Lexington, Massachusetts Investment Management
Lexington, Massachusetts Investment Management
The Seatbelt Light is Still On
"When I get to the bottom, I go back to the top of the slide, where I stop and I turn and I go for a ride.” - Lennon-McCartney, Helter Skelter
Tray tables up? Check. Seatbelts fastened? Check. Air-sick bags at the ready? Check. Knuckles white? Nope, and that could be a problem.
Normally, one has to visit aerial shows such as the popular “Blue Angels” exhibitions to see the kind of power climbs and dives we witnessed last week. They are fun to watch from afar, but as any civilian who has taken a one-off ride in a fighter jet can attest, riding in the jet itself usually offers the opportunity to re-examine the remains of one’s last meal.
The beginning of the week started with a soaring climb, fueled by a technical rebound of an oversold market, a favorable manufacturing report and “Mutual Fund Monday” (16 of the last 19 Mondays have been up days, anecdotally due to the buying of mutual fund managers. Note to same: I know it’s tough with all that money burning a hole in your pocket, but have you ever thought about waiting until Thursday?).
The rally kept going Tuesday, with CNBC spending the day talking about the “strong economic news” that ADP reported a minimal loss of (-22,000) jobs versus a consensus estimate of (-30,000). The Challenger layoffs report, which reported a surge in layoffs to the highest total since August, got a quick mention upon release and was never heard from again, certainly not by the strategist who went on the air talking up the economy and employment, the latter in view of the fact that “layoffs seem to have ended.” Note to same: try reading the newspapers.
The ride leveled out before taking a steep nose-dive on Thursday that continued into Friday afternoon. Then it put on one of those last-minute pull-out-and-climb maneuvers that one usually only sees in James Bond movies. By this time, the mavens who muse were chattering madly – who was to blame for the swoop, and how to credit the rebound?
Some of the main worries were evident enough, such as sovereign debt, another disappointing report on unemployment claims, and above all momentum: the intermediate trend of the market is still downward. Pay no attention to simplistic rants by the political preachers who infect our airwaves, because traders were not sitting at their desks Thursday morning fretting over the budget or health care.
No, the biggest concerns on Thursday were one, momentum, and two, momentum. The number one momentum fear was that the market might fall further and that somebody else might sell before you. It may be soothing to ponder the vileness of Washington in the post-close comfort of your favorite watering hole, but on the trading desk one watches the tape first, along with the charts, news and order flow. That other stuff can wait.
The number-two momentum fear was the Cisco (CSCO) effect, or perhaps the lack of it. The influential technology bellwether put out positive results and guidance after the close on Wednesday evening that went well past already-high expectations, leading traders to smile and expect some sort of nice morning rally. The failure of that report to light a fire under futures prices the next day had traders in sell mode from the opening bell.
Then there was the mystery of the sudden spring-back in the last hours of Friday. It looked like the classic reversal that defines the end of a correction, leaving many smiling faces ballyhooing victory for the economic cycle in its wake (not everyone though. CNBC had skeptic David Rosenberg on its panel right after the close, and he believes the economy will be feeble for the rest of the year. That seemed to infuriate the other brokerage house economists - traitor! saboteur! How dare he scare the customers!).
Yes, that reversal did look like a correction-ender – or did it? Consider that the Dow had fallen 450 points from Wednesday afternoon to 2 PM on Friday. It’s fair to say that we may have been a wee bit oversold at that point. Consider also that the market bounced at the exact moment that the S&P 500 fell to touch its 200- day exponential moving average, which is akin to putting your hand on “home” in a game of tag. If you’re any kind of trader at all, you’re going to look for a bounce at such an important milestone.
By lunchtime on Friday, it was widely believed that the day might end in a selling rout. What do you reckon you would do, if you were trading? Do you think you might want to sell first? Many did, until we reached that magic 200-day average. By then, though, short-sellers were already thinking about taking profits and going home. After such a big drop, it wouldn’t do to go home short for the weekend, not with the lurking possibility of an EU meeting or a soothing bulletin from China that might send the markets roaring higher on Monday. There was profit-taking and position squaring to be done, this time from the short side.
The fact that the Friday recovery was a technical trading recovery isn’t necessarily bad; it’s a technical market. What worries us is the aftermath. Bottoms do typically come about with a morning sell-off followed by the afternoon reversal, but when it’s a real bottom traders are still nervous at the end of the day. It appeared Friday as if everyone was quite satisfied that the bear had been run off and it was time to put on the buying shoes. Where was the downside overshoot, the lingering fear?
