Avalon's MarketWeek

Last Days of Warmth


“It is a silly place.” – Monty Python

Well, it is August, after all. During a week of extremely light volume, stock prices continued their spiky rebound off the nearly two-year old trendline that goes back to the beginning of QE-3. As I wrote last week, every day of calm in the Ukraine would offer the chance to push the tape higher and squeeze short-sellers. Next week it could all reverse again, as the situation looked to be getting a fresh burst of tension as MarketWeek went to press, but in the meantime, last Monday’s action of a tape running wild on no gas (one of the lowest volume days of the year) was the poster child of the move.

Fanning the rally were two Fed appearances, in a manner of speaking: the release of the minutes from the July meeting, and a Friday appearance by Fed chair Janet Yellen at the annual Jackson Hole monetary policy conference sponsored by the Kansas City Fed. It has turned into quite a high-profile event over the years (if you haven’t heard the story, the Kansas City organizers moved the venue to Jackson Hole back in the early 1980s in order to lure then-Fed chairman Paul Volcker, a dedicated fly fisherman, into attendance. Apparently it worked – Volcker went and the conference has turned into a big deal).

The markets were hoping for more of the same dovish confirmations from both the minutes (the release is a near-automatic rally occasion) and the Jackson Hole conference. Failing that, no turns to the hawkish dark side.

What they got was something in the middle. Stock market traders don’t expect to see anything new in the minutes, rather the hope is for the opposite, a tone of more of the same. Ideally the members remain in wait-and-see mode, which the market translates into many more months of easy money. The two key sentences began with the observation that “many participants noted that …it might become appropriate to begin removing monetary policy accommodation sooner than they currently anticipated.” That was an unexpected turn of events. However, traders took solace in the follow-up: “However, most participants indicated that any change in their expectations for the appropriate timing of the first increase in the federal funds rate would depend on further information…”

Not quite the stuff that dreams are made of, but enough for the tape to remain steady and after a break for digestion, continue the march onward to Janet Yellen’s inevitable dovish reaffirmation on Friday. It’s been a trade to bank on this year: Her various public appearances since taking over in January have reliably relit the fire under traders’ feet with their firm defenses of the need for lots and lots of policy accommodation (or as the Street likes to call it, “easy money”).

However – a word used eight times in her speech – Yellen’s Jackson Hole appearance was not the expected defense of accommodation as far as the eye can see. Instead, it displayed uncertainty and a chairperson (and by extension, committee) trying to get her arms around just what the true state of the labor market really is.

The evidence has admittedly been confusing. At one time in the recovery the Fed had used an unemployment rate of 6.5% as its guidepost for ending zero interest rates, but the rate fell past that mark so quickly, and without a concomitant acceleration in the economy, that it took the central bank by surprise and left analysts grasping for a satisfactory explanation. Indeed, multi-decade lows in the participation rate and surging levels of part-time work seemed to have left the broad rate tainted and led Yellen et al. to speak of a “dashboard of indicators” in its stead.

The condensed form of Yellen’s speech could simply have said “Things look kind of tricky right now and we’re not really sure what it all means. We could raise rates sooner than we thought, but then again maybe not – we’re going to need some serious confirmation first. In the meantime we’ll keep tinkering with our models.” The results included the slowest (non-holiday) trading day of the year; a mild pullback in the recent ascent that may or may not signify anything; talk of Yellen being a “two-handed” economist (after President Harry Truman’s famous desire for a one-handed economist who couldn’t say “on the other hand”); and dissension over whether she was more dovish, less dovish, or exactly as dovish as expected.

The real point of all of this, so far as the stock market is concerned, is not the potential damage to the economy from a Fed funds rate that might be at forty basis points instead of fifteen. It’s the perception that the Fed has the market’s back, and will not only not do anything to make prices fall, but will come running to the rescue at any sign of trouble. That is why the S&P was up 30% last year, why it remains up this year even as bond yields continue to move downwards (until Russia marches back into the Ukraine, anyway), and why many worry about what could happen to valuations in the aftermath.

Appropriately enough, the stock market itself is beset by contradictory forces heading into next week. Usually, the roughly ten trading days that come at the end of August and extend through Labor Day mark the stock market’s “silly season,” when vacations rule and junior traders inevitably bid prices higher on the astonishing development that the world didn’t end the night before. Even 2008 had its silly season rebound just before Lehman Brothers crashed and burned.

Last week’s sharp move on flimsy volume might have used up some of the buying zeal. S&P 2000 is so temptingly close it seems impossible to avoid, but it would seem that the Ukraine is in the same position with respect to Russia. The market is overbought, and Labor Day is coming as early as it can. One can’t deny the short-term momentum, but it seems to have built up a sense of foreboding to go with it. Maybe it’s best to just shut your eyes, lie back, and enjoy the unofficial last week of summer.

The Economic Beat

The focus of a relatively quiet week was housing. The homebuilder sentiment index, July housing starts and existing home sales came out, all ahead of expectations. The sentiment index came in at 55 (50 is neutral), the best reading since the beginning of the year, and was followed by a jump in the starts data the next day that led to a lot of nonsensical blather in the media that “housing is back.”

July was certainly an improvement over an upwardly revised June, but single-family starts are up less than 5% over the comparable period in 2013. Starts beat consensus because of a huge jump in multi-family starts. Big numbers in starts initial estimates are commonplace due to the very limited sample sizes, and are nearly always revised away (both May and June ended up taking big revisions).

Existing home sales also improved and are now down only about 4% from 2013. In a sign of an improving market, the percentage of distressed sales fell to 2008 levels, in single digits (9%) for the first time since the crisis. However, all-cash sales are still quite high at 29% , while first-time buyers are still struggling. July is usually the best month of the year for sales, so it will be interesting to see how the rest of the year develops. Regardless of what the weather does, mortgage credit is going to remain tight.

The Philadelphia Fed survey increased to its highest level (28.0) since March of 2011. The six-month outlook increased to its highest level since 1992 – but a point I frequently make is that it’s an excellent contrarian indicator. Peaks in outlook are reliably followed by drops in activity. The survey was echoed by a good 58.0 result for the Markit Economics “flash” purchasing survey index. The Chinese purchasing index declined back to about neutral.

The focus of economic data might have been housing, but the focus of the stock market was, as usual, the Federal Reserve. Markets rallied into the FOMC minutes, which seemed to show a tad more hawkishness amongst some of the members, then kept rallying on the expectation that Fed chair Janet Yellen and ECB President Mario Draghi would sing more soothing sounds Friday morning from Jackson Hole. But the somewhat more divided tone of the minutes presaged the uncertainty of Yellen’s Friday speech, and markets were left groping for their guaranteed dose of the dove.

Weekly claims have been improving and are coming in for some hosannahs. The rate of claims is a ways from peaking yet, as is the number of insured workers that is still lower than the last cyclical peak. The total for the two weeks that go into the August employment report suggest a pickup over the July numbers.

Next week will bring the rest of the housing data, with new home sales Monday, Case-Shiller price data Tuesday, and pending home sales on Thursday. July durable goods come on Tuesday, and what may be the highlight of the week is Thursday, with the second estimate of second-quarter GDP. Personal income and spending are on Friday, followed later by the Chicago purchasing manager index.

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