- The stock market has conflicting narratives.
- The FOMC wrestles with its own narrative.
- What the Fed's latest words might mean for the near term in equities.
The latest jobs report, the lack of exciting data and the fact that we're in the second quarter are leading some to start the annual push-back against the annual myth of a revved-up second half - or maybe their voices are just getting a public airing again. I heard one gentleman come on after Monday's sell-off and deliver the usual bombastic pronouncements about how everything is about to really take off (this is the fourth year in a row we've heard this); he cited surveys as evidence. To my surprise, he was flatly contradicted by a fellow who instead cited data (what a concept). Even Larry Kudlow could be seen expressing doubts on Tuesday: Doubts about more than 2.5% growth in GDP, doubts about growth in business cap-ex spending (despite all those surveys), doubts about the recent jobs report ("mediocre").
Another beaming face came on to assure one and all that since the markets never had a 10% correction from 1990-1997, it's not like one has to happen. I wondered if he was being disingenuous, deliberately misleading, or just dumb. They don't call them "corrections" when the market isn't going anywhere: In the five years from the beginning of 1990 through the end of 1994, the markets rose a grand total of about 30%, with nearly all of it coming in the rebound year of 1991. Once markets took off in 1995 and started stringing together 20%+ years, it wasn't long until a 28% correction in the latter part of 1998 (two years after Greenspan's infamous "irrational exuberance" observation).
In John LeCarre's espionage masterpiece, Tinker Tailor Soldier Spy, master spy George Smiley comes to the belated realization that whenever he gets closer to the "rotten apple" in his country's secret service, someone makes a remark about George's marital problems. It dawns on him that there's been something more going on than competitive nastiness - rather the asides have been deliberate attempts to put him and the conversation off-balance. It isn't just the bad guy that doesn't want to be found - hardly anyone wants George to find him. It would be an unpleasant truth, one that could violently rock the boat.
The episode comes to mind because the question is frequently posed of late whether the recent implosion in high-flying stocks is reminiscent of the Nasdaq meltdown in the spring of 2000. The question doesn't get answered. Instead, the subject is turned to how high the multiples were in 1999, and that "now these companies have earnings." It's as if someone in LeCarre's world were to say, "well remember that fellow Smith, he was a double agent, wasn't he," and the reply was that as there were no more agents named Smith, there couldn't be any more double agents.
Quite a lot of the high-fliers don't have earnings, but that's beside the point. The issue isn't a comparison of multiples to the biggest bubble in market history, we don't need to summon experts on television to find out the answer to that. The point is whether the severe bloodletting in momentum stocks is again a sign of trouble down the road for the broader market. When the tech index fell about 40% peak-to-trough in the early spring of 2000 (after rising 60% the prior four months), the S&P 500 was initially unscathed. The latter didn't start to come apart until late August.
Equity multiples in 2007 weren't remotely as high as 2000 either, though they were only a hair higher than now. But the sector at the center of the speculation, the homebuilders, fell by two-thirds that year even as the broad indices eked out small gains. Now we've seen the biotech index, which nearly doubled from the end of 2012 (more than 3 1/2 years into the bull market) to the middle of last February, turn around and fall 25% in less than two months. So it's legitimate to wonder if the cratering of the go-go sector is a similar warning, and it deserves a more considered answer than saying there are no more agents named Smith (he always shows up again anyway).
There is however, a child-like faith in repeating the incantation, "don't fight the Fed." Lacking much in the way of growth, we all seem to be falling back on inventing cover stories about what could be, rather than what is. That a sustained campaign to lower interest rates and thereby reduce the relative appeal of diminishing yield assets (bonds) to growing ones (equities) would divert money from the former to the latter is quite a reasonable conclusion. However, that this invariably seems to mutate into a stock market notion that the central bank has an infinite magic wand that it can wave for an infinite amount of time in favor of equities is a mistake that gets repeated every time. One may as well add, "don't think, believe."
I'm not sure how much the broader market is really going to swallow yesterday's batch of Fed minutes (from the March FOMC meeting) as some fresh impetus to pay even higher prices for equities. Clearly some took the committee's tergiversation as some sort of assurance that the central bank still has their back, but for me it was not so sanguine. I saw a committee spending most of its time excessively nitpicking over exactly how to word forward guidance, largely because words are practically the bank's only remaining policy tool: The report made more than one allusion to one of my favorite themes, namely that the Fed has little else left with which to deal with adversity.
The Fed's staff isn't entirely buying the weather excuse that's been all the rage, noting that growth slowed "likely only in part because of...the...winter weather." The bond market doesn't seem to be buying it either, as the yield on the ten-year ended up plunging back towards the bottom of its recent range. Of course, it too was more influenced by what appears to be the Fed's determined belief that it can dock an ocean liner into a parking space for compact cars by talking to it.
I wonder - does the committee really think it can get away with a zero-interest rate policy until unemployment is at 5 1/2%, or "complete recovery" in the labor market (which I take to mean full employment), or was that just a couple of maverick governors? There is already quite a bit of excess out there in fixed-income land, in margin debt, high yield issuance, leveraged loans and "covenant-lite" loans, all of which are at record levels. Do they really think nothing but forward guidance can manage the problem for the next few years? The Fed can mandate increased capital levels for the majors, as it just did, but the banks will just go on packaging the loans and selling them to a yield-hungry market - so hungry that Greece's next bond offering is massively oversubscribed and overpriced.
Well, a lot of people on SA and elsewhere take the Fed to task for the banalization of what are supposed to be extraordinary policies, but the market consensus is going to remain that it's tomorrow's problem until it isn't. More immediately, I suspect that the taper will hold for the time being, in part because the first-quarter earnings rally will eventually come along (barring the Ukraine turning ugly) and have the stock market at or near record levels when the Fed meets at the end of this month. It doesn't seem like the FOMC should leap onto a chair from seeing the mouse of one month's pause in the decline of the unemployment rate, but with the lack of progress in the latest JOLTS report (labor turnover, with hire rates unchanged from a year ago) and a group that may have become fatally enamored with its own self-assumed ability to fine-tune the economy, anything could happen.
I don't think that the current bout of early April weakness in equities is over quite yet, Wednesday's minutes-plus-rebound rally notwithstanding. The latest Chinese trade data is going to provide some fresh worry material Thursday morning, and I don't think that the March retail sales report will be setting the market on fire this Monday. Even so, I don't expect stocks to get into any serious trouble before the end of next week, not without some help from abroad. After that, we can turn our attention to all those excitable people talking again, this time boasting about how companies are clocking estimates - the ones that were reset from 4.5% in January to negative today - and the sacred first-quarter rally.