While new money is flowing out of the stock market, not in, we’re going to stay in technical trading conditions, currently overshadowed by fears of events overseas. On the technical side, only one test of the 200-day average would not be unprecedented and it would be nice – but there is often more than one. Another worrisome development is that the S&P has been sinking below its 15-week moving average for over two weeks now, something that hasn’t happened since the March lows. Technicians call that sort of thing a ‘confirmation of the move.’
As to the political events, there are two issues preoccupying the market. One is the so-called “PIIGS” countries (Portugal, Ireland, Italy, Greece and Spain), about which there have been mounting concerns over sovereign debt ratings, liquidity and even the Euro linkage. Perhaps the fears are overblown, but as Gretchen Morgenson observed in the Sunday Times, we have already seen the first “contained” movie starring subprime debt, and it didn’t end well.
Containment or not, there appear to only be two ways out of the European debt problem. One is the medicine of heavy austerity and budget cuts that would come at a very difficult time and would not lift growth prospects. Like chemotherapy, the patient gets saved in the end, but only after some noticeable weakness. There is also the problem that the track record of adherence to past such programs is spotty and even non-existent.
The other way out is some sort of reshuffling of the Euro deck. Looking at the behavior record of the European Central Bank (ECB) would lead to the conclusion that the first priority of the bank is to show everyone that it will not bow to pressure. In other words, the ECB will only be brought to the table kicking and screaming. An aid package announcement would certainly set off a day of short-squeezing, but how long would that last? The currency-debt crises of the recent past have never, ever ended in one day with the first proposal.
Europe will probably try to avoid at all costs anything that weakens EU integration, such as a two-tier currency system or countries breaking off entirely. Yet however improbable you may think such an extreme outcome, there is no escaping the fact that every outcome is going to involve some real cost. There will be no free lunch.
The other global issue on the minds of U.S. and global markets is the China question. How much tightening do they intend to do, and what is really going on under the hood? It’s a good question for the hero of last year’s rebound.
We don’t know. We do know that short-sellers are leery of some kind of soothing statement coming out of the country that could cause a big reversal, but we also know that the Chinese New Year is only a week away. If you were a member of the group running China, would you rather do something this week that could launch a big global rally and re-ignite commodity prices while you were on the sidelines, or would you maybe just sit tight until the holidays are over? Then you might be able to pick up some oil and copper on the cheap before pouring any oil on the troubled waters.
We don’t know the answer to that question either. That’s why we’re keeping the seatbelts fastened. Prices are certainly getting more attractive, but they have a way of getting even more attractive at times like this – or in other words, they keep going down. It doesn’t always happen that you get to see the fear in the whites of the eyes first, but we haven’t seen it yet.
One of the main drivers of our erratic week was the puzzling data. Traders crave clarity and they didn’t get it, a big factor in the sloppy tone of the equity markets.
Start with the ISM surveys. The manufacturing edition started off the week on a positive note, with an above-estimate result of 58.4 that is indeed a good reading. New orders rose as well to 65.9. It helped the market’s triple-digit rebound on Monday, and had the more bullish strategists crowing quite loudly about the massive V-shaped recovery. Thirteen out of eighteen industries reported growth.
Good news, but we would be negligent (or devious, maybe) if we didn’t remind you of two points. One is that the best time to go long is when the ISM manufacturing number is in the basement, not when it’s peaking. That’s because by the time it peaks, it has already been priced into the equity markets for some time. The other is that the data is still consistent with the thesis that we are experiencing an inventory restocking for a couple of quarters or so, rather than a sustained expansion. The jury is still out.
Consider the tepidness of the non-manufacturing sector survey. Though not as economically sensitive a signal, it is the much larger part of the economy. The results showed virtually no change. It did migrate to a positive reading, something commentators went out of their way to mention, but the move from 49.8 to 50.5 is not significant. The really odd thing is that only four of the industries reported growth, while eleven reported contraction, which is not exactly robust. Wholesale Trade, one of the four sectors in the plus column, had a comment that it was the highest production month since March of 2009, but it was still lower than December of 2008.
The employment indicator of the manufacturing survey reported growth, while the non-manufacturing sector reported another month of contraction, though the rate did improve a bit. The establishment portion of the jobs report reported that manufacturing did indeed add 11,000 jobs, thanks to the auto sector, but that service employment rose, while Wholesale Trade – one of the four growers of the ISM survey – fell! That’s not a clear picture.
The jobs report was certainly the puzzle of the week. Has the disparity between the two portions, household and establishment (companies), ever been so great? Probably, since there is very little new under the sun, but this one was a corker.
