Lexington, Massachusetts Investment Management
Lexington, Massachusetts Investment Management
10,000 Maniacs
"I have heard all the excuses everybody uses” - Natalie Merchant (10,000 Maniacs), What's the Matter Here?
Wall Street isn’t getting a lot of respect these days. The trip back across the 10,000 level on the Dow, accompanied by photos of veteran traders sporting celebratory hats from ten years ago, inspired a lot of sarcastic editorial cartoons around the nation’s press. At least those were funny. The bitter reproaches that decorated many an opinion column weren’t quite so humorous.
Not that this seems to bother our boys on the Street, where fast-money traders and mutual fund managers seem to be locked in some kind of weird symbiosis. The traders count on the fund managers to chase performance and buy every dip, while the fund managers count on the traders to rush back in just as soon as the dip buys are completed. It seems to be working. Despite all the talk about liquidity-fueled markets, very little new money has gone into equities in recent months. One could almost accuse the traders and managers of running a circular trading scheme.
Now that we have breached 10,000 on the Dow again, the new magnetic charm is 1100 on the S&P 500. It shouldn’t take long. It doesn’t make much economic sense, but that should never be mixed up with trading logic.
Leading last week’s charge were earnings reports from Intel (INTC) and JP Morgan (JPM) in the first half of the week. The two sent traders into a kind of frenzy, which at least in Intel’s case was somewhat deserved by its strong earnings. JP Morgan, on the other hand, saw declines in every business but investment banking and trading and raised their estimates of credit losses. You, dear reader, being a veteran reader of this column, will know to conclude that it was of course JP Morgan’s stock price that held its gains, while Intel was giving them back by the end of the week. It stands to reason.
It was a funny thing about those financials last week. To begin with, notorious banking Cassandra Meredith Whitney downgraded Goldman Sachs (GS) to a hold and said that she didn’t think much of the rest of the sector’s chances. It seems that Goldman had hit her price target, so she took it off the buy list. I guess that’s the kind of bizarre behavior one can expect from somebody who doesn’t have a retail brokerage force to feed. She may well have been right, as Goldman sold off on the news and results from Citigroup (C) and Bank of America (BAC) were a disappointment.
The other funny thing is that the sector’s results haven’t been that good. Did anybody actually read JP Morgan’s earnings report or Jamie Dimon’s remarks? Morgan and Goldman are making all their money from a prop trading and investment banking boomlet that doesn’t seem so likely to last – or so say the banks’ CEOs. Goldman, of course, is steering clear of traditional banking, despite its new status as a commercial bank. Rumors are that the company plans to go back to investment bank status.
Another rumor is that Goldman is going to try to show some discretion with this year’s bonus pool, lest it backfire on the company and/or sector. Even so, bonus accruals are running to record levels, and so the usual arguments are trotted out about paying people for their efforts and not losing top talent.
Excuse me, but Goldman’s big results the last couple of quarters have been mostly due to being in the right place at the right time, rather than to their levels of genius. Competition has shrunk dramatically (bye-bye Lehman and Bear Stearns) and implicit price guarantees have made it much easier to profitably trade certain securities. The company is operating under a virtual government guarantee. If you’re a corporate credit issuer, you can be sure that the one institution that won’t be allowed to fail is Goldman Sachs.
We don’t buy the argument this time out that Goldman is simply outsmarting everybody. They may be a clever group, but most of their success this year is due to their implicit government backing and a benign market for trading. Paying out billions to traders whose main talent has been just showing up, as Woody Allen might say, is more than a little ridiculous. Maybe the Street needs to keep up its fiction of how clever they really are.
Intel’s reports weren’t that great either, not when you consider that earnings and revenues are still down about six percent from the year before. GE’s results were a disappointment, as were those from IBM. For now, though, all anybody wants to talk about is beating expectations. Next week will bring a huge slug of earnings and a much better read on profit prospects, beginning with Apple (AAPL) on Monday.
As to the rest, bullishness is reaching dangerous levels. The market is convinced that it can’t go down this year and talking heads are jostling each other to get air time for their favorite picks. That’s dangerous enough, but mutual funds are practically out of cash to buy dips, and the retail investor still isn’t putting in fresh money. Maniacal bulls, complacency, and empty cash coffers – does it get any better than this?
With so much to choose from, it’s tough to say what the report of the week was. Maybe it was JP Morgan’s earnings report, which helped send the market flying, or if you’re a technophile, maybe Intel’s or Google’s (GOOG) strong results were the key. The Google results certainly helped its stock, pushing it up over $20, but were outweighed in the market by disappointing results from IBM, which couldn’t meet the raised bar of expectations, and Bank of America, which disappointed period.
Was it the retail sales report for September? Sales were reported to have fallen 1.5% from August, but the result was blamed on the “cash-for-clunkers” lump and Econoday enthused – sort of – that “otherwise, the numbers were surprisingly healthy for the most part” (italics added). The results beat forecasts for a 2.1% fall.
Good stuff, except that the results didn’t beat forecasts. Conspicuously missing from the Econoday report was the part about August being revised sharply downward. The markets just can’t seem to get enough of this game of comparing advance results against downward revisions, because it juices the numbers. But we might get a better picture if headlines compared like for like. This is especially true in retail sales, where the eventual totals have been coming in about a half of a percent lower than the advance data for a long time.
