- What recent economic data is saying.
- What investors want it to say.
- The market's outlook.
Last week I wrote a piece entitled - with tongue in cheek - "The Greatest Weather in History." The gist of it was that in our Teflon market, no piece of data could not be excused on weather grounds. Moreover, we were lucky to get such a stretch of bad weather, because it was creating historic amounts of pent-up demand that would lead to a magnificent spring, accelerated GDP, global prosperity and a cure for old age.
I've been consistent in this space in recent months about a few things - one, that the economy has consistently failed to live up to its advance billing; two, that the underlying trend of "new normal" in the economy has remained stubbornly intact; three, that predictions that the economy is about to get better continue unabated (and will so long as prices rise); four, that the stock market has become overvalued but because it's sentiment-driven, that doesn't mean prices are about to go down in a meaningful way. Last week I added that we were due for at least a pullback in the near term and a correction in the intermediate.
Through Thursday's close, we've gotten the mild pullback - these days, even one or two percent is a big deal - enough to take the markets out of very overbought territory short term and leave them merely overbought on an intermediate basis. Thursday's action suggested more selling pressure Friday, but prices will be apt to move either way into next week's Fed meeting, as persistent rally attempts have been met with selling while persistent sell-offs have been met with buying. If you're bullish you call it backing and filling, if you're bearish you accuse it of momentum breakdown.
The weather notwithstanding, there is growing reason for concern about the U.S. economy, though I would add that the recent sell-off was mostly due to worries about events abroad. To begin with, while some improvement ought to be expected after the weather breaks, a significant weather rebound is no lay-up: Real GDP fell for three quarters in a row after the coldest-ever winter of 1983.
It was indeed a cold and snowy January and February in the Midwest and much of the South and East - believe me, we are all heartily sick of it. But the deterioration in retail sales is still cause for concern. They were not good, despite the dubious "estimate beat" Thursday in retail sales (thanks entirely to a sizable downward revision to January sales). The year-to-date growth in 2014 retail sales is only 1.9%, compared to 3.6% a year ago. As I tweeted shortly after the report's release, that's a lot of weather and not a lot of rebound.
The last two times that the annual growth rate in core retail sales (excluding auto and gas) declined to the 3% level (as opposed to climbing back in a recovery) were November 2001 and November-December 2008. It's worrisome, and implies vulnerability.
I've heard for the last several years in a row now that corporations are poised to increase capital spending "this year." Though it has yet to pan out, another typical recent example of this groupthink popped up from Pimco: Corporations will raise the rate of capital spending because they're sitting on record levels of liquidity. They were sitting on record levels last year too, and it still didn't happen. What did happen is that the accelerated "bonus" depreciation in the tax code expired at the end of 2013 and hasn't yet been restored. It's often been argued that such breaks simply pull spending forward and not much else, but whether or not you agree, it isn't there right now.
I've seen the results of capital spending surveys. The problem is that the managers of publicly-traded companies don't really get paid for it. Some is indispensable, of course, and everyone may have ambitions about their markets, but management, particularly top management, gets its real compensation from the stock price. Woe to the CEO who tries to ignore it, too - a company price comparison chart is included in every annual proxy statement. With CEO tenure at Fortune 500 companies estimated to be under five years, the window for cashing in is short.
So while some officer (or assistant, more likely) may answer a survey saying they're ready to invest more, that doesn't change the fact that the biggest shareholders are in the room every quarter pressing you to buy back more stock and increase the dividend. With corporate revenue growth creeping along between 2% and 3%, which is the safer bet? Fund managers may want capital spending and R&D to go up in the aggregate because it's good for America - they just don't want the companies they own to be doing the heavy lifting. Not until they're out of the stock.
It's fashionable to repeat the argument about fiscal drag being removed, but I never read investment managers talking about the 1.3 million people who recently lost their unemployment benefits. So where are those people in the February jobs report (which the Washington Examiner characterized as "relatively strong," despite it being more than 100,000 less than last year's 280K)?
There was some weakness in the February report - the percentage bounce from January was only 0.55% (unadjusted), the smallest it's been since 2010. The household survey only added 42,000 to its employment count (seasonally adjusted), while the civilian labor force grew by 646,000 (unadjusted) in February, compared to a decline of 67,000 a year ago. These are only clues - the household survey is volatile and not well-suited to distilling too much from any given month. Surely some of the long-termers who were holding out for a job in their career and avoid a permanent decline in compensation level were forced to take what they could get. But the 700,000 swing in year-on-year labor force levels is a clue.
Here's another clue - the percentage of loss-making IPOs, it's the highest it's been since March 2000. I'm sure this time is different, but it does suggest that backers think it's time to get out while the going is good. Mortgage-purchase applications are down 17% year-on-year.
What's next for the stock market is that we could be in for an episode like the last two months of 2013, when prices sold off into early October, rallied sharply back, then traded nearly sideways for the next five weeks despite periodic attempts to break it back out. In the end we got our customary 5% year-end rally when the Fed revealed it had no plans to crash the financial system. That dip included a trip to the 50-day moving average (currently around 1830), rebuffed by Fed meeting magic. A similar episode could lay in store now - pullbacks are not uncommon at this time of year, coming anywhere from mid-February to early April - and there is another Fed meeting next week, followed next month by the first quarter earnings rally.
Sentiment still rules this market, and traders won't forget that April is the best month of the year for stocks. March retail sales will be held back on a year-over-year basis by the late Easter this year (April 20th), but traders will be poised to buy on any sniff of a weather rebound, even if only a few of the truest believers actually subscribe to it. Most people in this business don't get paid for being right about the economy or earnings, but for following the crowd, and I haven't detected any sign of bullish capitulation.
The late Easter might even aid a May rally, if the economic data can be properly underestimated and the Labor Department comes up with some useful seasonal adjustments for the jobs numbers. One could hear quite a bullish roar by then - depending on the small problems of China and the Ukraine: The impending Crimean referendum is likely to lead to more tension, not less. I don't guess policy decisions, but I do know that mistakes are sometimes made in the name of ideology. Sometimes they even hijack planes.
The recent rally in the price of gold suggests concern about the Ukraine, while the recent sell-off in the price of metals suggests worry about China. To hear many talk about China today is to hear an echo of the don't-worry housing talk in 2007: the economy is still healthy, corporate profits and cash are at all-time highs, the problem is contained, falling home sales will correct the inventory imbalance, financial failures are good for market health (my favorite graveyard whistle), bet on (emerging markets then, U.S. equities now) because they have decoupled from the problems in (name the region).
All of that suggests the possibility of a sharp reversal-rally if the Chinese leadership should ever have second thoughts about fiscal discipline. It'd make for a great exit opportunity. Keep in mind the lesson of both collapses in the last fourteen years: The stock market was the last to believe.