Lexington, Massachusetts Investment Management
Lexington, Massachusetts Investment Management
Pinball Wizards
"His disciples lead him in, and he just does the rest." - Peter Townshend (The Who), Pinball Wizard
One aspect of the market’s recent up-and-down, indecisive behavior is that it allows for a broad variety of viewpoints to circulate, even flourish. The resilience of buying action in the face of so much bad news provides a kind of proof to bulls that valuations really are cheap, and the economy will soon improve.
It is of course circular logic to claim that your own buying is evidence of market validation, but that kind of logic has never been in ill repute on Wall Street. Nor is it ever unpopular in the mutual fund business, where it is generally thought wrong not to be long.
On the other hand, the parade of bad news in housing and employment gives comfort to the bears that their argument will soon prevail. Short-sellers are used to the idea that it takes longer for the rest of the world to cotton on to reality - there is too much money to be made in selling the sunny side by corporate managers and stock purveyors. But bears do like to have their bit of validation as well.
On the bull side, it looks to us as if there are two main schools of thought. One is the die-hard believer in the cyclical recovery. They are more likely to be mutual fund managers, products of the long boom in the eighties and nineties. In the world that they know, markets may correct, but they always go up, and the ups are bigger and better than the downs.
They are joined by the “2004” crowd, which counts many other types of money managers (including mutual fund types), as well as traders. The 2004 theory is that we are repeating the 2003-2004 pattern of a big post-recession rally (2003) being followed by a long sideways period (the first three quarters of 2004). Then we get another great leap forward as the strength of the recovery becomes clear (the fourth quarter of 2004, lasting until mid-2007).
For both of these schools, the bottom was put in last year. The next couple of quarters will be chiefly a process of taking advantage of any dips to fortify one’s portfolio for the impending great leap forward. That is to say, as much as they can afford, for the lack of fresh cash is something of a problem. The benighted retail investor and pension fund consultant (there is no more devoted rear-view driver than a consultant) aren’t putting fresh money into the market. If they were, we’d probably be about ten percent higher, job losses or not.
Against them are the less numerous bears and at times, the technical traders who can be on either side of each move. The latter wants to agnostically jump onto every day’s move, selling the bad news as soon as it comes out, then quickly reversing course and jumping onto the buy side when the bargain-hunting true believers mentioned above show up, typically in late morning or early afternoon.
Much of the current resilience is a peculiarity of the Eastern time zone. Bad news from overseas arrives in the mornings before our markets open. Major economic releases come out between 8:30 and 10 AM. Earnings nearly always come out before the open or after the close. A year ago at this time, dark rumors would circulate in the afternoon about this company or that one getting ready to fail and accelerate the day’s fall.
These days, however, the afternoons are reliably empty of such problems, making it fairly safe for the self-styled bargain hunters to come in and nibble, and for the traders to run with them. The administration certainly doesn’t want to put out any nasty afternoon sound bites, especially on days when prices might be falling. The Fed does do afternoon statements, but it’s hard to envision Bernanke and Co. trying to undermine themselves by rattling the markets with late surprises.
Certain risks are still out there, most notably the growing awareness of sovereign debt quality and a potential slowdown (or worse) in China. But in the absence of some kind of afternoon thunder roll to cow the natives back into their caves, the markets may be able to resist any serious move downward for no other reason than an inability to get downward traction from the afternoon news flow.
That could allow a combination of warmer weather and data juiced by the overdue arrival of restocking to take the market back to over-inflated notions of recovery, along with prices. March has been strong for equities for the last four years in a row, which may partly explain last Thursday’s afternoon comeback rally. April is the strongest month for the Dow. That will add confidence to momentum traders.
Yet spring in 2006, 2007 and 2008 all proved to be infatuations built mostly on warmer weather and the ability to ignore the flashing lights. The current market seems poised to follow their lead, both in moving upward and in ignoring problems that are nonetheless real. Too much faith in the spring could lead the markets to pull off its favorite trick of frustrating the most people possible. You may need to be a pinball wizard to slip through the impending season intact.
The heart of last week’s data was from the housing sector. The only silver lining to the data is that the market seems numb to how bad a shape that the sector is in. Prices keep falling and sales are falling again too, at times to record lows. I suppose we’ve become inured to the phrase “record low.” After all, the inference is that things can only go up, right? Yes, that was also said about the recent previous record lows, but eventually it has to be right. Some day.
Sales of both existing and new homes both fell in January. The sale of new homes fell to the lowest annual rate ever recorded, but let’s be fair: the data only goes back to 1963. We’re sure that there must have been lower rates in the nineteen-forties, when all those servicemen were overseas.
January and February are both slow months with lots of seasonal adjustments, not the best indicators of a year. There’s also bound to be another rush in April, when the tax credit has a fresh expiration date. At least that’s what the market seems to keep repeating to itself, although real estate analysts do not echo them. The percentage of foreclosure sales keeps hovering around forty percent, this year’s total of new foreclosures will be almost double of last year and the number of all-cash transactions is rising.
Mortgage-purchase applications have been plunging of late, falling last week to their lowest levels since 1997, said the Mortgage Banker’s Association (MBA). Our informal tracking of the no-longer-published index suggests that it’s threatening to fall below the 200, a level we’ve never seen. Excuse us for piling on, but we should also add that to the best of our recollection, the index only goes back to 1997.
