- There's more to the economy than weather.
- Rising prices distort information.
- The market is too complacent.
I was watching some investment fellow glow on the tube Tuesday about the coming spring and all the wonderful things in store for us when the weather turns, when I had an epiphany: This winter's weather is the greatest thing ever to have happened to the US economy and stock market. If we can only get lucky enough to have a couple of big hurricanes come roaring up the East Coast in late summer, or - dare we hope? - even an earthquake or two, why, the Dow could hit 25,000 next year. Why shouldn't it, with all that pent-up demand sending GDP to, say, 7% next year?
I couldn't blame you for saying that sounds silly, but it's exactly what's happening. As the market has risen, the weather fever has grown commensurately stronger. That's not to say that everyone on the floor believes it - they most certainly don't - but it's become a fashion wave that's gone from eye-roll to openly enthusiastic embrace. Who wants to fight the tape?
Last week I wrote about wanting to fade the small-cap ETF IWM Friday afternoon, but events in the Ukraine took away the opportunity as I prepared to pounce. By the time I posted my own weekly blog Saturday morning, I had changed course, fearing both a Ukraine relief-rally and a positive ISM manufacturing number on Monday (after the estimate-beating Chicago PMI on Friday).
The complacency on Monday was impressive. The VIX volatility measure barely yawned, topping out around 16. By early afternoon, it was clear many traders were scrambling to get long for a non-worst-case outcome, and they got it on Tuesday. It was an impressive short-squeeze of a day that had the same worried prophets of doom at Monday's close ("don't think that this is over!") beaming with condescension 24 hours later ("you've got to buy these dips!").
It's all very much emperor's-new-clothes kind of stuff. Let me give you a couple more examples: That February manufacturing PMI was 53.2, beating understated expectations (did anyone really expect it after the Chicago PMI of 59.8?). The Wall Street Journal wrote the result up as showing that despite the weather, manufacturers have "confidence about growth prospects at home and overseas."
Never mind that that's at least the hundredth time in the last two years I've read that some estimate-beating number is the definitive sign that the economy is poised to finally take off. Last February's PMI was 53.1 - no change - and yet 2013 GDP came in at 1.9%. Were those manufacturers simply misinformed last year? Ah, but there's the weather, you see, so you have to throw in a weather-sentiment adjustment (because this is a sentiment survey, not a measure of output). If manufacturers didn't think it was the weather, the result would have been lower - but then the result wouldn't be higher either, would it, because they're still confident it's only the weather, and - it gets confusing.
Last year's February PMI was originally released as 54.2, helping to set the market on fire, yet we still got that 1.9% real GDP, despite all that manufacturer confidence. Suppose we throw in a couple more points on for the weather on the latest read and bring it up to 55.2. How much difference do you think it would really make? Before you answer, you might want to know first that this was the fifth February in a row that the index has been over 50, and that since the beginning of the PMI series in 1948, it has never, ever been up six Februaries in a row. Not once. Would your prognosis be the same? The manufacturing PMI has rarely been up five years in a row for the month, and when it has the subsequent slowdown has been pronounced, often leading to recession. I realize that this time the business cycle is different, though. We have Facebook now.
It goes on. In the latest Barron's, writer Gene Epstein retorted to a letter doubting the 2014 4% GDP model this year written up in the magazine two weeks earlier by wondering if the author of the letter had noticed that new home sales reached a 5 1/2 year high in January. Really.
I can't fault Epstein too much for repeating that beguiling statistic, because it's been passed around quite a bit the last week by the die-hard bulls. The only problem is that it probably isn't true. January 2014 (468K) was indeed the highest rate - annualized and seasonally adjusted - over that period, with only one other month coming close: January 2013, with a rate of 458K. The year-ago number was an outlier that wasn't matched again the rest of the year. Far from being a harbinger, 2013 - a year remarkably free of natural disaster - finished with 428,000 actual homes sold, pending final revision.
