Lexington, Massachusetts Investment Management
Lexington, Massachusetts Investment Management
Rally Crackers
“I'm ready to go anywhere, I'm ready for to fade.” - Bob Dylan, Mr. Tambourine Man
Well, one thing is clear: we can’t say the market is complacent anymore. Last week’s air pocket, presaged by a couple of dips and swoops the week before, has the “Fasten Seat Belts” signs illuminated. The drink cart has made a hasty retreat back to the steward’s station, and fingers are beginning to wrap tightly around the armrests. Go ahead and try to look blasé, but another fall like the one we just had will wipe out all bored looks.
Losing five percent in three days on the Dow – it took the S&P about a week – is not a common occurrence. The two-day drop at the end of the week was the steepest stumble we’ve had since the March lows. Are we going lower? Maybe. Have you got your blame gun locked and loaded?
The shortest explanations are usually the most popular, because they are easily understood and repeated. That they are almost never right matters little, any more than the fact that J.R. Ewing was some improbable made-up guy that never existed – half the country still spent months wondering who shot him.
So you might read that it’s Obama’s fault – blaming the government is always in fashion. All presidents have a blame target on their backs, and Democrats are never the party of choice on Wall Street. Or you might read that it’s the deficit, or the dollar, or some kind of cabal up to something. You could even blame Scott Brown. His election upset win for the Senate seat in Massachusetts was followed immediately by three days of carnage.
Leave all of that stuff to the tabloids, and get back to basics. To begin with, let us recall the law of gravity. It may take time to do its stuff, but it has a really good track record when it comes to bringing things back to earth. Put another way, trees don’t grow to the sky. By the second week of January, the market had risen nearly 500 points on the S&P since the March low. For those of you keeping score at home, it works out to approximately seventy-three percent in less than twelve months. Want to know how many seventy-percent calendar years the S&P has had? Not one.
The second problem was rampant complacency. Momentum trades usually fade when all resistance has evaporated. Recent polls of money managers have shown near-universal bullishness, with the overwhelming favorite being the view that although the second half might bring problems, for now we were good to go.
This particular view overlooked a number of structural problems that were indisputable. One was the low volume of the move, always a sign of underlying weakness. Very little new money came into the market during our seventy-percent move, and without a strong tide of new money, rallies cannot ride out the inevitable piece of bad news. By late November, it was widely accepted that the market was going to cruise into the end of the year on autopilot, as nobody had any interest in trying to upset the applecart and mess up the big fees that were waiting to be collected. After that, the thinking went, we were on our own.
Yet as we drifted gently higher through the ever-balmy month of December (for the stock market, anyway), that turn-of-the-year problem was forgotten and traders were lulled to sleep by the tape. The one-way ride lower by the VIX volatility index to fresh 52-week lows in the early part of the month caused us to ring the alarm bell a couple of weeks ago. We certainly weren’t alone on that one. When the typical leap forward at the beginning of January is accompanied by very little new money, it isn’t a good sign either.
The crumbling began with Alcoa’s (AA) disappointing earnings a couple of weeks ago. We don’t want to put too much stress on that one, because the markets have become accustomed to Alcoa disappointments. Even so, it didn’t fit the recovery narrative. But when Intel (INTC) put out a solid earnings report a couple of days later and sold off on the news, veteran traders arched their eyebrows. Selling on the news isn’t exactly new on the Street, and chip stocks coughing up blood after crushing estimates has been seen before. But it usually means call a cab, because the party is about to break up.
At that point, every stock that didn’t rally on earnings was going to compound the problem. The real measure switched from the size of the beat to the size of the post-announcement move – and every company that couldn’t hold a stock price gain from its earnings announcement raised the level of doubt for the next one.
There are other problems, of course. Grecian problems have been in the headlines for weeks. The economic data, particularly in housing and unemployment, has started to weaken again. Probably most alarming of all for many is the steady parade of moves China has made to rein in expansionary policies. China is supposed to be the global growth engine. That has commodities weakening too. Treasuries, universally agreed to be the worst place to be at the beginning of the year, are doing what universal trades always do – going the other way.
Are we in for more red ink then? The logical answer is probably, and it would be a good idea to put up the storm shutters. But nothing on the Street is ever a sure thing. Take the China situation, for example. It’s only recently that worries about China being in a bubble, or near-bubble, have started to gain traction in the financial community.
Typically, though, such situations do not come apart during the early warning period or the first time of stress. More often there is an initial mini-correction, followed by a vicious short-squeezing rebound rally that aims to put the doubters to shame (and possibly allow the craftier players to exit at a more advantageous position). Then we get the big sell-off.
It must also be said that late January sell-offs are a pretty common occurrence, and are often followed by rebounds. This is a trader’s market that we’re living in now, without any steady rush of new money to prop things up, so such an event would be fairly standard practice.
The first bout of anxiety that things might be really, really bad is often too dramatic to sustain itself, and can easily be subverted by a bit of bargain-hunting that turns into a stunning two-hundred point squeeze-rally. Bulls announce it was all a silly case of nerves and the buying resumes – while the craftier veterans quietly begin unloading their positions. When the next case of nerves turns up, there are no more buyers. Ouch.
But isn’t it supposed to be all about earnings? Ordinarily, yes. But the news out of the financial sector has been mixed. Earnings are good, but credit losses haven’t stopped going up. The doubling and tripling moves in many of these stocks has left many owners in a state of sell first and ask questions later. Remember, 2009 is over and those bonuses are safe. 2010 starts a new performance year.
Although Goldman Sachs (GS), ever the shrewdest in such matters, discreetly cut cash bonus payouts, most of the bigger banks were too pugnacious (and, one might argue, too spoiled) and practically begging for the kind of fight that the President offered. At other times such sparring might have been overlooked, but not at the moment.
