Wall Street certainly had a holiday feeling on Wednesday, and there will no doubt be numerous timely comparisons in the press between Ben Bernanke and Santa Claus. The Fed started its taper with the bleat of a lamb, the market greeted it with the roar of the bull, and so all is assuredly well. Isn't it?
Yes, and no. The defiance rally is vintage Wall Street, a phenomenon I addressed two days before the meeting. The first step of a long-anticipated tightening is nearly always met with a big rally, made up of equal parts testosterone, short squeezing, and the trader playbook that says you do whatever history has done, the last tendency made more pronounced in recent years by algorithmic trading programs.
The typical pattern for these rebounds is a fade by the close of the next day, occasionally as early as lunchtime. Then a couple of days of backing and filling follow, and in this case, off we would go with the Santa Claus Rally. It will be hard now to stop the market from reaching for 1850 before year-end, if not skipping right past it.
All of that said, there are a couple of variations in this year's holiday pageant. For one, it isn't a tightening, strictly speaking, a point Bernanke was at pains to emphasize during his press conference. It's merely a tightening of the liquidity spigot - oh dear, I've gone and used the word again. Rather, the Fed is still expanding its balance sheet, just at a slower rate, and - as Chairman Ben casually, offhandedly mentioned about twenty times - the bank can reraise the level of money printing. Or as they affectionately call it in Washington, "asset purchases."
For another thing, it is December after all, and there's a non-negligible chance that traders decide to skip the backing-and-filling part and try for the 30% S&P move instead. The short position doesn't appear to be as big as it was back in May when prices went briefly parabolic, so there's probably less chance the move will be repeated, but doing the unexpected is after all a Wall Street specialty. I suspect many retail investors are also ready to go jubilantly all-in after Wednesday's big move.
An enduring characteristic of the post-war stock market is to rally at the beginning of every tightening - er, reduction in liquidity supply - cycle and at the beginning of every easing episode. The excuse for the former is that it means the economy is doing so well. The excuse for the latter is, "don't fight the Fed" - and forget that part about the economy getting worse.
In the end, though, the bravado wears off and reality eventually takes hold. It usually takes about three to six months for a majority, maybe only a plurality, of the Street to accept this. That enhances the possibility that stocks could pull off one last repetition of the November-to-April move traders have become so fond of the last few years.
It doesn't make the move odds-on, in my opinion, in fact I think it will be rather more difficult than the broad investing public expects. For one thing, it's so widely expected, and the market usually likes to do something besides the universal expectation. But it might slip through, if the background seems benign enough.
That will not depend on a strong pickup in economic growth, which would probably end up spooking the markets with the specter of an accelerated withdrawal of QE and an advance of the rate-tightening horizon, however much the Fed might try to forward guide otherwise (the bank is supposed to be "data-dependent, " is it not?). Rather it will require a modest pickup in growth.
Despite the effusion in evidence Wednesday morning, a moderate economic pickup is very much more in the cards than a strong one. While the Street talks itself into all manner of dreams with the parlor game of falling for the surprise of its own estimates being beaten - they are, after all, designed that way - things are not as rosy as the unwitting press (which tends to lap these things up) would have you believe.
Indeed, John Ryding's take was typical of the Street strategist - everything is going great guns, from strongly increasing retail sales to stronger housing. Deflation is just some silly notion that came about from a drop in oil prices. Jim Cramer talked about how "overwhelming" the economy is, before being obliged to retreat to, "better than it seemed in the summer."
The skinny on retail sales is that beat estimates in November and not much else. In Street-speak (and thus repeated everywhere, from USA Today to your friendly local NPR station), this is broadcast with words like solid, accelerating, unexpectedly strong, etc., and the repeated and passed around ad infinitum. In short, wonderful.
But outside of the cloisters, retail sales aren't special, nor are they behaving at all out of the ordinary. The reality from the Commerce Department data that everyone is raving about is that year-to-date (YTD) retail sales growth (unadjusted) through November 2013 is 4.269%. Compare that with October, when it was 4.271%. I'm sure there must be acceleration somewhere - perhaps a tick here or there in the next revision - though even if November does get revised upward, maybe to a YTD rate of 4.28%, I won't be so impressed.
One reason for that is the comparison with YTD sales data from 2012. Thirteen months ago in October of 2012, the YTD rate stood at 5.69%, followed by November 2012 at 5.68% (which may not bode well for much of an upward revision to November 2013). A year later, these rates are running 140 basis points lower - and that's without inflation, because retail sales data is not price-adjusted. It's the same story with industrial production: A year ago, up 3.7% YTD, this time, up 2.5%. So expansion yes, but not the big advance the Street is trying to sell us for the nth time.
So is deflation just a myth, an artifact of lower oil prices? West Texas crude is actually $7/bbl higher than a year ago. It's true that there was a speculative pop in the summer, largely based on Middle East concerns (something to do with Syria, as I recall), but it's since receded, because, after all, global growth is so strong that Brent crude is flat from a year ago. Import and export prices are both down from a year ago, not just petroleum-based, and the CPI is up 1.2% overall, That's not inflation, by any means, with the 1.7% increase excluding food and energy largely plumped higher by housing-cost calculations.
The housing market is booming, though. So much so that the Mortgage Banker's Association composite index is at a 12-year low, while the purchase index is at a 12-month low. But look at housing starts, you might say, even if mortgage credit continues to be tight.
I have to admit to being more than a little skeptical about the November starts data. Commerce has the year-year rate (unadjusted) falling in September, falling in October, and then rising by over 20% in November! Well sure, everyone knows that November is the big month for new home construction. Have to take advantage of the weather, after all. One figure that really stood out was the spike in the Northeast for single-family home starts. Despite an unseasonably cold month and early snow, the Department reported housing starts for the region to be at the highest level since July of 2008. Hmmm.
I do believe that starts had a good month, or the homebuilders sentiment index wouldn't have improved a few ticks. But I also suspect that the shutdown has messed things up a bit, and that downward revisions to the month are in store. Here's a chart of single-family starts:
Housing isn't booming as much as the estimate beat would have you think, or the headlines of seasonally adjusted data: the year-to-date rate of increase has fallen from 23.1% in August, 19.3% for single family, to 19.4% and 15.9% respectively. Growing, but the second derivative is less than zero.
That leaves the possibility of a modest pickup in the first quarter economy a bit better, ironically enough. There will be a moderate lift in January from the sequester modification, and in 2014 there won't be an increase in the payroll tax to offset the 2% average raise that awaits the rank-and-file. I don't really see a genuine real pickup in corporate investment, not with corporations choosing financial means of keeping up the stock price - buybacks and increased dividends.
The latter two phenomena are supposed to be more great reasons to support stock prices, but the times you really want to buy stocks are a few months after the dividend has been suspended, along with the stock buybacks, and corporate executives are hiding in bunkers next to the price of their shares. When corporations can't get enough of their own shares is the time one should be thoughtful, courteous, and polite, and start slipping them your own. But that's a tale for a different holiday. In the meantime, have yourself a merry little Christmas.