Last week we wrote that an oversold market should generate an upside bounce. Shortly afterwards we realized that we had neglected to take sufficient note of options expiration week, and so by Friday, we were predicting that the S&P should challenge the 1370 level by yesterday (Wednesday).
Now comes the hard part.
Let's review some of the recent economic data, because that is what the FOMC is going to be doing ten days hence, and without the hope of more FOMC action, markets would be lower. Year-on-year changes in inventories have fallen for eleven months in a row. Put that one in the slowdown column (though if it goes on long enough, it would lead to a rebound). Retail sales fell in June instead of rising as expected. Was it serious? Looking at some of the trends, the year-on-year change in sales (unadjusted) of 3.6% was below the average for June of 4.6% since 1993. The change for the second quarter, though, was 4.7%, slightly about the second quarter average of 4.6%. So the quarter wasn't bad, but for one thing - the sharp deceleration (334 basis points) from the second quarter of 2011. Declines of more than 300 basis points in the year-on-year change have only happened twice since 1993 - in 2001, and in 2009. Put that one in the slowdown column too.
The Beige Book authors may have worn out their thesaurus looking up synonyms for "mixed," "tepid," and "modest." In twenty-five words or less, the report said that apart from housing, things aren't bad, but they're not as good as they were. In housing, things aren't good, but they're not as bad as they were. It was a mixed report.
The New York Fed survey came in above expectations on the headline number, but the sharp declines in new orders and backlogs point to problems next month. June Industrial Production data was good however, with manufacturing recovering its May losses, despite a drop in utility production. The total index rose to a new high on the year of 97.4 (sadly, still below the 2007 reference year).
The Fed has two mandates, as we all know: price stability, and employment. Price inflation is subdued, and the latest data on CPI and PPI leave maneuvering room for the Fed. Bernanke made it plain in his testimony that he does not expect problems on this front over the next year or two. He even allowed that some deflation threat still exists - probably thinking of the fact that both import and export prices are now running negative year-on-year.
He also insisted in his testimony that there is more that the Fed can do, and it is carefully studying the options in case employment stays a problem. Note, however, that a Fed chair never, ever says that there is nothing more the Fed can do, or would even hint at it. There are certain institutional limitations in Washington that one simply does not transgress: the Secretary of the Treasury does not ever trash-talk the dollar, the Fed chief does not ever say the economy is going to hell or that the bank is helpless, and the President does not ever joke that he is about to push the nuclear button. Hypocritical for some perhaps, but we are not fans of shouting "fire" in a crowded theatre.
On employment, Bernanke did hint at something that we've been writing about, which is that incoming data on jobs has been distorted by seasonal factors. It isn't that job growth is robust, it's just better than the pattern that the reports have described. But there is no job report before the next meeting, just two more incidents of jobless claims. Last week's data turned up nothing unusual; we don't think that the next two reports will stun the Fed either. The sense one gets from companies lately is "not hiring, not firing."
That leaves two more variables for Bernanke and the stock market to think about. Forget earnings, because even though the usual vaudeville routine of beating estimates is being produced with some "coulda-been-worse" relief rallies here and there, overall the picture is as tepid as the Beige Book says it is. IBM's revenue declined year-on-year, as did gross profit. It may have squeaked out another earnings gain, but that isn't going to fool many for long. Honeywell (HON) and Intel (INTC) lowered their outlooks for the rest of the year. These are bellwether companies.
No, the other two pieces of the mosaic are Europe and the stock market itself. From Europe, there will be nothing before September. The holidays have already started, and when the next FOMC statement is read on August 1st, most of Europe's elite will either be sitting with bags packed or be in the act of unpacking them at their vacation spot. There is some sort of statement due on Friday the 20th about the Spanish rescue, and when it comes along we'll let you decide how to day-trade it. It isn't going to be more momentous than that.
And why would European leaders want to do anything differently as they get ready for August? After this week's flurry, markets are mostly up on the year. The German equity index is up 13%, the US is up around 10%, most of the non-bailout country markets in Europe are up on the year. We can't think of how this is supposed to be the backdrop for a new round of aggressive policy. Probably because it isn't.
The markets should start to back off a little soon, though whether it starts today (Thursday) or Monday is anyone's guess. Short interest has been running high, so there's still some room for shaking out weak hands. If you really want something to look forward to, though, it's next Friday, the 29th. Normally the market would be in buy-mode that day, as the next-to-last day of the month is a time for the usual game of marking up client statements with gains that vanish a few days later. On top of that, the FOMC announcement is due two trading days later, and one generally buys the run-up.
The catch this time is that the first estimate of second-quarter GDP is due an hour before the market opens that day. Estimates that were above 2% six weeks ago have been hacked to something closer to 1.5%, with some dropping to the 1% zone. If it comes in weak, does the market rally on the "guarantee" that the chairman just has to give them more sugar now? Will it sell off if it's closer to 2%? The latter is a possibility, because we smell a weak deflator coming this quarter, which boosts real GDP (the reported number, anyway).
We can't tell you what excited traders might do, but one thing we can tell you is that if the S&P 500 is sitting atop 1400, there isn't going to be any Fed action, and you can bank on that. Nor is the Fed going to act at 1390 or 1380. In fact, we rather doubt that anything above 1300 is going to get the FOMC interested. With the election three months off and a market sitting comfortably positive, politically it would be quite reckless to launch some new program without the cover of approaching cannon fire.
Fund managers have been building cash levels lately. If traders keep demanding equities between now and the end of the month, you should oblige them and let them give you their money. You won't find many deals that are better, and the odds are excellent that if you find yourself missing any of your stocks afterwards, you will be able to buy them all back later and still have plenty of money left.