January 2013 shows actual sales of 32,000 homes (rounded), while January 2014 is initially estimated at 34,000. That doesn't look like sales are exploding. Two weeks ago I wrote that growth in permits and starts are converging around 10% year-on-year growth, and so it would appear that new home sales are going to slow to 10% growth this year, compared to 15% last year. That's still a good year, but if 15% sales growth was good for 1.9% real growth in 2013, then how does 10% get us to 4% in 2014? I guess raging bulls have different calculators - the ones that say that manufacturing will still be expanding next February, for the first time in 67 years.
So it doesn't matter that ADP February payrolls missed on the downside at 139,000, or they revised January down a whopping 48,000 (more than 25%). It's just the weather, and the greatest spring rebound in the history of the United States is coming just around the corner. You've got to look across the valley!
Well I like to look at things, so I did a little checking on winter weather and looked at 1983, seeing as the winter of 2013-2014 was the coldest winter since that time. In July of 1983 - the coldest year recorded - the actual number of new homes sold was 51,000. In January of 1984 - still at record cold, mind you - the number was 52,000. In July of 2013, the number was 33,000, and January 2014 is estimated at 34,000. Still the same pattern, but the curious part is that in 1984, the annualized sales rate fell almost every month until September, from 773K in December 1983 to 567K in August 1984. Either there was no weather rebound, or the annualized rates don't always tell the best story. Sales grew by 3% for the year in 1984. In fact, after the winter of 1983-1984 ended in the first quarter, nominal GDP growth slowed the next three quarters in a row. Could it be that there's more to the economy than the weather?
If a housing boom is going to lead us to 4% growth this year, then why is Fannie and Freddie bond issuance down 57% year-on-year? That's more than weather, as is the fact that "private label issuance [mortgage bond] has once again vanished," according to a story in the Journal. For that matter, with banks like JPMorgan (NYSE:JPM) and Citigroup (NYSE:C) warning that trading revenue is going to be down over 15% year-on-year, why are the bank stocks breaking out, and why was noted banking analyst Dick Bove on CNBC telling us that bank stocks are set to take off? Mr. Bove, whom I don't dislike, did allow that the first quarter wouldn't be good, but insisted that rising interest rates would help profit margins and allow the banks to trade at two times book, for a 100% gain. I see. Five years into a bull market, rising interest rates are going to double stock valuations. Why hasn't anyone thought of that before? I was so impressed I started selling my XLF.
Over the years, I've had to explain to clients many times why one doesn't simply load up on emerging market stocks. Since they grow faster than the U.S., their thinking goes, shouldn't we be invested there? But it's not just growth, it's the starting price one pays for it. If valuations are too high, you're just not going to make money. I was thinking of that today while reading and hearing the love feast over Honeywell (NYSE:HON), which just announced its latest five-year plan. Honeywell is a very good company, one of those market bellwethers that one can say that as the company goes, so goes the economy. It plans to deploy $30 billion over the next five years - $5 billion in cap-ex, $10 billion in M&A, and the biggest part in dividends and buybacks. I.e., about 80% in financial engineering.
As I said, it's a very good company. But the stock has nearly doubled in two years, and is now the most overbought and overvalued it's been in my thirty years of tracking data. That's on a long-term basis, meaning the party could go on a little bit longer, just like the stock market. For that matter, one could post this entire article on the front page of the Journal and Barron's, and unless it carried Janet Yellen's byline, it would probably be forgotten in a day or two (maybe an hour). That's how complacent and self-assured the market is again, that's what momentum can do. But anyone who thinks current valuations are suitable for long-term investing here needs help.
We are at or very near an intermediate top in this market. It isn't so overbought short term that it can't go up a couple more days, but we are nearing at least a pullback in the near term and at least a correction in the intermediate. Don't think the market has a clue - it doesn't. Rising stock prices lure people into saying and believing nearly anything. I spent the weekend reading stock market news and outlooks from the first quarters of 2000 and 2007. They were full of confidence and benign predictions and - as always - conviction that the Fed would protect stock prices. Until they weren't.
Additional disclosure: I have no intention of buying any of the stocks in this article