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“Now it’s too late, though we really did try to make it.” – Carole King
"Whether it’s ugly last quarter, or ugly this quarter, my money is on ugly.” So spoke erstwhile trader and CNBC commentator Rick Santelli Friday, moments before the release of the fourth quarter GDP advance estimate. We couldn’t have put it better ourselves. The gory details can be found below in the Economic Beat, but know that last week was another bust, keeping January intact as the most busted one ever.
Some companies reported decent earnings, mostly pharmaceuticals and energy types, but by and large earnings stink. So do corporate outlooks, at least the ones that can be found, as confessing to total ignorance seems to be the latest trend in managerial wisdom.
Perhaps it’s another import from investment banking, where there’s been a bull market in ignorance for some years running now. You might have thought, given recent history, that ignorance had already reached overbought levels on the Street, but last week’s revelation that investment banks that have been clamoring for TARP funds decided to use them to hand out eighteen billion dollars in bonus money, suggests that ignorance on the Street has reached the bubble stage. Maybe one of the banks could get a market going in common-sense default swaps. You know, CSDS. There seems to be a market for it.
Coming back to earnings and outlooks, the reason they all stink, of course, is because the economy stinks. That’s a given, but the concept with which the market continues to struggle is the degree of stinkitude. Early December’s confident predictions of a second-half rally seem long ago and far away now. The announced time frame for the economy to recover is beginning to creep into the fourth quarter. The stimulus program, which was most popular when it was most vague, has lost its glitter. Looking at the details, nobody is getting quite enough money, but the total is still a dauntingly large number.
Seventy-five thousand job cuts were announced on Monday, but the market rallied anyway. Partly it’s because it was oversold, yet even so it was stunning to hear people talk dismissively about unemployment as “a lagging indicator.” That is so, and it is also usually the case that unemployment peaks after the economy has turned around. But here’s a helpful hint: it isn’t true that accelerating unemployment signals the end of a recession. That’s something different. It means we’re getting into the nastier part of it.
The truth is that layoffs are just getting warmed up. After a month of studying the plunges in demand and spikes in unemployment, we have come to our own, standing silent on the peak with a wild surmise kind of moment. We are cooked. Even if the credit markets were to thaw this quarter – and they are slowly but steadily doing so - it’s too late. The damage has been done. We are down three goals and it’s injury time, ladies and gentleman. Time to start thinking about next season.
That’s not usually a problem for the markets, because optimism about next season is as natural as the rain on Wall Street. But we don’t know when next season is going to be. We are almost certainly done for it for the rest of this year. The recovery isn’t going to be the quick bounce that the Street wants. It’s going to be slow in coming and likely to be even slower in development.
Therein lies a problem for equities. A lot of comparisons have been drawn in the last two years between current economic conditions and those that existed in the nineteen-twenties and thirties. Of late, the emphasis has been more on the indicators reaching nineteen-thirties-style stress levels. This has occasioned a lot of back-and-forth between those pointing out the similarities to the Great Depression, and those extremely annoyed persons fuming that the press is being highly melodramatic in equating that much worse time to our own.
It is most unlikely that we will revisit the misery levels of the nineteen-thirties. We may hit double-digit unemployment percentages, but not the twenty-five percent levels of the Great Depression. Yet there are some valid parallels, and while we are not going to have Great Depression II, we could have the Great Recession, or perhaps the Great Stagnation, or Depression-Lite.
One of the ways that we may resemble a cut-down version of the thirties is in the stock market. Despite the continually anemic economy of the earlier era, equities put on several furious rallies that in time fizzled out and gave back their gains. One may wonder why, but a primary reason was conditioning. Traders and investors had become conditioned to expect markets to recover and resume the “natural” upward course they’d become accustomed to during the Roaring Twenties. They didn’t know that the Depression was going to last years and years. It’s obvious to us because it’s history.
We aren’t far from that situation today. We’ve a generation or two of portfolio managers, investors and just plain traders who have grown up learning to buy the dips. Yet we’ve done an entire recession’s worth of contraction in just the last couple of months, and things aren’t getting any better this quarter. The cumulative effect on demand from accelerating unemployment and still-frozen credit is going to take a very large toll this year, thaw or no thaw, yet many traders are still milling about waiting for the band to start playing again.
For that reason, we think that the market could well see a series of busted rallies for the rest of the year. Each one will be accompanied by similar songs: the market rallies before the economy does, a program is going to cure all of our ills, six months from now the medicine will take. The odd uptick in some economic gauge will put the bulls back in front of the cameras for a week or so, and then we’ll see it all evaporate again.
We just visited Europe. Things over there are deteriorating faster than you may realize. For that matter, the global economy is doing the same thing. In December the IMF was predicting global growth of around 2% for 2009. Now it’s been cut down to 0.5 percent, the lowest in sixty years.
