Lexington, Massachusetts Investment Management
Lexington, Massachusetts Investment Management
A Calm Before the Storm
“Get Ready, cause here I come.” - The Temptations (Smokey Robinson), Get Ready
Ladies and Gentlemen, return your trays to the upright position and fasten your seatbelts, for we fear that atmospheric conditions will soon be turbulent. Air pockets are about to ensue.
What, you may wonder, brings us to such an outlook? Plenty. The VIX, or “fear index,” has fallen to 18, its lowest level in over a year – and nearly in a straight line at that. The markets rose five days in a row last week despite plenty of disappointing news on the economic front (see below). Portfolio managers are fully invested, bearish sentiment has nearly disappeared, and every single strategist is predicting a ten or twenty percent up year on the market. Complacency reigns supreme.
The possibility of a correction has been reduced to the just-in-case model, as when portfolio managers begin to drag out the hoary old cliché that well you know, we might get a five or ten percent correction anytime, but the trend is up. Most certainly, definitely up. Quarterly earnings season is nearly upon us, the S&P has recently broken above its trading range, and the banks are starting to get reckless again.
Yet a thorough look at the economic canvas makes one wonder where all the complacency is coming from. So far as the economy goes, we are at best creeping along. Although last week’s jobs report was a serious disappointment, we rallied anyway. The slow but steady flotation upwards in equity prices has had hardly a hiccup in many months. Whom the gods would bring down, they would first raise up.
We cannot tell you the number of the day, but be assured that we are soon going to see some action. We may even get the false “upside break-out” first that completely takes control of the headlines – the kind of thing that just precedes the big wet cream-pie to the face.
One storm that that we are certain is about to burst – possibly beginning this week – is the one over banker compensation. In short, our boys just don’t get it. The entitlement culture on the Street has gotten so strong that they truly believe it’s a divine right. The fact that bank profits have been almost entirely made possible by taxpayer money, poured in massive amounts to try to fill the craters left by the banks themselves, seems to be quite beside the point.
The warnings from the regulatory authorities and public about being greedy have been numerous and heavy-handed, yet the bankers seem to be comporting themselves like so many Marie Antoinettes, urging the proles to eat cake if they cannot have bread.
In the United Kingdom, banks are doing gross-ups to get around the threatened fifty percent tax on large bonuses (in other words, the banks will raise the payouts by a sufficient amount to cover any extra tax payment). Anyone who read the recent article in the New York Times magazine about Ken Feinberg’s experience in setting pay limits for the senior executives of the top TARP recipients has to be appalled at the cluelessness of our boys in pin stripes.
Of course, these exorbitant payments always come with the same justification: “it creates jobs.” Would that be the eight million lost since the onset of the recession? Or the net zero jobs added in the United States since 2001? Come to think of it, the drug trade, the opium trade, prostitution, and murder for hire all create jobs. We are heartily sick of this hollow threat.
These bankers have a sense of entitlement that would put Reagan’s apocryphal welfare queen to shame. In Ken Feinberg’s case, some AIG people were saying look, my department didn’t lose money so why should I be punished? Because your company needed $180 billion from the taxpayers to survive, that’s why, laddies. If your company doesn’t have the money to pay the bonus, you’re not entitled to get it from the taxpayers. No, really. You’re not.
If that seems too unfair to you, then start your own business. Of course, it might be harder to do those trades without the company brand behind you. Life can be so unfair.
Don’t get us wrong. We aren’t in favor of the government getting mixed up in private-sector pay matters – although in the case of the TARP banks, it’s hard to make the case that they were really in the private sector in 2009. Nor are we against people making money – it’s a rather pleasant thing to do. But we are against the kind of naked, unbridled rapaciousness that gives the system such a bad name that it invites the kind of intervention that everyone will wish had never happened a few years on.
Between the bonuses and markets trading almost entirely on technicals and fantasies of the most benign order, we think it’s time to start buckling up. We can’t tell you from which direction the storm will come, or which week, let alone the day. We freely admit that we could lurch another five, even ten percent higher. But the handwriting is on the wall. It won’t be long before those last scoops of money are taken back.
We may as well start where the week ended, with the grande enchilada, the jobs report. For the optimists, the good news was in the November revision, which resulted in a net addition of 4,000 jobs from a previous report of –11,000 jobs. The gain was offset by a slightly larger downward revision to October, but many news outlets led with the story that November was the first positive print since 2007.
As you might expect, the market rallied on the news of the very wide miss of a loss of 85.000 jobs (the consensus was for no change, and many were predicting a positive print). What, you mean you didn’t expect that? Why then, it’s time for a quick rundown of market logic.
Despite the hand-wringing in the media over the economy, Wall Street considers the recovery a done deal. Portfolio manager cash levels are the lowest they’ve been since October 2007, when the market last peaked. Indeed, many expected a positive job result to confirm that the recovery was well underway and that managers would need to go back to obsessing over the next interest rate move – which, by necessity, would have to be upward. Hence, many felt that a good jobs number would end in a market sell-off.
