Lexington, Massachusetts Investment Management
Lexington, Massachusetts Investment Management
The Time of the Season
"It’s the time of the season, when love runs high.” – Rod Argent (The Zombies), “Time of the Season”
One week is starting to look very much like another this spring, We rally for some number of days, then have a “correction” that may last a day but sometimes only an hour or two. In any case the pullback costs very little, and there has been practically no change to the narrative.
The press is taking an increasingly rosy view of things. They have to explain why the market keeps going up (the Dow hit an eight-day winning streak last week), and there has always been a reluctance to admit how often the tape is ruled by short-term momentum. The herd instinct runs strong in the animal kingdom. Besides, too much skepticism by a national reporter these days can invite a storm of accusations about being ignorant, a saboteur, or both.
Friday’s tape did see a small pullback, major by the standards of the month, leaving the market still over-extended in the short term, but in a firmly bullish posture in the intermediate term. A historic health-care bill that was passed Sunday night will probably generate some reaction on the Street, but it will be mostly noise. Yet it may push the pullback to a second day. We usually get a short hiccup in March, so we’re due, but the calendar is running out and the mood hasn’t let up.
Another week of a rising market might disappoint conservatives, who will be apt to predict Armageddon in the wake of the new legislation. But they should take heart – a correction in the market between now and the fall appears to us to be not only likely, but increasingly likely to be steep. Such a correction would have nothing genuine to do with health care, of course, but that wouldn’t stop politicos from seizing upon it for their pet rants and raves.
The same potholes still loom every week, being mainly the dangers of some sort of Greek-Eurozone dust-up or a piece of unwelcome news from China. We probably need to get at least another five percent higher, though, perhaps ten, before the equity markets start to become truly vulnerable. Complacency is starting to get a bit heavy, but isn’t unusual by the standards of the season.
We attended a series of investment presentations last week, as it happens, and the slate featured outlooks by heads of equity and fixed income for a major mutual fund organization. Both ran true to form, in that the equity chief was optimistic and his fixed income counterpart worried. Nothing new there.
But the thing that struck us as odd was that the bond guy wasn’t really worried about rising rates or inflation, the way one would expect from a fixed-income general exposed to your average rising stock market. He was actually worried about the possibility of some kind of double-dip, and was quite pessimistic about the outlook for housing prices.
For the bond guys to worry, that’s normal. For the bond guys to be worried that the economy might be heading back down while the equity guys are sure it’s going up, that’s not normal. We’re not encouraged by the knowledge that it’s usually the bond guys who get it right in these situations.
We’re not looking for the double-dip ourselves, only for the bounce of the rebound to settle. But that leaves a double-dip in the stock market quite likely, and the knock-on effects could drag things down for a quarter or so.
Will it happen? We don’t know. We do know this, though – that the stock market very rarely corrects in the springtime, and that momentum markets hate to give up at all, let alone easily. We know that trading-system advertisements have been proliferating again, that retail investors are still skeptical, yet institutional buyers are heavily bullish and running out of cash.
We know that the markets are about 25% overvalued using the Shiller normalized earnings, but that number can go to 40% before it gets a nose-bleed. We may be due for a pullback, but there’s no evidence that the market penchant for trying to squeeze the last buck out of a trend has changed. It’s springtime, and the time of the season still calls for an up tempo.
“Fed signals optimism over US economy,” proclaimed the headline in the Financial Times. They did? Was it the part about keeping interest rates at zero for an extended period? Actions speak louder than words, it is said, so one might conclude that despite the professional hopefulness, the Fed is still so concerned that it’s keeping rates at zero. Well, the press has to write something.
The industrial production data for February was middling. The increase of only 0.1% was expected, though the decrease of 0.1% in manufacturing wasn’t. But manufacturing output has been following a sputtering pattern of alternating decent increases with small declines, the kind of thing you might expect from a recovering sector not quite firing on all cylinders. Overall it’s going up.
However, manufacturing capacity utilization did decline last month, and the total would have declined as well but for an increase in utility output that was weather-related. In a similar vein, the leading indicators were only able to manage a minimal increase of 0.1%. That is consistent with an economy that is bouncing off the bottom, but the bounce is nearly finished.
Yet the New York and Philadelphia business surveys for March released last week both showed expansion. That points to manufacturing output maintaining its pattern, and follow last month’s small decline with a more robust gain for March. Thus, the ISM and industrial production data for March will show an increase that is consistent with the “V” narrative, What’s more, the releases will arrive in early April, the best calendar month for the stock market. The bulls will love it.
The buy narrative is all about technology and a classic manufacturing rebound now. Ergo, we are encouraged to ignore such things as the housing market, which the stock market is only too happy to do. The homebuilder’s sentiment index fell this month, as did housing starts last month, but not to worry – the magical snowstorms of February immediately got the blame.
But housing permits fell as well, which isn’t weather-dependent. In fact, the sentiment index isn’t supposed to be affected by weather either – although there is one possible explanation: the homebuilders had never seen snow before. Yes, it stands to reason. Doubtless they are still getting over the shock.
The grand “V” isn’t having much effect on prices, either, excepting food and energy. Import and export prices both fell in February, as did the Producer Price Index (PPI). The Consumer Price Index (CPI) was unchanged. That was largely due to the stock market dip taking commodity prices back down with them; when equities bounced back, so did commodities (supply and demand are practically irrelevant). The latter have been moving up and down entirely on speculation, yet one still reads stories attributing increases to the ‘strengthening economy.’
Employment, despite its excuse status of a lagging indicator, has continued to worry the market. Initial claims have stayed stubbornly high. The four-week moving average did ease slightly last week, but is still above January levels. Yet the mood on the floor of the NYSE was positively giddy by Friday, with talk of the March jobs report showing a consensus estimate for a gain of 200,000 jobs, with the ‘whisper’ number being 400,000! From what we can see so far, it would take the granddaddy of all seasonal adjustments to get us there.
We’ll get the rest of the monthly housing update next week. Existing home sales for February are due on Tuesday and new home sales Wednesday, with not much change expected for either. February is the least important month of the year for home sales, so unless one pitches a big surprise, the reports are likely to be quickly forgotten. Some house price data is on tap as well, but is unlikely to move equities.
Durable goods could be the report of the week, with the report for February due Wednesday. The final (sort of) revision for fourth quarter GDP comes Friday morning, with no change expected to the still-unchanged estimate of 5.9%. At this point the market’s interest in last quarter is fairly minimal, and for ourselves we have never believed it. One problem is that the result uses an annual inflation rate of 0.4% in the fourth quarter, a number we think ridiculous.
The last consumer sentiment reading on March is due on Friday morning. The recent market rally and improved tone of headlines should have pushed it up a bit, but we don’t think it’ll have much impact absent a big positive surprise. Unless durable goods or initial claims produce a really ugly result next week, the pattern of bias confirmation should hold. Positive news will be feted, negative news ignored.
Avalon Asset Management Company is a Registered Investment Adviser
Avalon's MarketWeek is not intended as a market timing newsletter or service. No buy or sell recommendations are made for any of the individual stocks mentioned on the site, and neither Avalon Asset Management Company nor its officers, directors or employees make public stock recommendations. Please address comments to MarketWeek@AvalonAssetMgmt.com