, but everyone else does so what choice does one have?

Germany certainly gave Greece a bloody nose in the bailout negotiations. However, in turning the process into a “submit or die” scenario, it gave itself a nice black eye in the process. The premise that the euro is irrevocable has been badly damaged, while the premise that the EU is really the GU gained some traction. Were it not for French moderation and Germany’s deep reluctance to abandon its commitment to the Franco-German alliance at the center of the EU, Greece might well be out of the group this week. German Chancellor Angela Merkel has always aimed at maximum inscrutability, so I don’t know whether she was taking a Grexit seriously, or just letting her finance minister be the pit bull (a role he relishes) as a gesture, or even allowing him enough of the stage to make himself thoroughly unpopular with the rest of the EU (she and the minister are not fast friends). Maybe she just had her finger in the air, as politicians and football commissioners are wont to do.

I could and would love to write much more on the topic, but this isn’t a column about politics, it’s a column about the markets (and a late one at that), so let’s sum up by saying that for those markets, the damage has been contained, at least as far as the very short time horizon of traders is concerned. There will likely be more fallout ahead, perhaps at the end of the summer and in ensuing elections, and certainly some major fallout come the end of the business cycle (yes Virginia, there is a business cycle), but all of that is far off in market time. No one has come out of this looking good, least of all the GU, er, EU. The phrase “Pyrrhic victory” comes to mind, one that has endured for good reason. The affair may seemed to have ended well, but it was only a respite and not a pretty one.

Looking at the rest of the world, the short-term outlook remains benign. The Chinese stock markets are responding to intensive government manipulation and the earnings rally has its usual tally of surprises of both the forced (the banks) and unforced (Google) variety. The stock market is being carried by tech and biotech as the money river chases fewer and fewer names (see chart, with the S&P 500 at the bottom, the Nasdaq in blue and the biotech ETF in green).

It’s a phenomenon common to the end of nearly ever market cycle, but what of it? On Wall Street, there is no market cycle until there is one again. In the meantime, I confess to having some anxiety about August, but for now a quiet calendar, warm weather and the usual parade of earnings beats should prevail.

The Economic Beat

The report of the week had to be retail sales, though the stock market managed to completely shrug off the disappointing data in favor of more alluring music, such as Greece and the prospect of riding the inevitable rebound in the indices to new highs. Besides, a weak report has to put the Fed on hold, right?

June sales fell 0.3% seasonally adjusted from the May tally, though they were supposed to rise by about the same amount. Looking at the year-on-year numbers, June did improve to 2.87% not seasonally adjusted (NSA), thanks to an extra weekend day (SA up only 1.4%), but the second quarter fell to 1.62%, reminiscent of the 1.68% in the second quarter of 2008, when we were in recession but didn’t know it yet.

There is one big extenuating factor, and that is the price of oil. It last peaked in the summer of 2008, so gasoline sales were inflated then, and now it’s near multi-year lows, reducing the total dollars spent on gas for increased volume. But consumers can respond at least partly to changes in gasoline prices, and one incontrovertible fact remains – the growth in total spending has nearly ground to a halt. The drop-off in the growth rate from the 4.8% of the second quarter of 2014 is over 300 basis points, the kind of decline that in the past has preceded an imminent recession. However, the data series only goes back to 1992.

Manufacturing is barely growing as well. The industrial production report for June showed an increase of only 0.3%, led mainly by increased utility and mining, both warm-weather related. Production was negative for the quarter and fell to 1.5% year-on-year, 1.8% for manufacturing. These are stall-speed numbers, and the 1.5% is the lowest since February 2010, a recovery month. The last comparable number for the post-recovery part of the cycle is the first quarter of 2008, but sometimes there is sporadic weakness in the mature part of the cycle with the end still a year or so away. That said, the year-on-year decline is now eight months in a row. Once again, oil is partly responsible, but the rest of production is not taking advantage of lower energy costs.

The New York and Philadelphia manufacturing surveys have little to do with oil, and they were surprisingly muted in view of the expected second quarter rebound. New York increased to 3.86 from a decline of 1.98 in May, narrowly beating consensus but not by enough to impress. New orders fell for the fourth time in five months. Philadelphia, the older and more influential survey, fell to 5.7 from the previous month’s spike to 15.2. For what it’s worth, the small business and consumer sentiment surveys both showed unexpected declines of several points, though it could just be noise.

Housing appears to be much better, emphasis on “appears.” The sentiment index was unchanged at a respectable 60 (50 is neutral), while starts had a decent month in June, rising to a 1.174mm annual rate. The latter number was driven mainly by multi-family housing, though, in turn mainly driven by an expiring New York City tax break. Next month may not look as good. Single-family starts are chugging along, up 9.1% year-to-date, compared with the 4.9% increase for all of 2014.

The Beige Book did not surprise with its summary of mostly “modest to moderate” growth, while continued weakness showed up in export-import prices, both deeply negative year-on-year and negative almost across the board. Producer prices inched up to a 0.8% increase year-on-year, while consumer prices got a bit of a lift from the avian flu (chicken and eggs) and the muted bounce in oil prices, inching up to 0.1% overall but 1.8% excluding food and energy.

Weekly claims continue to show no weakness, perhaps emboldening Fed chair Yellen to keep talking up an imminent rate increase in her Congressional testimony last week. Yellen’s recent remarks seem to sum up to me as wanting to get off the zero bound (we will raise rates) but not by much (her admonitions to keep one’s eye on the actual path of increase, with the plain implication that it will be gentle).

The week of the 20th will be a quiet one apart from earnings. The main reports are existing home sales on Wednesday and new home sales on Friday; other reports include the Chicago Fed’s national activity index and the little-heeded leading indicators, both due on Thursday along with weekly claims and the Kansas City Fed regional survey. Enjoy the summer weather.

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