For traders, it's probably time to take some money out. For investors, it's time to look at something else besides the stock tables. Christmas cookie recipes, perhaps.
The good is that the market has recovered from its post-election sell-off, a decline driven largely by sentiment. So was the recovery, aided by a mix of hope, technical factors and generally benign news flow: Greece got its latest bailout, the Fed telegraphed its latest installment of accommodative policy, and Washington hasn't pulled down the roof over our heads (yet).
The bad is that the recovery is living largely on carrots, to the consternation of many still indignant over last quarter's earnings and waxing wroth over trivialities such as the current quarter GDP rate and the ever-descending estimates for fourth quarter earnings. Now that the Fed has acted, only two carrots remain to be found: a fiscal cliff deal, and the end of the year. One of them is certain, the other is not.
Back on the good side, let's look at the recent data in jobs and wholesale sales and inventories. The November employment report was not evidence of an economy teetering on the brink, on the contrary, it was one of the better reports of the year. Granted that employment levels are not robust and it's a lagging indicator, an upward trend rarely precedes a fall.
The year-over-year change for November payrolls (using BLS unadjusted establishment data) was 1.4%, the best rate since March and above the 20-year average of 1.2%. Through the end of November, the establishment data has added 1.6% more jobs from the previous December, the best rate through eleven months since 2006 and a trend that has been improving in recent months, even if the rate of improvement is mild. The 20-year average is +1.3%. Weekly jobless claims data have returned to pre-Sandy levels.
The wholesale sales data was something of a mystery again in terms of seasonal adjustment factors, but the underlying data was reasonable. Although the adjusted data showed a slight decline, year-on-year sales were up 8% unadjusted in October and the moving 3-month unadjusted average rose 3%. The unadjusted inventory-sales ratio was 1.16 (1.156, to be precise). That's the lowest October rate since 2007, and well below the 20-year average of 1.25.
An encouraging implication of the wholesale sales and inventory data is that once the budget uncertainty is resolved, we should see a lift in activity levels. Standard & Poor's issued a report Wednesday warning of underinvestment by U.S. firms over the last three years. I wouldn't expect a rash of panicked treasurers writing checks next week, but these kinds of things do percolate into the business community and in time get companies to increase investment out of competitive fear as much as anything else.
But there are signs of weakness too, though the market is choosing to overlook them for the time being. Gasoline usage is down year-on-year, despite comparatively good weather. The approximate 5% year-year increase in gasoline prices (while the price of West Texas crude is down over 10%) isn't helping.
EU industrial production last month showed another steep decline, though the December German investor survey picked up noticeably. Declining import-export prices reflect weakening trade. Both consumer and small-business sentiment reported sharp declines in the last few days, doubtless reflecting pessimism over the fiscal cliff. The trailing twelve-month change in wholesale sales has also been falling steadily for a year, and while some slowdown in growth is to be expected as the recovery matures on top of the drag from the budget deadlock, it won't help the current quarter.
Ugly is the disconnect between sentiment and conditions. The DAX is up nearly 30% this year as the German economy paradoxically sinks into recession. Markets are supposed to rally at the bottom of a recession, not at the prospect of one. The outlook for Europe doesn't look better for next year, either, not until they scare the daylights out of everyone first. And while I wouldn't say that the market has fully priced in a fiscal cliff deal, prices are nowhere near the exit door. The last couple of rounds of saber-rattling by Democrat and Republican leaders have had very short-lived impacts on markets more worried about missing the year-end performance rally, as this clip with Art Cashin illustrates, but don't look for the indifference to continue as we get closer to running out of time.
It isn't just a game of chicken between the Dems and the GOP. It's also a game of chicken between those intent on not missing the rally and those worried about getting caught in a flight-to-safety sell-off. The market isn't fully extended technically, not yet anyway, but we're certainly due for a couple of days off. That doesn't mean that we have to get them, but as the market rises on hope, it is growing increasingly vulnerable to getting rattled by a breath of bad news.
You can read a mountain of analysis in the next few days about the implications of the Fed's latest move, but in terms of the rest of the month for the stock market, there are only a couple of things that you need to think about. One is that QE is done. That carrot is gone. Another is that recent Fed moves have meant short-term tops in the market on the day of the meeting or the day after. There was no shock and awe in Wednesday's proceedings, and the market closed near its lows. The Russell 2000 finished in the red. That's worrisome.
Thursday's retail sales report may prove to be the swing factor, but I cannot make an estimate. Auto sales were good, yet the weekly chain store sales reports were tepid, and then there are the seasonal adjustment factors to think about, making the number a guess. The rest of the news flow could be positive - Friday's industrial production report should show a post-Sandy rebound, along with next week's New York and Philadelphia surveys. Housing data is back on the scene next week, and judging from mortgage-purchase application data, the market continues to improve.
It's no secret that December is the second-best month of the year for equities, or that the herd really, really wants the Santa Claus/year-end rally more than anything else. Yet the market is up six days in a row, and the one scenario I have never been able to picture is that of the market marching placidly higher throughout the month as the two political sides walk peacefully hand-in-hand to bring a neatly-packaged solution to a painless vote. Instead I seem to recall the Dow Jones dropping like an absolute stone within minutes of it becoming apparent that the first TARP bill wouldn't pass in October of 2008.
The swing factor is still the fiscal cliff, and I cannot recall a divided Capitol Hill working smoothly towards a budget solution, not ever. From George H. Bush's bitter-pill tax increase, to the Clinton-era government shutdown, through the TARP mess and last August's fiasco, the peace treaty has always come after the battle, not before. I don't expect total meltdown, and I still hope for the mini-bargain scenario with the larger conflict two or three months later, but what I worry about is that it appears that both sides are locked into the familiar script of trying to prove their worth by getting the other side to blink first before they can get on with any deal. The stock market rebound has left politicians with more room for bravado, yet prices with less room for error.
A popular prediction in recent months has been that the Dow will rally a good 500 points or so if we get a decent deal. What has been left out of the itinerary's description is that we may need to lose 500 points first to get the deal and subsequent rally. The rule throughout the last twenty years of budget showdowns has been first comes the bad, then the ugly, and only then the good (or at least the less-bad).
Maybe markets will just ignore it all until the first week of January. Maybe the premise will be that something is bound to get done anyway after the first of the year, while the reality is needing prices to stay up until December 31st. Maybe this time is different. I just can't quite bring myself to believe it.