We like to check up on Diane Olick’s Realty Check blog at CNBC’s web site, as Diane is in the minority position (at CNBC anyway) of trying to stick to real journalism with her sector. No Pollyanna gushing or crackpot theories for Ms. Olick.
One of the problems with other commentators such as Cramer or Santelli is a problem common to the industry, including investment banking and asset management, of having a very narrow circle of reference. They mostly only talk to other very rich white guys who know mostly only each other, making tons of money doing similar things while swapping the same indignant stories about welfare cheats and the horrors of government and taxation.
Thus Jim Cramer, who is often a pretty smart guy, was trying to sell the theory on television last week that the problems in housing are due to the fact that the threat of bank reform has the banks afraid to lend (i.e., it’s the government’s fault). This despite the fact that he knows perfectly well that as long he’s been in the business, the banks have made the same mistake over and over again.
Dazzled by early reports of gold somewhere, banks cannot resist flooding a sector with too much credit. Not surprisingly, they end up losing their shirts in the end. The aftermath is that management doesn’t even want to even hear about that stuff again, whether it was bulk shipping, or Texas oil, or Florida condos, or junk bonds, or Internet start-ups, or office space, let alone lend to it. This time banks topped themselves by managing to blow up the entire residential real estate sector, a feat not matched since the Depression.
On top of that, housing prices are still falling: both Case-Shiller and the FHFA (government agency lenders) reported declines in prices last week. We can make excuses about the time of the year and the weather, but banks don’t like to lend money to buy assets falling in price, especially when it’s an area as infamous as housing is now.
Bankers also read the newspapers, and the recent headlines about the job market haven’t been encouraging. Weekly claims are creeping back up to the 500,000 level (496,000 last week) and the total number of people collecting some form of government unemployment assistance topped eleven million. That won’t entice lenders to loosen their credit standards anytime soon. It isn’t surprising that according to the Wall Street Journal last week, lending has had its biggest drop since 1942.
It’s true that there were mitigating factors in some of last week’s data. The Labor Department is guessing to an extent on how to adjust for all the snow the country has been experiencing – the unadjusted number actually fell to 450,000. Unadjusted or not, though, that’s an outrageously high number twenty-six months into a recession. That little piece of ugliness was accompanied by a disappointing durable goods report that showed a drop in orders excluding transportation, rather than the anticipated rise. Non-defense capital goods excluding aircraft (i.e., private business investment) fell (-2.9%).
The markets had survived the previous day’s bad news in housing by dialing in instead on Chairman Bernanke’s reiteration before Congress that rates will remain low for an extended period (what a surprise that must have been). But the reverse moves in labor and manufacturing were a bit too much, and the markets headed sharply downward.
However, CNBC’s Rick Santelli, another usually smart guy who should also know better, tried to convince viewers that the real reason for the sell-off was the prospect of health care reform (i.e., it’s the government’s fault). Apparently they don’t read the newspapers in Chicago, if they were only discovering this news last Thursday.
All of this proved to be too much for the CNBC viewers who decorated Ms. Olick’s blog with the penetrating insight that the reason housing stinks and the market was down is because unemployment is very high and the economy stinks. I.e., it’s the economy, stupid. N.B. to Messrs. Cramer & Santelli – perhaps it’s time to broaden your email list.
We doubt very much that it was either the prospect of bank reform or health care reform that caused the Conference Board’s consumer confidence index to plunge back to 46 (from 55 in January) last week. A good piece of that would have been due to the recent stumble in equity prices and the stench of the partisan gang wars in Washington, but the realities of the lack of employment, income and credit are sinking in on Main Street better than Wall Street. The University of Michigan sentiment index was unchanged in its final February measurement.
One glimmer of good news came from the Chicago PMI on Friday, which advanced to a very respectable 62.6. The inventory section of the January durable goods report showed a slight, unexpected decline, so putting that in juxtaposition with the February business surveys, we continue to suspect that the long-awaited inventory restocking has arrived.
Coming on the heels of the bump back up in auto production in the fourth quarter, this has the potential to provide a series of positive industrial data points over a four to six month period. That should provide ammunition to those investors unable to believe in anything but another eighties- or nineties-style cyclical recovery, even though such an outcome is most unlikely.
Despite the steady flow of warnings that such a rise in production is but a temporary one that will fade as the spring goes on, the arrival of warm weather and the memory of last year’s run-up could quite easily prove a lethal combination in the streets of Manhattan and the running paths of Central Park and southern Connecticut.
First, however, we need to negotiate next week’s data, in particular the jobs report on Friday. As we go to press, the consensus is for a loss of around 50,000 jobs in February, but that may be largely dismissed as a weather effect. The influential ISM manufacturing report comes out at the beginning of the week, and given the regional surveys it’s not surprising that a good result is expected. The non-manufacturing report follows on Wednesday.
Monday will also see reports on personal income and spending (February) and construction spending (January). Motor vehicle sales are scheduled for Tuesday.
Thursday is a big day, with February same-store sales reports, jobless claims, productivity and costs, factory orders (January) and pending home sales. It could generate more of a move than Friday’s jobs report, which should be partly tipped by the private employment reports in the days leading up to the report. You may want a supple wrist this spring, when all the lights are flashing.
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