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“Been down so long, it looks like up to me.” – Richard Farina
It’s an old adage but a good one – the sharpest rallies are in bear markets. How else to explain the five percent rise in the S&P 500 last week and the eight percent rise last week in Nasdaq stocks? The latter was led by a ten percent rise in Cisco’s (CSCO) stock price, when traders were overjoyed to discover that the company was sharply lowering its near-term outlook to a revenue decrease of fifteen to twenty percent. The analysts that follow the company were nonplussed, but if they knew how to trade they wouldn’t be analysts, would they?
The jobs report was certainly helpful. Everything the Street could hope for was there: a wide miss to the downside (-598,000 actual versus –524,000 estimated), a big negative revision to the previous month (an extra fifty thousand in the loss column), a larger-than-expected jump in the unemployment rate (7.6%, the highest in sixteen years), even the extra bonus of an additional twelve-month revision of 400,000 more jobs lost than previously counted.
It was the largest monthly loss since December of 1974. Bigger, actually, because when the revision comes out it will have surpassed it. Throw in a huge increase in initial unemployment claims to the highest level in over a quarter-century and what more do you need? This economy is on fire!
It all seems counter-intuitive, but that’s often the way short-term action works on the Street. The two favorite trades are first, riding a momentum bull (everybody’s favorite), and second, catching a reversal of tired short-selling. When the selling becomes extended and momentum begins to flag, everybody knows it. The news needs to get exponentially worse to shake out more sellers, so the stops get set tighter and tighter. Art Cashin, the celebrated dean of NYSE floor traders, referred to Friday’s rise as a “short reduction” trade.
As for the employment report, it is an oddity of Wall Street that the markets usually rally on a weak jobs number when the economy is in decline. A bad jobs number in a bull market is death, but when the economy is suspect the markets tend to stage big gains. One reason is that weakness has usually been anticipated and traded on, such that only numbers that are completely off the charts can still shake the crowd. Otherwise, traders are going to look for the reversal move.
The other, larger reason is the thinking that job losses force the government to do something that will benefit equities, such as interest rate cuts, or tax cuts, or bigger stimuli or putting men on the moon or whatever the flavor of the month is. Therefore, one must buy rather than sell, because selling is too simple and obvious and lacks foresight. Buying is crafty and clever and shows real manhood.
That may seem odd, but the really odd part is that it’s nearly always the right move to start selling again as soon as the market opens on Monday (the jobs reports always come out on Fridays). After the testosterone flush has worn off and the weekend analysis digested - usually some revelation along the lines that sharp increases in unemployment aren’t good for the economy or profits – fear creeps in and the wave reverses.
One would think that having been through this any number of times, traders would have grown cynical about these jobs-report rallies. Many are, but a trade is a trade on Wall Street and you don’t get rich fighting the tape. That’s what people tell each other, anyway.
Lurking in the background of this particular rally was an appearance earlier in the week on CNBC by Charles Nenner, a technical analyst with a not insubstantial following on the Street. Nenner’s prediction in late 2007 that 2008 would be a lousy year didn’t do anything to hurt his reputation. On Tuesday, he predicted that the market would find a selling bottom by the end of next week and then stage a month-long rally, give or take a day or two. Traders being traders, they may have already started drawing an advance.
We don’t know the exact workings of Nenner’s formulae, mostly because he doesn’t reveal them. In this particular case, though, there are some market conditions that favor his latest prediction. For one thing, traders are heartily sick of the endless bad news and are fairly desperate to put on some kind of extended rally. They don’t need much of an excuse for a good old-fashioned bear raid. Earnings season is nearly over, and without all those pesky CEO’s telling us how bad business is, it’ll be easier to float a narrative more conducive to the bull disposition.
The “stabilization” theory that is just beginning to get some legs should get some help from some sideways movement in the economic data. This theory holds that the easing by the Federal Reserve is gaining traction, as witnessed by an uptick in December pending home sales and a not-quite-so-atrocious result from the January ISM survey of the service sector.
In the short term, the thinking goes, there will still be some bad news (a prediction that we certainly won’t dispute), but with the first breezes of the Fed spring starting to stir and the double-barreled federal package coming this week – a stimulus plan and the Treasury package – the economy should be on the mend within six months. Therefore, the time to buy stocks is now. Quod erat demonstrandum.
The misleading lull in some of the economic statistics should provide further support for the new narrative. There won’t be any relief coming from the employment data, but the great thing about unemployment is that you can always dismiss the latest reading as a lagging indicator. On the output side, we’ve reached a kind of plateau that is typical of any downturn, which in turn gives rise to the usual hope that maybe things are getting better. And if all that isn’t enough for you, the 8000 level on the Dow has held successfully (more or less) three times, including the “Hogan’s Bottom” of 7850. What are you waiting for?
The market is essentially rising on the theory that the rate of bleeding has slowed. The problem is, that is true of every corpse. The fact that a cadaver lacks sufficient blood to keep bleeding in quantity hasn’t really worked as a good indicator of imminent recovery, not when one excludes zombies. Perhaps the recent flurry of stories coming out of Texas, of computer hackers posting zombie warnings on highway information signs, is somehow related. Whatever the case, we think that this zombie rally will turn out like its predecessors.