The most obvious contradiction consisted of the establishment survey’s announcement that another 20,000 jobs were lost in January, yet the household survey reported that unemployment fell a sharp three-tenths of a percentage point, to 9.7%. Not only that, but revisions to the establishment survey for 2009 announced that nearly 1.4 million more jobs were lost last year than previously announced.
That makes the total loss a staggering 6.1% of the workforce – according to the people at the Liscio Report, who study such data closely, it’s the biggest such chunk since the end of World War II, when demobilization suddenly put millions of soldiers back into civilian clothes. It’s also three times the average of post-war period recessions, a figure you may want to keep at hand the next time you are seized with the desire for a large stick after hearing yet another brokerage house strategist assure you that the economy is roaring right back.
Despite the massive number of additional jobs lost, though, the household survey blithely announced that the number of the unemployed shrank – although the number of people collecting unemployment benefits (regular plus extended plus emergency) goes up every week and has topped ten million. We have a wee suspicion that the household survey result will be revised. It often is, and is prone to much larger revisions than its establishment counterpart.
So the jobs report left everyone scratching heads, but there was some good news in it, despite the negative number (most were hoping for a positive print). One is that the biggest losses (-75,000) came in construction, which a turn in the weather might mitigate. Another is that temporary help rose again, often a harbinger of improving employment conditions. Aggregate and average weekly hours also rose, although only back to the levels of November. It did look as if the jobs market has at least stabilized.
But it didn’t look that way on Thursday, when the weekly unemployment claims report came out and showed that claims had risen again, this time to 480,000, instead of pulling back as the market anticipated. That was the third week in a row now that we’ve had a sharp disappointment on claims, and it pulled the four-week moving average up for the third week in a row. That helped pull the stock market deeply down on the day.
Those last three weeks have all come after the cutoff for the January jobs report, so February isn’t exactly looking rosy at this point. The media didn’t want to talk about them much, but the Manpower Index declined again in January and the Challenger layoffs number hit its biggest level since last August. These are signs that point to another negative number for jobs in February.
However, it does appear that business spending is improving, a fact very much repeated of late by conventional Street strategists and fund managers (not that their professional opinion might be at all influenced by an urgent professional need to see the market keep going up). Factory orders did rise more than expected in December, by 1.0%, a number made even better by an upward revision to November. Shipments were strong, and inventories fell slightly, which points to a need for further rebuilding (though possibly also to a lack of confidence on the part of manufacturers).
That result was reflected in the productivity number, which we said would show a ridiculously high result. It did, at 6.2%. Fire enough people, run down inventories, and you will get a pretty high productivity number. Labor costs fell sharply. But falling labor costs means falling incomes, and that means weak consumption. Pending home sales rose only one percent in December, which is quite weak given the sixteen-plus percent tumble the previous month. The frigid January weather didn’t help the sector either. Maybe it means we’ll get another surge in March and April, when it’s supposed to expire again – and maybe we won’t, and so it will get extended yet again. At least mortgage purchase applications got a good lift last week, although the absolute level remains very weak.
Although personal income rose by 0.4% in December, wages and salaries only rose 0.1%, and God only knows where we’d be without government transfer payments. Spending slowed to a 0.2% increase; inflation was quite weak (however, the January ISM manufacturing survey showed a sharp rise in prices paid). Weekly sales data showed more softening and domestic motor vehicle sales fell in January. It seems to point to a red number next Thursday, when the January retail sales report is released.
Construction spending fell more than expected (-1.2%) in December, on top of a downward November revision. That’s going to shave some points off the fourth-quarter GDP estimate. The business is still stuck in its bottom, so one can at least say there’s almost nowhere to go but up. Eventually.
Consumer credit didn’t fall as much as expected, for a change, which some said helped the market get back its losses on Friday. It probably didn’t hurt, but we should tell you that revolving credit took another big hit, to the tune of (-$8.4) billion. The headline number of only (-$1.8) billion was helped out by the uptick in December vehicle sales.
It was a very busy week indeed, but filled with cross-currents and perhaps information overload. Next week is just the opposite, as we hit the early mid-month lull. The only real day of note next week on the calendar is Thursday, when we get the retail sales report and weekly claims at the same time.
We’ll get some useful filler data too, such as wholesale trade and business inventories for December, along with that month’s international trade report (Wednesday). None of those are market movers. Friday will bring the first look at consumer confidence in February, which looks to have waned with the headlines (e.g. the CASH index, reported last week, fell sharply). The week should belong to earnings, politics and momentum – but in which order, who can say?
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