As we head into what looks to end up being the most crucial period of the year, the investing world seems to be divided into three camps. For the first camp, populated by the likes of CNBC, Bloomberg, Markit Economics and the typical equity mutual fund manager, the world is getting better every day, better in every way.
This is shown in particular by the (mis)use of PMI surveys, which journalists seem to have trouble understanding. CBNC reported that the US manufacturing sector "grew at its fastest pace in more than two years" in August, basing this conclusion on the rise in the PMI from 55.4 in July to 55.7 in August.
To begin with, that kind of change in the PMI - three tenths - is no more than statistical noise. The heart of the matter, however, is that diffusion surveys like the PMI don't tell you very much about output levels. July's ISM reading of 55.4 was also "the highest in over two years." Growth in July industrial production: zero, according to the Federal Reserve. Negative, according to the Commerce Department, which reported that both shipments (-0.3%) and new orders (-7.3%) for durable goods fell in July (as an aside, the comments from respondents included in the August survey were fairly lukewarm).
For its part, Bloomberg reported that the increase in the trade deficit "signals improving US demand." Although allowing that some of the increase in imports was due to the jump in crude-oil prices, the article went on to state that "a strengthening U.S. expansion is helping companies in the European Union and China boost sales, which will stabilize global growth and, in turn, improve prospects for American exports."
Wow, talk about a virtuous circle. According to the latest data from Commerce Department, exports of goods are up 0.09% year-to-date over last year. Over the same period, imports of goods are down 1.3%. I guess the next article will be about the US overheating the global economy.
On that subject, I'm sure you've all heard that the US recovery is being led by housing and autos. Here's a chart on residential construction activity:
I like the slope at the right end too, but we've quite a ways to go yet before catching the levels of 2003. I hate to say it, but nothing lasts forever, including economic cycles.
For example, here is non-residential construction:
Apart from the fact that the growth rate has been slowing for months, I'm not entirely sure what this means. I haven't drilled through all the details, but it isn't a one-off and it isn't all from public cutbacks - the year-on-year growth rate in the private commercial construction category peaked in April 2012 at 15.8% (NSA) and has fallen every month since then, now resting at 5.6%.
The second group, which includes a lot of hard-money advocates, consists of people who believe that the world is going straight to hell, all courtesy of the Federal Reserve. Last fall these folks were writing contemptuously that the only rational thing to do in the wake of QE-3 was to flee the debased dollar and take refuge in the emerging markets. The money river indeed flowed into foreign currencies.
Since the Fed began the taper-talk in May, many of these currencies have experienced sharp corrections, leading the same group to now condemn the Fed for wreaking havoc around the world. Personally I think the currencies simply became too overbought. The countries were saying the same thing too until people started taking them seriously. Now the round of competitive devaluations triggered by Japan's weakening of the yen has backfired and finance ministries are fleeing in the opposite direction as import costs soar.
In the middle of these two is a third group that include most of the rest of us. We are a motley group, trying to figure out if the economy will ever really get better and wondering whether the stock market will keep going up anyway on perpetual hopes of next year - or just the next Fed meeting.
Equity prices will depend most heavily on what the Fed says in two weeks' time. The consensus seems to be that if the jobs report on Friday provides a number in the 160,000-190,000 range, the Fed will announce plans to taper (note that this is a not-so-subtle shift from the minimum threshold of 200K that had been all the rage earlier in the year). But not all of the Fed feels this way, as Minneapolis President Narayana Kocherlakota made plain with calls for more stimulus, not less. St. Louis president James Bullard is of the same opinion.
Then there is Syria, where some sort of US military action seems bound to happen. I'm not sure what or when it will be, but you could see stocks rally almost as soon as the first shot is fired. The fears of contagion may be legitimate, but could also end up very short-lived.
In 2007, the markets rallied almost continuously on hopes of a rate cut that never came - until it was too late. We could end up seeing similar behavior this year with the ever-receding topic of the taper. Some are convinced that the Fed won't move until later in the year, which would certainly give most of the asset classes a jump in prices.
There is also the reasonable possibility that the Fed splits the difference. The main two assumptions have been that either the bank cuts back on buying both kinds of bonds - Treasuries and mortgage-backed securities (MBS) - or it will cut back on Treasuries only. It's worthwhile to consider that Messrs. Bernanke and co. will make a cut in Treasury buying while simultaneously increasing the amount of MBS purchases, thereby addressing issues of Treasury bond supply and related leverage, while increasing help to mortgage rates and the housing market. Buying more MBS could be a real psychological coup.
All of this argues for staying relatively neutral and in the middle of the road for the next couple of weeks, unless there we get more concrete evidence for action. A few PMI surveys and excited journalists aside, all of the hard economic and earnings data I look at continue to suggest declining growth rates in global output and production. This week's early rally helped lift the S&P out of its oversold posture, but one little slip and the 20-day EMA could cross the 50-day and trigger more selling.
This has been a sentiment-driven rally, not earnings-driven, and we are entering the time of year when sentiment is most vulnerable to changes in direction. So much depends on the next policy words from the Fed or about Syria. Your experience may be different, but I have much better luck guessing policy changes after they've been announced.