All this talk of the living dead brings to mind the current brouhaha over bonuses for bankers. It’s a touchy area, isn’t it? We have to confess that we ourselves do not at like the idea of government setting compensation levels in the private sector. On the other hand, we have to confess that the standard defense being put on by the private sector makes us wonder why they are paid at all, let alone angling for hefty bonuses.
The most common refrain one hears is that the financial sector will suffer a severe talent drain if it can’t maintain its bonus practices. I’m sorry, but help us out here - does that mean that the banks could actually do worse than they already have? Is that even possible? It would be understandable if people in the banking world have shut their eyes of late to current events, so we’ll post a helpful reminder – don’t bring up the last ten years when pleading your case. Try another tack, like the weather, or sports.
It really isn’t as if the current model has much to show for itself. The other pupil-popper one hears is the old saw, “if I don’t pay them enough, they might go elsewhere.” Where are they going to go, exactly? Gringotts? (Harry Potter’s bank, in case you didn’t know) Maybe it’s actually meant as extortion, you know, pay us big money to stay where we are or we’ll come infect your industry too.
Watching an exasperated Alistair Darling (U.K. Chancellor of the Exchequer, an analogue of our Treasury Secretary) remind the cameras that bonuses are supposed to be special rewards for exceptional performance and not something that bankers have a statutory right to, we finally understood what all the fuss has been about. You know, these entitlement programs that one always hears about. It really is time do something.
Our theory is that it’s time to bring the partnership model, or some hybrid form of it, back to Wall Street. When the current partners are firmly on the hook for what may go wrong, they will start being a lot more careful with money and risk. The compensation problem will sort itself out on its own.
We don’t agree with the fashionable notion that the bankers were operating blithely on the assumption that all of their mistakes would be covered by the government. Nobody wants to suffer the fate of a Bear Stearns or Lehman Brothers or be forced to resign in disgrace. That said, though, it’s only human nature to be more aggressive when you’re playing with the house’s money, so more personal responsibility needs to be brought back into the system.
And speaking of personal responsibility, we watched the testimony of Harry Markopolos last week describe how structural weaknesses in the SEC allow the Bernie Madoffs to go on undetected for so long. That reminded us of a presentation by some bright young hedge fund attorneys we attended last fall. When we inquired about the effectiveness of SEC regulation, there was a pause, followed by the observation that at most of their seminars, the people that were furiously writing down everything they said and asking all the questions were gents from the SEC trying to understand how the hedge fund industry actually worked. It wasn’t very reassuring.
One theory gaining currency by week’s end that we did approve of is the “shock and awe” one. We watched Mohammed El-Erian, head of Pacific Investment Management and generally conceded to be one of the top two or three investment minds in the country, react to the employment report on Friday. We don’t know if he originated the remark or was echoing it, but he made the point quite ably that the financial system needs such an approach or we’re going to have a much deeper problem than people realize.
Maybe that explains the rally, that traders were already trying to jump on the idea that Treasury Secretary Geithner’s program would be in the shock and awe league. We are afraid though, that even if that is the case and the govvies are able to put a blowtorch onto the credit markets – and we would welcome it - a great deal of damage has already been done. Wall Street may turn on a dime, but the economy does not, and the Street is forever bumping its head on that reminder. But when a market’s been down as long and as hard as this one, just about any path can look like the way up.
The highlight of the week was the news on employment and the diminishing amount thereof. The current figure of a loss of 598,000 was joined by a revision downwards of 50,000 or so to December and an additional net loss of 400,000 jobs for 2008. All told, the tally is a little north of four million over the last twelve months.
Though the number missed the estimate, it was within the whisper range. Despite the market’s bravado, though, there is cause for deeper concern. Unemployment is accelerating, not flattening, and the reported number actually benefited from a measurement period that excluded the last two weeks of accelerating layoffs. Initial claims for the last week of January soared to 626,000.
The wide miss in the face of a calendar benefit that we thought might keep the tally in check is all the more alarming. Given the accelerating layoffs and revisions pattern, it seems to us that by next month the January total will be closer to 650,000. The only thing that might keep February under 700,000 is that it has three days fewer than its predecessor, and even that might not suffice. That will give us five and five: five million jobs lost in the preceding twelve months, and five million in continuing claims (which touched a new record last week of 4.8 million).
The markets seemed cautiously pleased with the ISM survey results, which were not at all good, with the manufacturing sector being particularly bad. Judging from the reporting, the press doesn’t seem to be making much progress in understanding the ISM methodology, and for that matter neither do a lot of denizens of the Street.
The ISM survey data don’t represent absolute levels, but changes relative to the previous month. If the entire country were to go on strike and not return to work for months, the ISM survey would show a dramatic drop in the first month and then return to fifty, the neutral reading, by the second. We’d still have no output, but the ISM number would go up anyway. The January manufacturing result of 35.6 is very poor, but there was plenty of “guarded optimism” going around because it was “better” than December’s 32.4.
