The First Pivot Point

by: Kevin Flynn, CFA

The World Bank made it official - this is the year we reach "escape velocity." The fact that this is the fourth January in a row for this particular announcement shouldn't dampen your spirits, as the institution, which ran the headline "World Economy Set to Turn a Corner in 2014" on its homepage, did not make the call in 2013. A year ago, the 2014 outlook was for 3.1%, so you can see why markets got excited - it was upgraded to 3.2%.

If you're keeping score, the bank's outlook at the outset of long-ago- and-far-away 2008 was for growth of 3.3%, followed by 3.6% in 2009. The latter was to be led by a resumption of growth in the good old U.S. of A. First 2008 growth would be fueled by developing economies (surely you recall the talisman of "global growth"); in 2014 it's the turn of the U.S. to be the shepherd. That alone makes me want to short the indices.

I suppose 2014 could see an upturn, though most of the growth lately has been in poor financial journalism. Besides the jobs report that we are told to ignore, we have had a bunch of reports that actually beat estimates, and we all know how unusual that is on the Street. More alluring is the regular sight of stocks starting their quarterly rise as earnings season gets underway. Oh, and as for that bit about the Fed beginning to withdraw stimulus, Monday's worry, never you mind, because growth will take over for the next leg. After all, stocks rallied on Tuesday and Wednesday, and they can't be wrong.

If you think I'm being too cheeky, apologies but I'm not. The usual momentum-following faces were deathly ashen after Monday's sell-off, wondering if we were getting ready for the big one. Wednesday's close generated a chorus of cheerful talking heads singing "What a Wonderful World."

The last GDP revision, the one that put third-quarter growth at 4.1%, seems to have thoroughly infected the brains of the media. A Reuters report that's a fairly typical representation of the disease talked of the economy gathering "steam at the end of last year and ... poised for stronger growth in 2014." I could pick the news story apart at length, but it would be unsporting and anyway, the Reuters report isn't any worse than the others.

When one puts aside the facade of "beating estimates," the realities of the data are quite different. Retail sales growth in 2013 is estimated at 4.2%, or about the rate it's been running for several months now. In 2012, retail sales were up 5.4%. You can see what's accelerating - the hype. In fact, the trailing twelve-month growth in sales has been in a narrow range for the last ten months, ranging from 4.09% to 4.46%, with a mean of 4.25%.

That's not all. The biggest characteristic of December sales is that Thanksgiving fell on the latest possible date, the 28th of the month. The result was what you would expect - year-on-year sales for November fell below trend, and then rose back in December. For the fourth quarter as a whole, they rose 4.2% in 2012, while in 2013, the initial estimate is for an increase of 4.18%. Yes, the old economy is really taking off.

The Reuters reporter who glowed over the unexpected surge in "core" consumer spending might have paid more attention to the fact that the ex-auto, ex-gas rate fell year-over-year in November because of the late holiday, then returned to the trend rate of 3.89% annual growth in December, right where it had been in September. That rate too has been in a tight range the last ten months, with a mean increase of 3.88%. So spare us the stories about the resurgent consumer, who in fact had to be bribed with heavy markdowns in late December and is now staying away from the stores in droves in January.

Mark Zandi of declared the December jobs report to be flat out wrong, predicting big upward revisions coming next month (from the annual benchmark revisions) that would add "a whole bunch of jobs," while CNBC's Steve Liesman is still repeating that there was no correlation in weekly claims data with the December jobs report.

They both need to be looking more closely at the data. I've written several times in the past about the 2013 efforts by the Bureau of Labor Statistics (BLS) to match up incoming data with the revised growth rates that last year's benchmark revision produced. Presumably the goal was to minimize more big revisions. The problem is that the payroll report's figure for 2013 is currently at a net addition of 2.2 million jobs, which is about 50% ahead of the household survey. That's a very, very large gap.

If 2.2 million is to be revised up to say, 2.5 million (an average of about 20K extra jobs per month might correspond with a "whole bunch of jobs"), then the household survey - which does converge with payrolls over time - is about a million short. And if the household survey is a million short, then is the unemployment rate already 6.5%? Maybe - and maybe we're due for a massive revision to the household survey. I don't think markets would like it.

As for there being no correlation with claims data, that's just flat-out wrong. There was huge volatility in claims around the end of November and beginning of December, as I wrote in my own weekly column of January 10th, which dissected the report in detail. I guess Steve didn't read my account - most disturbing. The net of it is that November was probably overstated and December understated, but even a 100% upward revision to December jobs is going to be well short of trend. I like Steve Liesman, but I don't know where he got his firm declaration that second-half growth was at 3.7%. Most current estimates I see have the fourth quarter at a 3% rate or less. It's not like we're in China, where the official GDP rate is known well in advance.

As for the inventory buildup, we have had such events several times in the last four years and it's always been nothing more than a restocking episode. Perhaps this time will be different, but after two strong months of year-on-year comparisons in September and October, the wholesale sales rate fell sharply in November - and that was an easy comparison, given the Washington-fueled hesitation of a year ago. The annual growth rate in wholesale sales fell back to 3.5% in December, leaving the mean for the year at 3.3%. It's been steadily decelerating: in 2012, the mean year-on-year growth rate was 8.2%.

Perhaps growth in 2014 does increase, but at the moment, it's mostly been in the form of the usual hype. That might be good for markets, because a genuine acceleration in growth would probably end the party quickly on the back of rising rates and quickening central bank withdrawal.

I've been wondering if this would be more of a 2000 year - when markets were rattled for a small loss in January, but then went on to new highs in March, or 2007 style, when the merrymaking didn't end until October. One early indication that it's more like 2007 is in the behavior of nifty-fifty type stocks rallying 5% when they announce the data of their impending earnings release - no warning of a shortfall being so very bullish. That's quite reminiscent of 2007 (in the 1999 mania, companies merely had to open for business every day in order to watch their stocks go up).

Perhaps it will be a blend of the two, but the first real pivot point of 2014 should come this month. A rally in the first couple weeks of earnings season is practically carved in stone on the floors of the New York Stock Exchange, but the genuine indications of sentiment should come towards the end of the season. This month is complicated by the late (January 29th) announcement of the FOMC, and for that matter could be complicated this week by Fed Chairman Ben Bernanke, scheduled to speak late Thursday morning. Stocks typically run up into the FOMC meeting and then sell off afterwards, but this week's volatility is a clue to elevated feelings of uncertainty in the herd.

This is still a sentiment-driven market. A bit of rally after the first few megabanks report results has been standard fare in recent times, leaving their stocks overbought - can the non-financial part of the pack keep it up next week? One third of Bank of America's (NYSE:BAC) fourth-quarter earnings was in the form of more reserves release, and for the magnificent job of increasing book value by 2.3% in 2013, the stock now trades at 19 times earnings. That's not a trick industrials can pull off. But so long as they beat estimates, no need to pay attention to that other stuff. At least, not until everyone else does.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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