Comparing the two advance estimates, sales were down 1.9%, which was closer to the market’s estimate of (-2.1)%. Before you run out and buy a basket of retail stocks, you may also want to consider that on an unadjusted basis, sales were down 7.5% from August, or 4.8% excluding the auto sector. Companies don’t get to report seasonally adjusted earnings, although I’m sure that they often wish that they could.
Consistent with that is that the weekly sales data has flattened out from its year-on-year declines and are now running about a percent up. That sounds nice until you recall that sales were falling off a cliff a year ago, running double-digit declines from the previous year. In other words, there hasn’t been any improvement from last year’s abyss. The Commerce Department reported that the year-on-year decline in September was (-5.7%) compared to (-5.8)% for August, an improvement that will disappear with next month’s revision. Should we mention that if oil keeps going higher, it won’t help?
A good piece of news came from the Industrial Production report for September. Production rose 0.7% for the month, 0.4% excluding autos, and capacity utilization finally went back up over seventy percent (70.5). However, consistent with the retail sales report, the year-on-year decline is still (-6.1)% and underlying bits of weakness – business equipment up a sluggish 0.1%, boosted mainly by the automotive industry, construction and business supplies both declining – are worrisome.
In fact, looking at the numbers in autos and defense, any gain at all that isn’t based directly on government stimulus is hard to find. A victory for stimulus, but it doesn’t seem to be spreading to the private sector, where we are mainly seeing the other side of all the cost-cutting that’s been driving earnings improvements.
The regional Fed business surveys produced mixed results. The New York report nearly doubled its headline rate of change, going from 18.8 in August to an impressive 34.6 in September (zero is neutral). New orders, shipments and employment all showed strong gains, though inventories continue to draw down. The Philadelphia survey, however, showed a slowing rate of increase at 11.5, compared to 14.1 in August. The latter region is thought to be the best precursor of the next ISM national report. Employment and inventories fell, while new orders posted a small (and smaller) increase.
Looking at the business inventory data for August, which fell 1.5% overall, there seems to have been recent replenishment primarily in autos (stimulus) and in clothing, with the latter benefiting from the changing of the seasons. Outside of these sectors, there doesn’t seem to be a lot going on.
Insofar as inflation is concerned, it’s still mild on the consumer side, with the core rate at 1.5% over the last twelve months and the monthly indices advancing a moderate 0.2%. That result was also reflected in the regional Fed business surveys noted above, yet the respondents also complained of rising input prices.
Perhaps that will lead to a surprise in the Producer Price Index scheduled to be released next Tuesday, where neutral to down changes are expected. The continuation of such a trend could lead to a squeeze on profits, in spite of the cost-cutting. Export prices fell in September and imports were nearly unchanged, but the latter has surely reversed this month on the momentum reversal in the price of oil. That isn’t going to help any bottom lines outside of oil either.
The world has plenty of crude oil, with inventories higher than last year or the year before, but refiners cut production of gasoline and heating oil – both of which are also pretty well supplied and well above year-ago levels – and that news sent the price of oil soaring. The oil markets are usually driven by financial speculation, and that has never been more marked than the past couple of years.
A much-covered story that didn’t deserve it was the release of the Federal Open Market Committee minutes. Such juicy nuggets as “some firming,” and “some data suggested a modest recovery in consumer spending” weren’t exactly headline news. The staff increased its projection for GDP growth, but did not explain how they reconciled this with a simultaneous prediction of lower inflation and resource under-utilization. To tell the truth, we haven’t noticed much predictive value in the staff forecasts in recent times.
Jobless claims eased somewhat, though still stuck above the 500,000 levels. The unadjusted claims data rose sharply, however, and are still up ten percent year-on-year. Continuing claims are falling also, though that is due to time running out on the unemployed. That points to some upcoming softness in personal income. Mortgage purchase applications fell back sharply from the prior week, although refinancing activity is still strong.
A disturbing story making the rounds in housing, one that we’ve mentioned before, is that many former scamsters who infested subprime lending are now taking the FHA to the cleaners. Just what the industry needed – more bad loans. Realty Trac announced on Thursday that foreclosures rose another five percent in the third quarter. Monthly filings fell from the July and August records, but were still up 29 percent over the previous September. The damage is still concentrated in the usual states – California, Florida, Nevada, Arizona, Michigan and Illinois.
In a surprising development, the University of Michigan reported that its consumer sentiment index fell back below seventy when a gain had been expected. The survey tends to track stock market and economic headlines, making the drop all the more surprising. Could people not be taking Wall Street seriously?
Earnings should dominate next week, but news from the housing sector should get attention. The homebuilder’s sentiment index will start things off on Monday afternoon. September housing starts, reported on Tuesday, are expected to have risen a few percent from August, while the consensus estimate for existing home sales on Friday is for a gain in the neighborhood of four percent. That’s not a bad number, but seems rather timid in light of the weak August number and the presumed rush to take advantage of the expiring tax credit. Purchase applications rose smartly during the month. Price data for home sales traveling through the Fannie-Freddie pipeline are due on Thursday.
The PPI reports its prices on Tuesday as noted above; leading indicators are expected to show another big pop on Thursday. People will probably pay more attention to the coincident index, which given the cash-for-clunkers program, should show some pickup.
The Fed has a lot to say next week. The Beige Book, its compendium of regional conditions, is due out Wednesday afternoon. Governors will be speaking throughout the week, with chairman Ben Bernanke slated to speak on bank supervision on Friday morning at a conference on Cape Cod, and Vice Chairman Donald Kohn to follow later in the morning. Charles Plosser’s speech on monetary policy on Tuesday, however, may get the most attention.
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