The consumer is cautious. Business is cautious. You should be cautious too, at least when it comes to the current market and any potential fireworks next week.
Spending is cautious: the May retail sales report was worse than it looked, and better than it looked. It was worse than it looked because while the headline decline of (-0.2%) matched estimates, the dollar decline was sharper due to the downward revision to April. Compared with the original April estimate, sales were down (-1.0%). Excluding autos, sales were down (-0.4%), also considerably worse than consensus estimates of (-0.1%).
Core sales, which exclude autos, gasoline and building materials were up 0.1%, the same as April. That's not the better part, though, because CPI core inflation has been running at 0.2% monthly. Even if it drops in Thursday's release to 0.1%, that translates into, at best, April being slightly down and May flat. Consumers spent less on gas, partly due to lower prices, but they did not put the money to work elsewhere.
Sales were better than they look, though, when looked at through an unadjusted lens. Actual May sales, based on current estimates, rose 6.4% from April on a dollar basis, compared to a 3.0% monthly increase of a year ago. A year ago Easter came in late April though, making the comparison more difficult. This year Easter came earlier and the bulk of the holiday spending took place in March.
May 2011's change was eventually revised to a 0.1% increase, also flat when adjusted for price inflation. Perhaps May 2012 will get an upward seasonal tick in due time to a similar level, and it must be acknowledged that at least some of the consumer spending component has risen for new car payments. The year-on-year change (unadjusted) currently stands at 7.1%, which isn't bad, even when factoring in that May 2011 was kept down by spending for the late Easter holiday.
The stock market, for its part, was down (-6.3%) in May with lots of scary headlines. One can certainly understand consumers feeling more cautious. Business spending is down:the national small business optimism index fell a tenth lower this month, and while we don't consider such a change to be significant, we did note that expectations for future sales are the lowest since 1973. That qualifies as cautious. More importantly, the report also noted that current capital spending was planned for maintenance rather than expansion.
It's usually a good idea to take these surveys with a healthy dose of skepticism. Future outlook surveys are as a rule very good contrarian indicators, though it is true that there is a distinct shortage of big companies talking this quarter about how good customer demand is. Employment, though, is actually doing better than recent headlines make it out to be. The job market is by no means booming, but it really has been consistently better this year.
Consider weekly claims, which the warm weather initially bounced around quite a bit. The average seasonally-adjusted total for the last 26 weeks is 374,100; last week checked in at 377,000. The latter will likely be revised upward to 380,000, but that is still very close to the mean. Unadjusted claims for the previous 26 weeks are averaging 10.3% lower from the same period a year ago, which is definitely an improvement. Let's not jump at notions about the weather, either - the trailing 52-week average for unadjusted claims is lower by a virtually identical 10.2%. Claims are down and the 10% improvement rate has been fairly steady throughout the past year, even if weather and holidays throw off some odd weeks here and there.
Despite the bigger increases in GDP during the early stages of the recovery, the size of the insured work force did not stop shrinking until a year ago, when April of 2011 recorded the first such increase since January of 2008. That's right, the covered work force shrank for over three years, and for about two years after the recession was supposed to have ended (a good illustration of why employment is considered to be a lagging indicator). It now stands 1.2% larger than a year ago, which isn't exactly huge, but is moving in the right direction and certainly in contrast with Europe.
Wage growth has been difficult to come by, however, as Robert Reich pointed out in his review of the latest Survey of Consumer Finances put out by the Federal Reserve. Median family income fell (-7.7%) from 2007 to 2010, and while the labor force data suggest that it should have improved since then, that would be partially offset by the reality that housing prices - and therefore household net worth - have continued to decline in all but a few areas since that time.
We're healing, but it's slow. That surely isn't news to anyone, but the point we make is that it's steadier than the headlines and market gyrations make it appear.
Considering the volatility of the market, then, which tends to extend every data point in a straight line to infinity, it's surprising that the market didn't sell off more than it did on the disappointment of the retail sales data. European data confirmed a continuing slowdown as well (though a couple of data weren't as bad as expected, weak consolation indeed).
Markets, though, seemed to still be dreamy-eyed over the soft tones of Chicago Fed governor Charles Evans, who espoused any accommodation necessary in a television interview Tuesday morning. Our inference from the interview is that Evans is signaling some continuation of Operation Twist coming out of next week's FOMC meeting.
Buy commodities then? Not hardly. The results of this weekend's Greek election are a complete unknown at this point. Based on the last polls, it looks like the odds are about fifty-fifty as to which side prevails. We actually think that the pro-agreement side will come out on top, and if that happens equities and the euro are going to rip higher. But we lack enough substance to put any money on it, and as the Spanish situation showed on Monday, any rip may not last long.
Should a surge manage to survive a day or two, the Fed could hardly be wheeling out much accommodation in its wake. Giving another fillip to a rally in oil prices isn't exactly on the Fed's agenda, and would not thrill its many critics in Congress.
And if the anti-bailout party wins, and the market panics? Shouldn't we expect a consoling, maternal Fed on Wednesday? Wouldn't this be a case of equities coming out right either way?
Maybe, maybe not. While an anti-bailout victory would certainly unsettle the markets, the ultimate outcome for Greece isn't going to be known to anyone only two days afterwards. Given such a result, the Fed would have to keep some heavy-duty live ammunition in reserve against the possibility of a later disorderly exit and potential financial panic. We don't doubt that the Fed would do something helpful, but it really might not be enough to keep equities inspired for more than a few hours.
So yes, maybe the pro-bailout party wins and the Fed extends its twist program. Equities are a bit oversold and anxiety levels are exponentially higher, so we could get an even better week than the last one. It wouldn't last, though, because whatever happens this weekend in Greece, Europe's problems are far from over. The Germans are talking about "no big bang" at the end-of-month summit and "constructing frameworks for discussions." Not exactly hot stuff.
Europe almost certainly needs to be forced into greater cohesion, and we continue to believe that the gaze into the abyss is likely to be the only thing that does the trick. Our markets wouldn't escape the fallout, even if we do get a 2008-style rally-in-the-face-of-death next week. If you really have to make a bet this weekend, our advice is go to Vegas and start betting red or black. The odds are no better and the strategy no sounder, but at least they'll give you free drinks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
