It’s not exactly the Newsweek indicator but anyone with contrarian instincts had to note the cover story of Barron’s this weekend, Bears Beware!, with at least a modicum of concern. The story concerns the magazine’s recent Big Money Poll survey of money managers who it turns out are – surprise! – bullish on stocks. I’m sure that has nothing to do with the fact that two thirds of their portfolios are already invested in the equity category. By the way, this poll was apparently conducted in Lake Woebegone where all money managers are above average; 80% of the respondents reported beating “the market” which proves either that choice of benchmark is critical to marketing success or that money managers as a group have only a passing acquaintance with the truth.
In another section of Barron’s we find the American Association of Individual Investors poll which is also marked by a paucity of bears and a bovine majority. With most everyone now firmly ensconced in the optimistic oxen camp one can’t help but wonder who is left to heed the warning on the cover. This rampant bullishness on stocks stands in stark contrast to the pervasive pessimism of the general public and reflects a confidence in the efficacy of government that I do not share. The recent conversion of former bears into bulls may be partially about the impending change of Congressional control in the mid term elections – talk about misplaced optimism – but mostly it is the expectation of more Fed meddling that has set bullish hearts aflutter.
The Fed has spent the last six weeks raising expectations about the next round of quantitative easing and if they believe that a lower dollar and higher commodity prices are the key to economic revival then they must surely be pleased. Yes, stocks have risen too and I suppose there could be a wealth effect from that, but with investors yanking money out of stock mutual funds for most of the last two years a lot of Americans won’t see any first order benefit from higher stock prices. Indeed, if higher inflation is part of the deal – and Bernanke has made it clear that it is – then a lot of Americans will be hurt by QE II with no offsetting benefit. Will the Americans who benefit gain more than the ones who are hurt? (More importantly, why is the Fed allowed to favor some Americans over others?) That seems to be a bet the Fed is willing, indeed eager, to take. We’ll find out this week whether they go all in or merely call what the market has already anticipated. As I’ve said the last couple of weeks, the potential for disappointment is large.
The economic data last week probably did nothing to deter Bernanke’s inflation faction from implementing QE II at the FOMC meeting this week but there were some interesting positives in last week’s reports. Two reports on housing provided some hope that that market is stabilizing. Existing home sales were up 10% month to month (although still down over 19% from last year) while new home sales also clocked in better than expected, up 6.6% to an annualized rate of 307k. There was conflicting data on prices with the existing sales report showing a steep decline (-3.5%) while new home prices rose 3.3%. Case Shiller data also showed a decline but the prices were from August so it doesn’t help much in determining what is happening today. I can’t help but think that the Fed’s wish for inflation is mostly about stopping the fall in home prices and preventing another round of bank losses.
The Goldman and Redbook retail reports showed solid gains and the GDP report Friday showed a healthy 2.6% gain in personal consumption expenditures. As I said last week, the weakness in GDP growth is not about consumption but rather investment. For the second quarter, residential investment dropped 29% and growth rates for all categories of investment except non residential structures was lower than last quarter. To emphasize the positive, the only negative category was residential investment and as I said above that market may be stabilizing at this lower level. Merely stabilizing would be a positive; residential investment subtracted 0.8% from GDP in the third quarter. One area that did show some optimism was inventories which accounted for more than half the gain in GDP at 1.44%.
The durable goods report was a mixed bag with a headline gain of 3.3% that was concentrated in aircraft orders. Ex-transportation orders were down 0.8%. Again, to emphasize the positive, year over year orders ex-transportation are up 9.5% and this is a very volatile series. Non defense capital goods ex transportation fell a bit (-0.6%) but that was after a good jump last month; the trend is still higher. The Chicago PMI also offered good news with a reading of 60.6, up two tenths from last month. New orders were particularly strong at 65. The employment component was also strong at 54.6. Input prices rose again despite the Fed’s worries about deflation. The national ISM report will be released next week.
The jobless claims report offered a rare piece of good news on the employment front. New claims dropped to 434k. Excluding the weird, outlier, seasonal adjustment plagued readings in July, this is the first reading below 440k since February. This might finally be a resumption of the downtrend in claims. Both of the last two recessions also saw new claims stall around the 400k level for a number of months after the recovery was officially underway so this isn’t unusual even if the timing wasn’t particularly favorable for the Obama administration. I still want claims to get under 400k before getting too enthusiastic about employment but this is a move in the right direction.
Next week brings not only the mid term elections and the FOMC meeting but also a very full slate of economic reports. Both the ISM reports, income and spending, construction spending, factory orders, jobless claims, pending home sales and the all important employment report will all be released next week. While the election and the FOMC meeting are obvious potential sources of volatility the economic data also seems to be at a potential inflection point. The fears about a double dip were, in my opinion, always a bit overblown and while the economic data has not been great, it also hasn’t been double dip, new recession bad. Last week was the first week in a while that offered some optimism and a series of good reports next week might be enough to produce some momentum.
Next week could prove pivotal for the economy and the market. High expectations for the election and the FOMC meeting probably mean there is little market upside – and plenty of downside – from those events. A Republican takeover of the House and potentially the Senate is fully reflected in markets already and likely way overblown. No matter how successful they are on election night, Republicans will not have a sufficient majority in the House to override Obama’s veto pen. In the Senate, there seems little practical difference between a slight Democrat or Republican majority. 60 votes are required for cloture and neither party will have the votes to push any legislation that lacks broad support from both parties. As for the FOMC and QE II, there seems little doubt the Fed can affect asset – and other – prices. I have considerable doubt as to whether that power to affect prices will be used wisely. History would suggest optimism is not warranted.
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