We saw some remarkable things last Thursday, the first day of March. It wasn't that stocks went up, for it's practically written into exchange by-laws that stocks must go up on the first day of the month. But there were a couple of remarkable segments on a business news channel. One bit gushed about the improving manufacturing outlook in Europe and China. That made us stop and stare. The European PMI announced that morning was 49.0 - contraction. But Germany, France and the UK, said the newsreaders, were improving. Germany has been 50.1 and 50.2 the last two months, which any survey maven could tell you means, "unchanged." The UK measure fell from 52 to 51. The French data looked unchanged to us as well.
The European recession is deepening - unemployment fell to 10.7% in January. Spain revised their GDP outlook for 2012 just a tad - from +2.3% to (-1.7%). The press has been trying awfully hard of late to sell us the idea that all is well.
It's true that the official Chinese PMI - which is not taken very seriously - is hanging in at about 51, but the private measures have been consistently around 49 (slight contraction). The services PMI was reported over the weekend to have dropped to 48.4 - and promptly blamed on the Chinese New Year. China announced it was cutting its GDP forecast to 7.5% (also the fault of the New Year, no doubt).
Another remarkable segment focused on two fund managers. We are sure that it will come as quite a shock to you that they avowed that it's a great time to invest (it is always a good time to invest in fund-land). The two of them allowed that it was possible that a minor dip of 3%-4% could occur (in mutual fund parlance, this means 4%-10%), and that they would both avidly buy any such dip.
We're nearly there, so far as that dip is concerned. Despite Tuesday's steep drop, a benign ADP number could indeed start the wheels turning the other way again. Any shortfall will be an occasion to bring out the hard hats, of course, but if either the ADP and/or BLS jobs number on Friday are rally-worthy, it would reinvigorate bulls.
Also on last Thursday, U.S. chain-store sales were being reported as above expectations, though none of the retailers wanted to lift guidance. Clearly they're worried that the weather has created an illusion. Strategists are proposing that the warm weather will lift the February jobs report; some went so far as to propose that the Fed will have to start raising rates in the second half of this year. Now that's a weather illusion. Yet we read at least one scribe's opinion that, although the weather may have been a lucky break, it has nevertheless propelled us into the "virtuous circle" of increasing spending and demand.
We also read on the 1st that the January-February start for equities was the best since 1995, when stocks rose 38%. A promising omen, we were told. Let's marvel at the parallels, shall we? In 1995, interest rates fell, rather than rising as expected. Long-term bonds roared, rising by 30%. We're going to boldly forecast that short rates won't fall this year. The unemployment rate in 1995 fell to around 5.5%. Well, at least it's been slipping (although the real rate has arguably stayed in double digits). Perhaps most importantly, corporate profit growth accelerated to a 19% rate in that halcyon year, while such growth is on course to shrink to a 7-8% rate this year.
However, there is one similarity for the rosy-eyed to dream upon: Europe and Japan were out of fashion in 1995, with the former struggling with austerity and the latter in semi-recessionary conditions. Ergo, the U.S. is the logical alternative again for investors. That may happen, and it's certainly an opinion in wide circulation. But the European markets had outpaced the U.S. through the first two months, despite economic data pointing towards deepening recession.
What the latter suggests is that the rally in both places is due to two factors: momentum, and the non-exit of Greece from the Euro. How much longer can either sustain prices? Some Europeans are indeed arguing that the Union must do more to stimulate credit and investment, and therefore growth.
Stimulus is going to be an even tougher sell in Germany than keeping Greece from going under. It's one thing to avert the Lehman-monster of the disorderly exit as being necessary to avoid another systemic meltdown. However, the Austrian school of economic thought that is still cherished in German circles is very much against government expansion of credit and investment, seeing it as a temporary fix that can lead to disastrous inflation. The only "safe" cure, the thinking goes, is prudence and time.
Rising markets are not only not a disincentive to action, but breed the kind of complacency that can further imperil the European economy, not to mention the peripheral group that includes Greece. But that, at least, would give the markets something to rally against.
There was actually a report last week that was better than advertised - the ISM manufacturing survey. Despite this, durable goods fell sharply and unexpectedly in January, down (-4.0%) overall and down (-4.5%) in the business investment category. The latter ended with a 6.5% increase on the year, which isn't all that impressive given the accelerated depreciation bonus that expired in December.
The regional manufacturing surveys that appeared all posted good numbers: Chicago, Richmond, and Dallas. That's good, but we have to point out that all the numbers were below the levels of a year ago. Some other things to ponder in the Chicago report include the home page of the group remarking what fine weather Chicago has been experiencing. We cannot ever remember somebody boasting about the great weather in a Chicago February. The other item of note is that the respondents' remarks were, on balance, surprisingly cautious. It's clear from the monthly auto sales figures released on Thursday that that sector is doing well, and the Chicago region is a particular beneficiary of auto strength. Ex-autos appear less robust.
Although the national ISM headline number of 52.4 was below the consensus of 54.6 (the whisper number was much higher, with some hoping for something in the 60 range), the ratio of growing-to-contracting industries was a reasonable 11-4. The subcomponents showed broad improvement in respondents indicating a better mix of activity, but the seasonal adjustment factors rubbed them out. Like most of the recent economic data, however, the ISM numbers in January and February are lower than they were this time a year ago.
The non-manufacturing numbers are also lower. The survey released on Monday showed an index of 57.3, versus 59.0 a year ago. The seasonal adjustment factors are lower, but looking at the subcomponent for business activity and prices, the two categories we rely upon, they are definitely a step down from February 2011. The manufacturing comparison is more difficult to attribute solely to seasonal factors: the 52.4 compares to last year's 59.8. We don't question that the adjustment factors may be smaller, but given the remarkably warm weather, it's hard to see why the virtuous circle has started this year rather than last.
If manufacturing is enjoying a lift from the calendar and inventory cycle similar to the one a year ago, but less pronounced, where is first-quarter GDP headed? Last year's first quarter clocked a 0.4% annual rate that completely wrong-footed the markets. Looking at the first month of preliminary income and spending data isn't promising: real disposable income fell (-0.1%), and real spending (PCE) was unchanged for the third month in a row. The year-on-year PCE rate fell for the fifth month in a row. The February data is preliminary, but so far the rate is below the rate for the first two months of 2011. Oil prices are higher, raising our import bill.
Yet fourth-quarter GDP was revised higher, contrary to our expectations, to 3.0%. We correctly anticipated that the price deflator would rise and the import subtraction would be larger. However, the extra inventory addition was more than enough to cancel them both out. This modifies our view towards the first quarter; the inventory rebuild appears likely to be smaller than we first thought, largely because sales were pulled forward into last quarter. We also believe that the price deflator is still too low, and it will eventually pull four to five more tenths of growth percentage back out.
Construction spending eased (-0.1%) in January, a big miss in that it was supposed to increase by 1.0%. We were advised to ignore this number too. But we didn't ignore Safeway's (SWY) conference call last week. The CEO observed that although the high-end consumer is fine, the typical consumer is struggling to cope with large increases in food and fuel costs (their own data suggest a combined y/y jump of 12.5%). Given this, he assured analysts that promotional activity was "highly rational." We'll say this - it's a cinch he wasn't talking about Wall Street, because the wind blows mighty hot there.