There is hopeful talk about housing affordability returning to average. But when that happens, it isn’t as if a gong will go off and people will pour of their abodes to buy houses. Unemployment is deepening. The banks want to cut credit card lines further, which would deepen our economic peril. Home prices could overshoot to the downside. It can happen.
Earnings reports are beginning to thin out, and next week also has the advantage of starting a new month and trying to rebound off the Dow 8000 again. That could give us a lift. Against that is a heavy calendar of economic data that could keep things volatile. If you feel the need to get long these days, your horizon should either be three hours or three years. Outside of that is likely to be outside everybody’s comfort zone.
The week was bracketed by reports with promising covers and sour contents. At the front end was the existing home sales report, which reported higher than expected sales for December. The market seemed quite content to cheer the headline number and run with it, which is understandable given the oppressively gray winter we’ve been trying to endure. Still, we couldn’t help wondering what the celebration was all about.
In the first place, existing home sales data has been much like the reports on continuing unemployment claims. They can and do both put in the occasional reversal, but the direction is unmistakably negative. In the second place, the “increase” in sales was essentially due to big slugs of homes being run through foreclosure. Almost half of the sales, 45% to be exact, were foreclosure sales.
The median price of existing home sales in the NAR report has fallen twenty percent in six months. You don’t need an almanac to know that that’s the sharpest decline since the nineteen-thirties. The year-on-year rate of decline is still accelerating. When distressed-transaction sales become half of the action in the midst of a price collapse, we don’t celebrate. The oft-repeated tale in the media described “low mortgage rates enticing bargain hunters,” but we don’t think that banks processing their collateral at distress auctions quite fits into the category of bargain-hunting.
At some point, lower mortgage rates are going to pull buyers into the market, rather than re-financers, as is the current case. Bond doyen Bill Gross of Pimco thinks that this might occur at rates of around 3.5 to 4 percent, which seems reasonable. But there are other variables. Banks have to remove the eight or nine padlocks that they’ve put on the barn door, as one wag put it recently. Buyers need to believe that prices will stop falling, which isn’t yet happening, and they have to have steady incomes, which is going in the other direction.
That all of these variables are still missing was made clear during the week. The Case-Shiller housing report showed continuing deterioration in November, approaching the twenty percent level nationally and over thirty percent on the West Coast, where those “bargain-hunting” foreclosure sales were being jammed through the courts.
On Thursday the new-home sales report set a new all-time low, going back to when records first started being kept in 1963. Need we remind you that the population was about half the current number that year? Sales dropped forty-four percent from the previous December. I doubt that any builder alive thought that such a number could become reality twelve months ago.
The supply of new homes for sale jumped to a new record too, of nearly thirteen months of inventory. That number probably doesn’t reflect true inventory run rates, being based upon last month’s record low, but the same thing can be said about the “reduction” in the existing-home sales inventory, which got a bump from the year-end foreclosure gala.
The wrong direction in employment continued, with new claims hitting a post-1982 high and continuing claims setting a new record. It won’t be long before we hit five million, further straining local governments, demand, housing, in brief, just about everything. Imagine what the number will be if banks follow through on their threats to cut credit lines.
Our renowned banking cleverness may also explain why mortgage rates continue to languish at five-and-a-quarter percent, and purchase applications remain stuck at low levels. Fearing losses, the banks won’t lend anymore, which in turn leads to further economic deterioration, thereby increasing their losses. Ergo, they will need the money for more capital to absorb the losses. It’s a wonderful world.
At the other end of the week, the GDP number released on Friday caused a brief flurry of buying by traders when the headline number came in at minus 3.8 percent, well below the consensus of minus 5.4 percent. Gross Domestic Product is frequently maligned, and rightly so, as a misleading reading of the economic temperature, and this latest result was a very good example of the number’s shortcomings.
Within an hour or two after the report’s release, a steady stream of economists started pouring out written and televised commentary to the effect that the report was much worse than it appeared to be, causing stock prices to turn around and eventually thud. The headline in Saturday morning’s Wall Street Journal summed up the turnabout: “Economy Dives as Goods Pile Up.” It referred to the unexpected increase in inventories, not due to any hopeful build by vendors but to their inability to cut production as fast as demand: personal outlays fell by (-8.9)%.
In a similar vein was the cliff-diving drop in imports, down (-15.7)% in the quarter. Since they’re subtracted from GDP, this seizure in demand mutated into a benefit for the GDP measurement, making it appear stronger while real economic activity got weaker. Real non-residential fixed investment (capital investment of the nonhousing variety) fell (-19.1)%, durable goods fell a stunning (-22.4)%, exports fell (-19.7)%. To an economist, those are eye-popping numbers. When the unwanted buildup in inventories reverses, the fourth quarter’s gain will become the first quarter’s pain.
