Blessed is he that expects nothing, for he shall never be disappointed..” – Benjamin Franklin (ed.), Poor Richard’s Almanack
So. Here we are one week later, the market keeps steadily plodding higher, valuations get steadily more ridiculous, the noise in Washington feels ever more frenetic and disconnected, yet the stock market cannot shake its conviction that all will be well shortly. Despite a growing number of asset firms warning that any help from infrastructure spending or tax cuts is likely to be six to eighteen months into the future, traders keep swapping stories about which cement or steel maker to buy today, which bank is likely to get a bigger boost from deregulation, which corporation will benefit most from tax cuts that are just around the corner.
The market is in bubble territory. Now, the trouble with saying “bubble” is that everyone thinks of 1999 for comparison, though we are quite unlikely to see another bubble that crazy in our lifetime. The current market feels more like a combination of 1987 (the Dow Jones is on its longest winning streak since that time) and 2007. In both cases the feelings were that while the market might admittedly be expensive, it deserved to be and there was nuthin’ but good times ahead.
True, there are some familiar bubble elements missing. Traders may be completely gung-ho on the Trump presidency even as his approval ratings keep sinking, but there doesn’t seem to be widespread fever to buy stocks in the public at large. There wasn’t any in 1987 or 2007, either, but the crashes that followed were still quite painful. Consumer confidence is at peak levels, nobody wants to actually sell stocks, and asset managers are doing backflips to explain that even though valuations might be higher every week, they’re still not too high (so don’t sell). And as usual, the familiar chant is repeated that the end of the business cycle is at least one or two years away. Every end of every business cycle has always been at least two years away in market-land, until it wasn’t.
A telltale clue is that despite the market approaching ever more painful levels of being overbought, prices simply have been unable to begin any kind of normal technical correction. I watched with fascination last week as weak openings steadily gained back ground during the day, and weak days somehow managed last-minute pushes to higher closes. In ordinary times, traders will begin to step away from overbought markets and wait for a bit of selling to settle things before getting back into the action. In bubble periods, any dip of a few points or a few hours in stocks is an opportunity to get into a market that is threatening to run away from you.
Along with the elevation in stock prices is the broadening viewpoint that economic news has been really good so far this year. I must have missed that report. Optimism runs high in the surveys, but there was nothing in the release of the recent FOMC minutes that suggested the governors are thrilled about the economy. What the minutes suggest is that everyone expects more of the same.
Not everyone will agree, of course. Warren Buffett is one of the greatest investors ever, and is maintaining his usual sunny outlook – for the long term – in his latest annual letter.
I wouldn’t look to Warren Buffet for advice on when we are in a bubble. Buffett didn’t advise on getting out of stocks before the last two crashes – the 86 year-old takes a very long view, and reasonably believes that if you wait long enough you will eventually come out ahead. However, if you are thinking of retirement in the next few years and are not as rich as Buffett, you may not have the luxury of taking the super-long view.
It’s been weeks now that I’ve suggested the possibility of a minor pullback being imminent, if only for technical reasons and historical periodicity. The inability of one to get started is telling, and suggests that the bubble of faith will require many pricks before it gets punctured. That doesn’t mean that the market will keep moving relentlessly higher in the meantime, only that the state of invincibility and complacency that is characteristic of these episodes is likely to linger until a large shock intervenes, or perhaps a series of smaller shocks.
I have oft repeated that the employment report is the key to stock market hopes. Regardless of what other data there may be, until jobs begin to turn negative, every other cyclical indicator will be ignored. Perhaps it is the January jobs report that has the market so firmly rooted in its faith, but the January report is more than a little guesswork. It’s true that claims data do not yet suggest anything like a boost in firing, but hiring growth grows weaker every quarter. When jobs turn, they usually turn suddenly. It would be nice to say that we’re safe until then, but in today’s climate, nothing is really safe. I will say that a safe bet is that any non-commodity-related S&P stock you buy today will be much cheaper within the next two years. So why buy today? There’s no rush.
The Economic Beat
We’ll lead off this week’s summary with the latest release of the Chicago Fed’s National Activity report. The report, which is based on 85 monthly indicators, has little traction in the stock market and is mostly ignored, mainly because it isn’t much of a leading indicator, and perhaps partly due to the method of its calculation, which is designed to produce readings to be mostly within a band of plus or minus one. In practice, most of its readings fall between plus or minus one-half, which aren’t very sexy from a news point of view. The monthly values are also subject to considerable revision and so it’s the three-month moving average that commands the most attention.
The reason I want to draw attention to it this week is that the Chicago index does correlate qualitatively well with actual national activity and gross domestic product, or GDP, and the index is telling a far different story than the manufacturing surveys, which are not quantitatively based but have been producing soaring readings of late. The initial estimate of the Chicago index for January is (-0.05), hardly a disaster (and may yet be revised to positive), but a long ways off from the readings produced by well-known surveys like the Philadelphia and New York Fed regional reports. The more reliable 3-month moving average for Chicago has been slightly negative the last 6 months, but you would never guess from the hoopla around ever-mounting survey scores, which seem to be caught up in the same sentiment tsunami as the stock market.
The Kansas City Fed survey, for example, rose last month to 14, the highest level in over six years. Much of that can be attributed to the recent rebound in energy prices, but the rebound hasn’t been all that big and oil prices are nowhere near seven-year highs. It’s another example of the divergence between economic reality and euphoria that I’ve been highlighting in recent columns. As to the question on whether the euphoric readings are indicators of good times to come, that is always possible, but the readings have been moving steadily higher the last three months without any discernible sustained boost in activity. In fact, the Philadelphia Fed’s survey of conditions six months from now has historically been an outstandingly good contrarian indicator – and it too marked a recent high.
There wasn’t much notable news anyway last week, with the most prominent reports being the latest sales estimates for new and existing homes. The more positive of the two was existing homes, and so naturally it has attracted the most attention. The rate did rise to a better-than-expected 5.69 million (mm), the best in nearly ten years, but therein lies a tale. To begin with, the warm weather and fear of rising interest rates probably boosted sales in a way that seasonal adjustments don’t capture.
More importantly is that the level is still low by historical standards. It’s nice to see improvement, make no mistake, but it isn’t as if the housing market is catching fire, either. The rate for new homes, at 555K, fell somewhat below its trailing twelve-month (TTM) total of 560K and the latest report included a big downward revision to November. That TTM rate has been at or about 560K for the last three months now and with employment about maxed out, there is no reason to expect any sudden surge. Year-on-year home prices moved from 6.1% to 6.2% in the federal agency survey, with the more widely followed Case-Shiller index coming Tuesday.
Employment claims remained low, but we’ll have to wait an extra week for the monthly employment report this time, coming out an on an unusually late date, the 10th of March. It’s a still full schedule the coming week, with durable goods and pending home sales on Monday, the first fourth-quarter GDP revision on Tuesday, followed by goods trade and two regional surveys, Chicago and Richmond. Expect both to move up. The new president also plans a major speech for Tuesday night.
Wednesday brings the national purchasing survey in manufacturing (ISM), followed by the service sector on Friday. Will they too be infected with fluffiness? The day also brings January personal income and spending, as well as construction spending.