Lexington, Massachusetts Investment Management
Lexington, Massachusetts Investment Management
March Madness
“I'm afraid I can't put it more clearly”' Alice replied very politely, “for I can't understand it myself to begin with.” – Lewis Carroll, Alice in Wonderland
Another week, another percent, another round of March Madness. Rounding into the Final Four of the NCAA basketball tournament – the subject of office pools around the country – and the final four days of March (Friday is a stock exchange holiday, and we’ll spot Thursday the 1st), the markets are up around six percent and looking to add to their lead.
Should they? A fair question. Will they? Almost certainly. We’re riding the springtime momentum wave coming into quarter-end. That means marking the close – or at least keeping it from going down – and the anticipation of the first day of the month, usually a price pleaser. Thursday, April 1st may not quite get the usual welcome, though, since the jobs report is due the next day and traders will want to square off.
But a sell-off doesn’t appear to be in the cards yet. The market is still looking forward to April and the anticipation of first-quarter earnings. The main danger over the next couple of weeks isn’t Greece, or China, though they have certainly have the capability, but the relentless rise of stock prices. 1200 on the S&P, 11,000 on the Dow, 700 on the Russell 2000, right now those nice round numbers are flames to the moths. We should punch right through all those levels, probably this week.
That will leave 1250 on the S&P as the next obvious target. And in all likelihood, we will head that way. However, getting there isn’t going to be as easy as 1200, and the faster we approach, the more dangerous things will get.
If we do approach 1250 by the middle of April – what the momentum favors – we will already have spent most of the good news that the first quarter might bring. There will be very little room for disappointment, or even caution. That’s not to say we couldn’t get higher, because springtime rallies have a way of lasting into early May (hence the old adage, “sell in May and go away”). But they can founder in April, especially when expectations have left no room for error.
Turning to Greece, the situation is playing out in classic fashion. The playbook for these crises is that the markets get nervous at the revelation that all may not be well. Tip-of-iceberg stories circulate, and opinions square off in the press. Then some sort of program is announced – as just happened – usually followed by a riptide reversal that flushes out the shorts and seems to validates the generally bull case. Markets rise to further highs.
Later it will turn out that the program couldn’t possibly fix everything, but that bill always comes later, so make hay while the sun shines. In the meantime, you see, the increasing mantra will be that you’re going to get left behind. Thus the pitcher of kool-aid is prepared.
The China situation keeps flaring, but markets have a wonderful ability to ignore such problems until it’s too late. It may seem preposterous in view of the crash of 2008, but as behavioral economists like to point out, people have a way of remembering their victories and forgetting their defeats. A recent article in the Financial Times reported the classic syndrome of horse race bettors who will lose all day, yet only remember the name of the horse that won.
For example, retailer Best Buy (BBY) reported earnings last week that beat expectations and set retail stocks on fire again. The company is reaping the benefits from the demise of its main competitor, Circuit City, relief spending and lower prices on flat-screen TV’s. Moving up the income scale, the rising stock market and big China stimulus has driven sales of luxury goods back up.
It’s only a rebound that is about to hit the top of its arc, yet Wall Street analysts follow suit by drawing a straight line through the spending straight up into the distant horizon. It won’t happen of course, it never does. But the hustle and bustle has a way of pulling the curious into the rabbit holes. We remember the cheers and forget the tears.
In the fall and winter of 2006, the budding deterioration in new home sales began to accelerate. Far from causing homebuilder stock prices to weaken, however, the declines rallied them, on the grounds that it would facilitate a needed clearing out of inventory. Wall Street is a discounting mechanism, the sages explained. They’re looking ahead. Yes they were, but only to the next day’s trend.
Roll forward to last week, when the monthly sales rate for existing home sales set a new all-time low, at least since records began in 1963. The population was a tad lower then, too. Homebuilder stock prices? Up of course. The popular Spyder ETF XHB rose three percent, making it a nifty ten percent over the last month.
It stands to reason, you know. If new home sales are setting all-time lows, then they must be poised to rebound soon. Really, really poised. And you know what they say on the Street – if you wait for the move, you’ll miss the move.
New home sales did indeed fall for the sixth month in a row, and the low set by the February sales rate eclipsed the old record low that was set all the way back in January 2010. That’s right, the month before. Months of supply crept back up to 9.2 months, the highest level since last May (the last time we anticipated the bottom, no doubt), and the average amount of time to sell a new house hit a new record of 14.4 months.
