I'm afraid I won't have any charts for you this week - it seems that there is a problem with government websites. However, I still managed to come up with some observations and data that may be of interest.
The first concerns the state of the stock market. It isn't quite correct to say that Tuesday's rally proved that the market had already priced in a government shutdown, rather that the behavior of the last two days signals a market that firmly believes that this rally is innocent until proven guilty - and probably requiring more than one conviction.
Tuesday was the first day of the month and quarter, and the lure of that was stronger than any concern about the ramifications of a shutdown. One of the most circulated stories of the week, I'm sure you've noticed, is how well the market does in the months following a shutdown. I was curious myself on Tuesday morning to see if the market would put on a genuine defiance rally, but it has remained mostly unable to sustain an up morning since the day of the FOMC meeting on September 18th.
Yet traders are positively straining at the bit to position themselves for the expected relief rallies. One of the reasons selling isn't getting much traction is the widespread lack of conviction that the shutdown will carry on for long. Therefore, traders want to be long for the shutdown relief rally, long for the debt ceiling relief rally, and long for the fed no-action rally.
The closing action in the last fifteen minutes of Tuesday and Wednesday has been instructive. Both featured determined efforts to either mark the tape higher at the close or seize upon a chance to buy a dip, take your pick. It's been going on for the last five days now, in an amplified way the last two. Such rallies can be "lift the tent flap" ploys, break-out traps engineered to dump stock on the pigeons, but early on look more like a determined effort to ride to the putative new highs. The last ten minutes of Wednesday proved to be the first attempt in eight trading days to manage to pull equities back up to their high of the day, though the market was still down.
If this be madness, then there's method to it. The primary drivers of the bull market the last four years have been relief rallies, central bank rallies, and the first quarter sprint: In 2012, equities ended up unchanged from April 2nd to December 31st, in 2011 they peaked on April 29th and were lower the rest of the year; in 2010 prices had fallen about fifteen percent from April to August when the first QE program was launched. An extended Santa Claus rally in December, fueled by an extension of the Bush tax-cuts, put the rest of the year into the black.
Right now stocks stand virtually unchanged this year from the intra-day high on May 22nd, when they had their legs cut out by Bernanke's introduction of the Terrible Taper into the discourse. Unless we get into a situation of at least technical default or some other external event intervenes, it's likely that the market will indeed rise this month on the stepping stones of the aforementioned series of relief rallies - no more shutdown, no default, no taper.
There is of course danger in such a development. Markets love to rally against clearly visible obstacles being surmounted, but get very unhappy when the unlooked-for intervenes instead. My inbox is filling up with ways to tactically buy the shutdown, so some jolt from abroad - or the unthinkable happening with the debt limit - could hit markets quite hard. If neither of the two come to pass, we should reach my long-awaited October top, but at that point equities will be so overbought that they may fall all the way from the FOMC meeting on the 30th to Thanksgiving.
The earnings parade will get underway in earnest in two more weeks, and it's unlikely to be a pretty story. Recent news, whether it's unsold goods piling up at Wal-Mart (WMT), or Hertz (HTZ) and United Airlines (UAL) signaling air traffic softness, or Merck (MRK) cutting 20% of its workers, isn't pointing to a bang-up outlook. True, the latest ISM manufacturing survey was encouraging and year-on-year personal income growth improved in August.
Yet it's quite possible that the effects of the August snapback in motor vehicle production and sales will begin to fade now. Certainly the government shutdown isn't going to help matters. As for personal income, year-on-year monthly growth averaged 2.4% in 2011, 2.0% in 2012 and stands at 0.76% year-to-date for 2013. Some of that is due to the distortions brought on by the dividend shift into the fourth quarter of 2012, but even so the monthly average is only 1.0% since the end of the first quarter. The ADP payroll report - replete with downward revision - indicates the job market is going sideways as well.
The Federal Reserve has its own funding, so I did have some time to study the Philadelphia Fed's release of its leading indicators. The headline was promising - "signals expansion for the next six months" - but the details less so. The US index fell to 1.4, not a warning light but not signaling any uptick in the growth rate either. The index is good at picking up housing-led recessions - suddenly I'm reading that the housing recovery is far more fragile than was proclaimed up until one or two weeks ago - but from a market point of view, the index is generally more useful for what it doesn't say. In the current instance, it's not signaling recession. Be careful with that - that's not a promise of no recession, but a lack of promise that one is imminent. Good, but not great.
As for the debt ceiling, I'm sticking with my guns on no predictions of policy decisions. So far that posture is working well, as both the Fed and our elected leaders have done the unexpected in the last two weeks.
One of the chief problems dogging the impasse, though getting little attention, is the fact that both sides have been criticized by their more vocal wings for being too soft. The progressive wing of the Democratic party has been audibly disappointed by what it's viewed as President Obama rolling over too easily for the Republicans in prior showdowns, while the latter have been equally castigated in mirror fashion by their more ardent wing for capitulating to the Democrats.
Thus we have Washington behaving very much in keeping with the classic management-labor dilemma of heading into a strike that neither side wants, but that both sides feel they have to endure in order to prove they can't be pushed around. It can lead to quite unpleasant results.
Like most of the investment community, I'm not expecting the worst. I rather think it more likely that equities catapult to new highs on the strength of disaster averted. But unlike most, I'm not going to take anything for granted, either. We may yet get a much closer look into the abyss first than anyone had expected. Hedge your bets, because even if the situation sorts itself out and we do get to the new highs, it won't take long afterwards to cash the hedges in.