But we got a bad one, so the Fed won’t be raising rates soon, and the good times aren’t quite here yet. Therefore, they must be yet to come, and so one must buy stocks now. The worse things are, the more room there is for improvement, see, so just keep buying because in the lingo of the modern trader: “if you wait for the move, you’re going to miss the move.”
Whatever your views on the merit of that logic, we can tell you one thing: it was indeed a dismal report. There were a few silver linings: professional and business services employment rose, as did temporary help hiring. Growth in the latter is thought to be a harbinger of additional permanent hiring.
Hours of work and the weekly aggregate index, which are fairly good coincident indicators, were unchanged – a mild disappointment, to be sure, but not a decline either. Although construction lost 50,000 jobs, about half of that is likely due to the unusually cold winter weather.
Yet the household report was a disaster. The unemployment rate may be reported to be unchanged, but that came at the cost of kicking an additional 661,000 out of the labor force. The household survey reported a drop of 589,000 in employment from November to December. In fact, since the end of the third quarter, the household survey claims a loss of 1.2 million people from the civilian labor force, along with an addition of two million people to the “not in the labor force” category. The inescapable conclusion is that employment is much weaker than it appears.
The folks at the Liscio report point out that adding together the number of people in continuing claims – reported to have fallen last week to a seasonally adjusted 4.8 million – to the extended and emergency claims programs, the result is approximately ten million. Meantime, bullish Street strategists celebrate the drop in the seasonally adjusted figure of continuing claims, ignoring the continuing growth overall total (when the c.c. benefits expire, the claimants drop into the extended and emergency programs).
That’s not all that they ignore – the unadjusted continuing number rose 388,000 last week, as opposed to the fall of 179,000 in the adjusted number. The unadjusted number of initial claims last week was 645,000, an increase of 88,000 from the previous week and a difference of 210,000 – fifty percent higher – than the adjusted number! That’s some special sauce, isn’t it? We don’t buy it, and neither should you.
Another number doing the seasonal dance is the ISM manufacturing result. It was all right, with a result of 55.0, and new orders increasing to 65.5, a very good number. However, there was apparently some strong seasonality in those numbers – seven points in orders, reported economist Dave Rosenberg. The survey responses were mixed, just like the Chicago PMI report the previous week. One can see why, with only nine of the eighteen industries reporting growth and seven in decline.
The non-manufacturing number for December came in at 50.1, a little below consensus and effectively showing no change from the previous month. New orders were slightly positive, at 52.1; employment continued ton contract but at a lower rate. The mix was a little worse than the manufacturing sector, with only seven reporting growth and nine reporting declines.
The ISM numbers aren’t so bad looked at absolutely, but as recovery numbers go, they definitely leave something to be desired. It’s an anemic picture. Factory orders rose 1.1% for November, but that was mostly due to a boost in energyrelated pricing. We should see more of a lift for December, if anecdotal evidence of increased auto production holds true. Motor vehicle sales rose, led notably by Ford (F) and Toyota (TM).
Pending home sales for November were a complete dud, falling 16% from October. A drop had been expected from the credit-expiration frenzy of October, but the magnitude of the drop was an ugly surprise. December doesn’t look any prettier to us: the Mortgage Bankers Association report for the last two weeks of December showed a rise and fall for no net change from the first half of the month. The levels are very low, well below this time last year.
Chain-store figures weren’t bad, but not great either. They were largely better than expected though, with some strength at the higher end. You’ve probably already heard what every shopper knows: there was much less inventory on sale. Units were down, dollars up, margins up. The consensus for overall sales for the month, to be reported next Thursday, is plus 0.4%.
Consumer credit fell dramatically again in November. Some wondered if the size of the decline (-$17.5 billion) didn’t mean that the fall must be nearly at an end. The increase in December car sales should give a lift to the total, but these disappointments are adding up. Construction spending fell in November as well, which wasn’t unexpected, but from a downward revised October, which made it worse and will be a drag on fourth-quarter GDP. Wholesale trade inventories rose, but it was all price-related: durables fell.
After that very large chunk of news, next week will be quite light. The retail report on Thursday is easily the report of the week, but the Fed’s Beige Book of regional conditions is released on Wednesday afternoon. Monday is empty and Tuesday brings the International Trade report, but the market will likely be more interested in Alcoa’s (AA) earnings report after the close. It’s the official kickoff.
Friday will be the day of the week, though. For one thing, it’s an options expirations day. For another, Intel (INTC) will report earnings after the close on Thursday, followed by JP Morgan (JPM) Friday morning. The morning itself is laden with data, with the CPI, New York Fed business survey and the Industrial Production report for December all coming before the open. That ought to spice things up. The University of Michigan’s initial consumer sentiment reading for January appears after the open.
StockWatcher is ready with a fresh idea, but we aren’t done buying it yet. Please watch this space.
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