Sales of existing homes also fell in February, to an annual rate of 5.2 million, with some disturbing-looking ingredients mixed into the stew – foreclosure sales made up 35% of the total, and all-cash sales 27%. The supply of homes for sales rose a startling 9.5% to 8.6 months, which the National Association of Realtors admitted to be “discomforting.” The latter suggested that it might be due to stepup buyers trying to sell houses and take advantage of the expiring tax credit, but as Diane Olick reported in her realty blog, that seems hardly likely in view of the fact that the credit expires in five weeks.
What is more likely, as Olick and top housing analyst Ivy Zelman has suggested, is that banks have become more efficient at moving the foreclosure process along. It does make sense that with a year of rebuilding profits under their belts and the advent of a new year, the banks would switch their approach from hiding their collective heads in the sand to something more direct.
Such an explanation has several virtues. It dovetails with Bank of America’s (BAC) announcement last week that it would begin a principal-reduction program for much of its lower-quality portfolio – the bank probably feels it’s about had its fill of giving homes away at twenty or thirty cents on the dollar. An acceleration in foreclosures would not only explain the sudden increase in listings of existing homes, but also why homebuilders have been struggling to sell existing inventory: too much competition.
Homebuilders KB Home (KBH) and Lennar (LEN) both reported quarterly results last week, and note that we did not use the word, “earnings.” Both companies reported another round of losses, but - the losses were smaller than expected! Time to buy the homebuilders!
Now before we are accused of being too harsh, we’ve been saying for months that homebuilding is in a bottom. The major builders have been recapitalized nicely with the help of massive tax refunds that helped them recover from their stupidity. The industry sentiment index may be near its all-time low while industry executives talk about uncertainly and scraping along an uneven bottom, but we know that when they release results they are hopeful about a return to profitability sometime in the second half. Imagine that – a CEO hopes in the first quarter that business will pick up by the fourth quarter. What a novelty.
Yet if Lennar’s stock price was around three dollars or so, we’d be buying it, on the grounds that they should make money in 2011. Unfortunately it’s going for around $18.50. That’s an awful lot of recovery already priced in.
Sure, the homebuilder stocks could go higher – it’s springtime, and prices are riding high on momentum. But they are no investment at this point. Unless you can sit in front of a monitor (or pay someone else to) and watch prices all day long, as professional traders do while they talk to other professional traders (and we don’t mean bulletin-board coconuts), you will most likely see any paper profit turn into a real loss faster than you can react.
Homebuilding ought to begin a slow recovery at some point soon, yet home prices themselves could give up another ten to fifteen percent this year. Foreclosure, delinquency, and unemployment rates are still high, and mortgage applications are barely moving. The federally-based mortgage price index, the FHFA index, fell in January and December was revised down further. We’ll find out more when Case-Shiller price data will come out on Tuesday.
Moving outside of housing, durable goods orders for February rose 0.5%. That was below consensus, but after factoring in an upward revision to January, the dollar amount for February was about right. The private business investment category, non-defense capital goods excluding aircraft, rebounded 1.1%. There was also evidence of small increases in inventories.
Fourth-quarter GDP was revised downward to 5.6%, although we believe that the increase continues to be exaggerated by a dubiously low rate of inflation. At any rate, the fourth quarter is fairly old news at this point and the market was duly indifferent. Another non-event was the second consumer sentiment reading for the month from the University of Michigan: it came in at about its expected value, 73.6 versus a consensus estimate of 73.0.
Jobless claims continue to be a big story every week, and last week’s drop to 442,000 (versus consensus for 450,000) was warmly welcomed by the markets. It added some fuel to the frenzy that has the market expecting big things from the March jobs report due to be released next week.
That jobs report, set for Friday the 2nd, rates to be unusual in a couple of respects. To begin with, it is one of the rare times that a jobs report is going to be released on a day that the stock exchange is closed! How often does that happen? The answer is, only when Good Friday falls on the first Friday of April. Your next question might well be, how can that happen?
There is quite a bit of amusing nonsense that floats around concerning this question, so this year, in honor of the cosmic convergence, we are going to tell you the real reason why the equity markets are closed on Good Friday (apologies if you were looking forward to a fine joke, but this is the real thing).