Further evidence of the rapid deceleration in manufacturing was in the durable goods report for December and the Chicago PMI report for January. Durable goods orders fell (-2.6)% against expectations for a drop of (-2.0)%, but it was another report with details worse than the cover. Take out transportation, mostly propped up by jets for the military, and the drop was (-3.6)%. Take out all military spending and it gets even worse, a fall of (-4.9)%. It gets worse still: the tally for “non-defense new orders for capital goods,” which represents business investment, was minus 5.9%. All in all, awful.
The Chicago PMI (Purchasing Manager’s Index), which is thought to be a harbinger of the national ISM number due on Monday, fell again to a new 27-year low. The drop from an already miserable December showed not only a downturn still accelerating, with telling drops in employment and production, but an especially big drop in inventories. That fourth-quarter build is going to be a first-quarter teardown.
Consumer confidence remained mournfully weak, with the Conference Board reporting a new record low of 37.7 (don’t worry, they only go back about forty years) and the University of Michigan putting in another very low 61.2. Although both numbers were short of estimates, there was little reaction from markets that expected little.
The FOMC met last week in a time that was a far cry from the days of 2006-7, when the stock market would rally forever on the tantalizing promise of a rate cut and warning lights were laughed off as trivialities. Usually the FOMC meetings have the markets waiting in an exaggerated state of heightened anticipation, but last week had an anti-climactic feel to it. The rates are already in a range that is near zero and nobody is worried about them going up in the near future.
The main interest centered on what other things the Fed might do and what the outlook was. There was some disappointment that the purchase of Treasuries remains an idea rather than a promise, and while the Term Asset-Backed Loan Facility is talked about more than ever as about to happen, there weren’t any concrete details as to time and place.
The Committee outlook was grim but not unexpectedly so, with the usual hopes that things might get better in the usual six months, qualified with the usual downside risk rating of “significant.” The credit markets are easing, but economic deceleration is gathering speed. The report also managed to slip in worries about deflation without using the word. Clever lads.
The Leading Economic Indicators report, a big kahuna in its heyday, came out on Monday with a surprise headline gain of 0.3%. Like its cousins that week, the details were a lot worse. The Board predicted a continuing recession, noted that the downturn has accelerated and that the coincident index had experienced its largest six-month downturn since 1980. We would add that the increase was due mainly to the jump in the money supply, and that the increase in yield spreads that count as positive because they are usually a sign of accelerating growth, were in this case a reflection of panic.
Next week will have lots of depressing data for us to shake off. Maybe if something really bad crops up, like a seven-figure number in the jobs report, the markets will rally on hopes that all the stops will be pulled out. But with its recent run of bad luck, it probably can’t even get that.
The ISM data are due out, starting with manufacturing on Monday and services on Wednesday. Very little is expected of either, with the former thought to be in the low thirties and the latter in the upper thirties. It will be hard for them to surprise to the downside, but continued record lows in new orders might weigh upon market sentiment.
Personal income and spending for December, largely telegraphed by Friday’s GDP report, will come out before the open on Monday. People will be on the alert for signs of deflation or accelerating spending declines. Also on tap is construction spending, also with expectations set quite low. Nonetheless, if all three of the monthly reports come in on the low side, we could see a cumulative effect on stock prices.
Pending home sales for December are due out on Tuesday, and there may be a pickup from year-end factors (like banks writing off more loans and taking foreclosed homes onto the balance sheet). That could give us another head fake in stock prices. Motor vehicle sales come out the same day, but the markets seem to have largely written them off. We can’t help but think that they should have neared some sort of intrinsic minimum by now, increasing the chances for a monthly bounce. It would certainly help them in Congress.
Factory orders are due out on Thursday, and given the drops in durable goods and energy prices (non-durables), should show another sizable decline. Same-store sales reports for January are due from the ever-shrinking group of retailers that still report; most of the attention will be on just one, Wal-Mart. Productivity and costs report before the open on the same day, and we will also have heard from the Banks of England and the European Union. The latter has been good for the occasional bit of Ionescan farce.
Friday is of course the big cheese, le grand fromage, the jobs report. Or is it this time? Market expectations are once again very low, something north of five hundred thousand with outliers reaching as high as seven hundred and fifty. Given the timing of the measurement period and that companies are really only starting to warm up with layoffs, though, one might see a number that isn’t yet so bad. Probably the most attention will be on the revisions, to see if the recent trend of big downward additions continues.
In summary, it will be a week very busy with economic data, probably another week of ugly data, and another week that will be even uglier to write about, when all the little uglies are put together. Stimulus or no, we’re up against it this time. Sometimes you just can’t blame traders for wanting to focus on technicals. The rest is too depressing.
Stockwatcher returns next week.
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