The reality, though, is that arithmetically it becomes increasingly difficult to sustain very low readings for long. Manufacturing can contract dramatically for only so many months in a row before it approaches zero (although sentiment can distort the results). A certain amount of reordering is inevitable, whether the economy is improving or not.
The ISM readings can rise while the economy is still quite weak, particularly in the case of the service sector readings. The latter ticked back up to 42.9, but unless we switch to bicycles and resort to eating stores of rice and dried beans, it becomes very difficult to sustain such readings in the thirties. If the economy improves, the ISM readings will of necessity improve also, but the converse does not hold: we could enter a multi-year general depression and enjoy lots of “improved” ISM numbers at the fifty level.
Last December, the Fed’s move to purchase mortgage-backed securities led to a sudden drop in mortgage rates and a spike in mortgage-purchase applications. At that time, we speculated that the homebuyer bench might not be very deep. In other words, the number of would-be buyers waiting for a drop in rates to jump in might not be as large as the market hoped.
Since that time, the weekly mortgage-purchase application data has borne out our thesis: applications fell again last week to fresh lows. Rates have also crept up in the interim, but not dramatically so, suggesting that much lower rates may be needed to counter the effects of falling prices and rising unemployment. However, the December spike is still showing up in the data, specifically last week in the pending home sales report for December. Depending on how tight the banks were, that should in turn lead to somewhat better existing home sales reports for January and possibly February as well.
Although the data on purchase applications, new home sales and permits, and Case-Shiller pricing all point to a housing market still in a death grip, you can expect the markets and more hopeful members of the press to focus on “recovery” when the existing home sales report is released later this month. That recovery will start to unravel in early March when the January pending sales data appear, then collapse later in the month when existing homes sales are reported.
Looking at production, factory orders fell a steep (-3.9)% in December, with a very nasty revision to the November data (minus 6.5 from an original minus 4.6). The weakness was accentuated by the historically weak auto sales report, which dropped to a run rate (6.8 million) that I don’t think has been seen since the nineteen-seventies. Not coincidentally, Toyota (TM) announced that it would have its first annual loss since 1950 (though I still haven’t heard how the UAW must be to blame. Come on people, you’re not trying hard enough).
On the sales side, chain-store sales in January were weak, but mitigated by several factors, the principal one being that Wal-Mart (WMT) reported better-than-expected same-store sales results. The markets had less interest in the other results, but took some comfort in the fact that the majority of the chains left reporting were ahead of analyst estimates.
Wal-Mart itself became the latest company to announce it was giving up the monthly report in favor of the quarterly one. Now that the largest retailer has taken its ball and gone home, I don’t know how long we can expect the rest to stay. Promoters of the stabilization thesis may wish to note that weekly retail sales fell again, as did mortgage-purchase applications and employment. They have all been steadily deteriorating since the beginning of the year. It is a kind of stability, I suppose.
Moving into less-followed reports, personal income and spending for December were released on Monday, though pre-empted by the GDP and PCE reports the previous Friday. Income fell (-0.2)%, a bit less than expected, and spending was off (-1.0)%, a tad more. Both were revised downwards for November and December. Core PCE (inflation) was unchanged again, with headline still falling, but the leveling out of energy prices since December should put deflation to rest for a time.
On that subject, the continued build in oil supplies and declines in demand has taken the wind out of the sales. In January, many were crowing that the bounce in oil prices was an early indicator of economic recovery (we said it was an indicator of traders speculating on oil futures). Last week the markets rose smartly while oil fell mutely back below $40 a barrel. Year-over-year demand in gasoline and jet fuel were down 4.4 and 13 percent respectively. These figures really caught our eye. Capacity cuts by the airlines surely explain much of jet fuel decline, but gasoline? Maybe it’s weather, maybe it’s frugality, but one thing it isn’t is a sign of stabilization.
Productivity and labor costs reported much better than expected results, but they were largely overlooked. The markets aren’t concerned about labor as a potential source of inflation, and productivity rose largely because employment fell even faster than output. It isn’t the stuff of prosperity. The silver lining is that we are not in the bottom right quadrant of rising costs and falling output.
Next week will surely feature the federal government’s announcements for new plans to combat the rot in banking and the economy. Treasury Secretary Geithner has promised something for Monday or Tuesday (or next week, anyway), and Congress appears to be on the verge of getting a stimulus bill onto President Obama’s desk. Many Fed governors, including Chairman Bernanke, are expected to speak.
There aren’t any major reports however until Thursday, when retail sales for January are released, along with initial claims. A consumer sentiment measure is due on Friday. However, we will also see data on wholesale trade (Tuesday) and business inventories (Thursday) that promise to be of more interest in these turbulent times. The international trade report due on Wednesday used to be more of a market-mover, but hasn’t been lately. Perhaps it just isn’t producing the right kind of data (i.e., hopeful). Housing, banking and unemployment are keeping the trade data off center-stage for a while, but it’s still a good indicator.
StockWatcher is also waiting to see what the government unveils next week before crawling out again on that very rickety limb.
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