It was the usual post-EU summit proceedings at the beginning of last week, wasn't it? The markets put on a relief rally the Friday before because the EU said that they had made progress. More importantly, some of those earlier relief rallies had made some serious coin and with three weeks left to go on the calendar, it was no time to get left behind.
Unfortunately, there is always the morning after. We wake up and have a good look at what we took to bed - the morning light can be so cruel. The reviews are unkind, reality begins to set in, and that familiar sinking feeling in the stomach starts, followed by that familiar sinking in prices. Treasuries, anyone?
But before you swear to never do it again, take another look at that phone number you wrote down. It belongs to the ECB (European Central Bank), remember? They've promised to send over the limo and take last night's adventure right off your hands, anytime. Over and over. So if you're not really happy with that Italian number throwing off six percent, why, just hand it over to the ECB and they'll hand you ready cash at only one percent, with three years to pay it back. Sounds like you've just locked in three years at five percent, my friend. Is that so bad?
Indeed it isn't, and the markets may begin to cheer up a bit as banks get friskier about taking down peripheral debt that they can then immediately hand over to Signor Draghi, the ECB's Italian chairman. Those yields, which were already were tightening at the end of last week, could start to come in even more.
Before you start to get agitated, let us reaffirm our conviction that Europe hasn't really fixed much of anything. Disappointment is merited that Germany continues to press an agenda focused on wearing hair-shirts and self-mortification, while the root causes of too much debt all around the continent continue to go untreated. The European Stability Mechanism is insufficient and slated to start much too late, in July (though an immediate pull-forward is undoubtedly in the back pocket for emergency use). The current trajectory promises to deepen the nascent recession, and equity traders moan every time Kanzerlin (Chancellor) Angela Merkel and Signor Draghi trash the notion of eurobonds.
Yes, we quite agree. But we would add that while the markets are undoubtedly creatures of momentum on a day-to-day basis, all things being equal, the momentum they prefer is to the upside, not the downside. We entered the month of December carefully primed for disappointment, thanks to a mix of overweening complacency about the usual December rally and hopes that this time the EU summit would produce something worthwhile. Both hopes have been dashed, with the initial week's surge in equity prices wiped out in short order (though a cushion above the post-Thanksgiving low still remains).
Sentiment is quite bearish now, with the S&P 500 currently tracking to be down for the sixth time in seven days. The CFA institute, the investment-geek guild to which we belong, just released quite a pessimistic survey of member attitudes towards 2012. And that, my friends, may work to the advantage of what few bulls can be found still lowing across the plains.
The "Santa Claus" rally is not, contrary to what the media have been implying, a December-long rally that culminates on Christmas Day or New Year's Eve. It's supposed to mean the last five trading days of December and the first two of January. Ten days ago we posited that such a rally was unlikely if the market succeeded in continuing to move higher through December, because sentiment about January was deeply negative and traders were more likely to want to take profits in the waning days of the year rather than continue to bid prices up before an impending mass exit.
Now the situation is different. If this week's price action fails to lift the month into the black, or adds a further decline, then a different dynamic will be in place: the need to mark up the tape for the end of the year. Then we could actually see the Santa Claus sleigh at work, or at least a variation thereof.
One of the factors that could help out is, surprisingly enough, Europe. While the market is over-obsessing with the continued lack of enthusiasm on the part of Der Kanzerlin or Il Consigliore (Draghi) to expand bond purchases officially, the ECB is doing just that in the virtual universe: a bank buys Spanish bonds at say, 5.75%, forks them over to the ECB as collateral for a three-year "loan" (wink, wink) and gets ECB euros in return for a 1% processing fee. This is a problem?
Well, yes, in the sense that it's still a Potemkin village. But it is a real expansion of the ECB balance sheet and it won't be very much longer at all before the market catches on. Naturally, at some point the total on the ECB ledger is going to stir German anxiety, but that could be a ways off yet. In the meantime, those dreaded Italian bond auctions in January might end up going off much better than the Street is worried about today. We might soon find ourselves in the midst of a most unexpected rally off a combination of perceived American economic strength, the very negative current sentiment base and European bond yields besting expectations.
The ECB expansion would only be a band-aid, in our opinion. But the markets can grow quite fond of band-aids, even the ones known to be disposable. Our advice in these sentiment-wracked times is to avoid the big bet, short or long, because reversals and overnight gaps are probably going to be with us for many weeks to come, and the markets are likely to remain at the whim of political opinions. And by that we mean not only the ones that come in the guise of official statements, but also the ones that come out late at night over drinks in expensive saloons. It's that time of the year.
As for that American economy, well, last Thursday featured a nice trio of positive releases: weekly claims fell to an adjusted 366,000, and both the New York and Philadelphia Fed surveys had positive surprises. Were it not for the usual European worries, the markets might have put on a better day.
One of those Thursday reports did miss, though - November industrial production fell (-0.2%) instead of rising by the same amount, the way the market expected. Sometimes the number is thrown off by a big swing in utility production or mining, but this time it was a clean miss. It may partly have been a reaction to the October inventory buildup. The December Philadelphia survey (+10.3 overall) showed a good increase in new orders (9.7 from 1.3), and a big drop in inventories, while the New York index was similar, with an overall reading of 9.5, an increase in new orders of 5.1, and another drop in inventories. Both reports also showed price increases, a further sign of business momentum.
Retail sales for November, on the other hand, were a disappointment. They weren’t bad, at plus 0.2%, but the markets had dialed in something more like +0.5%. The number was the same with or without gasoline and autos, but at least October and November were revised higher.
Inflation data was benign, which is good if you’re a policy maker but perhaps not so good if you’re looking for signs of accelerating economic strength. The Producer Price Index (PPI) increased by 0.3% for the month of November, though the core rate fell to a 0.1% gain; the Consumer Price Index (CPI) was unchanged overall for the month with 0.2% increase excluding food and energy. The year-on-year rate for the latter is at 2.2%. Both import and export prices were below expectations, with exports up 0.1% and imports up 0.7%, (-0.2%) when excluding energy. If oil’s down month with commodities traders continues, we could see import prices fall again. And GDP do better than expected.
The FOMC statement only disappointed the traders who had hoped for some kind of veiled promise to do more. The Fed needs to save its powder for any European battles. The staff downgraded forecasts again, but the growing effect of the increased transparency regarding the forecasts is to get the markets to take them less seriously, as they haven't exactly been hitting it out of the park. They don't seem to be much more than a straight line drawn from the last couple of months.
Since the housing market index was up, expect housing starts for November to be up on Tuesday. They’ll be followed by existing home sales on Wednesday, which might be quite different. In fact, it seems that actual existing home sales have been quite different from reported for several years, and the National Realtor’s Association has consistently over-reported sales. Hmm, realtors exaggerating. Shocking stuff, isn’t it. The consensus is for a slight uptick.
We get another revision to third-quarter GDP on Thursday morning; we say ignore it and watch the Chicago Fed national activity index instead. Consumer sentiment, federal home price data and the Conference Board leading indicators all follow later. Friday wraps things up with some meatier data: durable goods, and personal income and spending for November. They’ll be followed by new home sales - will we set another post-war record low of new homes for sale? The best thing for home sales might be to force the Gang of Four banks to jettison their residential lending operations and allow other lenders to start over with a clean slate. Ho Ho Ho!