The New York Stock Exchange was founded in 1792, not long after the founding of the republic. In those days, a small group of twenty-four traders, brokers and merchants famously met under a buttonwood tree and signed the Buttonwood Agreement. Most of the trading, though, took place in a coffeehouse, especially during inclement weather, and the original group officially moved into a coffeehouse the following year.
The club would meet for a couple of hours in the morning, break for lunch, and then go a couple more hours in the afternoon. Before that gets you to longing for the good old days, though, you should know that they also met Monday through Saturday, as back then Saturday was just another working day in predominantly Christian early America.
There were very few national holidays at the time, but July 4th and Christmas were two of them. How did Good Friday get on the list? It was never a national holiday, but as Easter Sunday, not Christmas, is the most important holy day on the Christian calendar, for most of history Easter Sunday was the biggest holy day of the year in the West. Good Friday commemorates the day of the crucifixion of Jesus Christ, and Easter Sunday observes the resurrection two days later.
Tradition has it that Christ hung on his cross on that Friday afternoon. So in deference to those grueling hours, the faithful were expected to put aside earthly matters during that time and focus on more spiritual things. Trading stocks was definitely not on the list. Rather than meet for a couple of hours in the morning – which would have looked a bit unseemly - the brokers simply took the day off.
Officially the United States has no religious preference, so government offices do not close for any such holiday except Christmas, itself a centuries-old holiday in the West. Thus the jobs report will come out at its usual time. As for the Exchange, it’s a traditional place and while it does occasionally drop holidays (it used to close on Veteran’s Day, for example, in honor of the end of World War I), we doubt that it will lose Good Friday.
The bond markets will be open, though, with 12:00 the recommended closing time. How that came about is another story and not terribly interesting, so let’s move on to the other unusual aspect of the job report, namely the massive increase that the markets are expecting. The consensus for the jobs report is for an addition of 200,000 jobs, after last month’s loss of 36,000.
We’re wondering how the number is supposed to get there – let alone get to the whisper number of 400,000. While it’s true that initial claims have eased off the last two weeks to a mere 450,000 or so, the four-week moving average was still 475,000 going into the end of the measurement period. So what is the market counting on? The magic formula is supposed to consist of new census workers (temporary, but workers nevertheless), plus a slowdown in construction layoffs, plus a big snapback from the February snowstorms.
The last addendum is a bit of a puzzler, since the BLS has been claiming that weather had no impact on the February totals. The markets have looked at the matter differently, happily blaming any and every shortcoming of late on the snow, and marveling that any half-decent piece of news (e.g., Best Buy) was able to come about in spite of it.
We will certainly be surprised if the number even meets consensus. Granted that it’s springtime, that the BLS births-and-deaths model is still adding non-existent jobs, that the census workers will indeed be counted, and a big seasonal adjustment is in the cards. Construction usually does start to pick up at this time of year.
But there has been little evidence elsewhere of such a jump. Some of the regional Fed surveys have finally shown increases of late in their employment categories, but the bumps have been mild. Confidence surveys haven’t shown any improvement that might be tipping off better conditions.
We would also caution that if by some chance the whisper number did come about, the markets would probably sell off on fears that the Fed tightening schedule had suddenly moved up. Absent a freak, though, equities will try hard to find a reason to rally, because it’s what they do after jobs reports. But the long weekend in between could make things interesting.
Next week is filled with big reports, and is a month-end week to boot. Monday will start off with personal income and spending for February. Tuesday brings the aforementioned Case-Shiller report, but expect that to be overshadowed by the Conference Board’s report on consumer confidence for Tuesday. It’s usually a market-mover.
Since Friday is a holiday, we expect that the markets will pay extra attention to the ADP report on payrolls on Wednesday. It will be followed that morning by the Chicago PMI (consensus 61) and February factory orders (consensus 0.4%). The Chicago report will in turn be followed on Thursday by its national cousin, the ISM manufacturing index. The expectation on the latter is for no change from February.
Thursday should be the day of the week, then, comprising the ISM, initial claims, motor vehicle sales for March, two more employment indices, February construction spending and a heavy Treasury calendar. It’s also the first day of the best month on the calendar for equities. Get ready for another cup of March madness.
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