Far more serious than the bank tax, though, was the worry about the Bernanke confirmation. It isn’t that the Fed chairman is idolized on the Street, though he certainly gets at least a passing grade. But it’s well known in financial circles that the surest way to put a country’s currency into a death spiral and start a financial tsunami is to put the central bank under political control. Even a whiff of it is always good for a scare.
Taken individually, lightweights like Senators Barbara Boxer, Jim Bunning or Representative Ron Paul tend to be passing sideshow acts of little import. But during times of crisis, the bonehead factor always goes up dramatically. As the old computer programmer saying goes, “garbage in, garbage out” and that is exactly what the Street fears. Let us pray that cooler heads prevail, or times could get interesting. And that, dear reader, is an ancient Gypsy curse.
The funny thing about last week’s data is that the Leading Indicators rose more than expected, led by the steep yield curve. The gain of 1.1% (consensus called for +0.7%) was also boosted by building permits. It’s ironic, because most of the rest of the data disappointed.
The areas that seemed to weigh heaviest on market sentiment were jobless claims and homebuilding. Claims rose again, creeping back near 500,000 with a result of 482,000, about a ten percent jump from the week before. Although the unadjusted claims actually fell by 150,000, the unadjusted number of some 650,000 is still very high and only 100,000 below the equivalent week a year ago. Since the year-on-year comparison was 150,000 lower last week (about 800k vs. 950k), the smaller gap meant an increase.
These are not good numbers. Although it wasn’t as widely disseminated, the Liscio report, which is gaining traction on such outlets as CNBC, reported that state employment rolls fell nearly 200,000 more than the BLS national total of (-85,000) in December, with a sharp rise in the number of states experiencing large increases in the unemployment rate (including a 0.7% jump in Massachusetts, where the voters were plainly unhappy). If the January employment report doesn’t show some improvement in a couple of weeks, look for more market and political turbulence.
Although building permits rose 10.9% in December, the 6.9% November increase did not translate into an increase in actual starts, which fell 4.0% in December. The numbers could always be revised, but the homebuilder’s sentiment index probably won’t be, and it fell a tick to 15. The change from 16 means little, as the index has been stuck around this level for many months, but it didn’t come at a good time.
Next week brings the larger portion of housing news, and the market is obviously going to be apprehensive about the reports. Existing home sales are due for release on Monday, but we should point out that there is some possibility of an upside surprise there. The big drop in pending home sales has led to a consensus guess-timate of a ten percent drop in existing sales. That certainly leaves room for a fall that still has a positive “surprise.”
Tuesday and Wednesday will bring the Case-Shiller and FHFA home price indices, followed by new home sales. The price index data will be for November, when the tax credit was presumed to be expiring, so the rush to get in the door might mean a lift in prices. It might be mix-dependent, it might not be significant, but it would be welcome to the market anyway, while a drop will weigh heavily.
The consensus for new home sales is for an increase in December, but after last week’s data that estimate has to be at risk. Media reports about deteriorating trends in foreclosures and late mortgage payments have put nerves back on edge again. Purchase applications did rise again last week, but the small increase had little impact at such low activity levels.
Food and energy price movements led the Producer Price Index (PPI) to rise 0.2% last month versus the consensus for no change, yet the core rate remained unchanged. Putting aside the rebound from the collapse in energy prices at the end of last year, it’s hard to see any inflation in the system yet. The money supply fell last week, and so did the Fed’s balance sheet. Retail sales remain moderate, and the Philadelphia Fed report showed flat output prices.
The Philly Fed did show an increase in its survey, at 15.2. That was good, but the increase slowed for the third month in a row and came in below expectations, which wasn’t so good. The increase in new orders was very mild at 3.2 – at least the employment index rose as well. Along with the New York report, it still points to a positive national report for Monday the first. The last regional installment before the latter comes next Friday, with the report from the Chicago area.
There is much to occupy the market besides housing news next week. The calendar is so loaded with earnings and data that it will be difficult for any one event to dominate, and news out of other countries (Greece, Ireland, China) could well set the market mood.
The Fed’s Open Market Committee (FOMC) statement on Wednesday is ordinarily a major market event, but of late the typical reaction is to spend the rest of the day torturing the text over a few minor changes and then forgetting about it within twenty-four hours. Nobody is expecting a lift in rates, and Bernanke’s confirmation story is likely to overshadow the statement anyway.
Putting aside earnings and other countries for the moment, housing should highlight the first half of the week. The back half will be about production: durable goods on Thursday, and on Friday the first estimate of fourth quarter GDP, followed later by the Chicago PMI. Durable goods fell in November, so the market is expecting a pretty big rebound in the December data. As for GDP, the consensus has been around 4.5%, but more recent forecasts have been moving well north of five percent.
Two consumer confidence surveys come out next week, first the second January report from the University of Michigan, then the older and somewhat more influential confidence report from the Conference Board (Friday). They risk getting drowned out by all of the other events, but if jobless claims were to move up again on Thursday, for example, followed by a drop in the confidence number on Friday, the combination could rattle the markets and overshadow the GDP number.
Oh yes, President Obama’s State of the Union speech is Wednesday night. The equity markets aren’t especially sensitive to the annual event as a rule, but they are when feelings are running high: fear, confidence, or in the current case, anxiety. The Street leans politically to the right, broadly speaking, so if the market is still correcting by the time the President speaks, he’s going to get the rap no matter what he says. It’s the nature of the Presidential beast: they get too much credit for the good times, and too much blame for the bad.
StockWatcher will return next week.
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