Weekly Update: Are you sick of hearing about 'the cliff?'
When I got up to speak before a group of financial advisors in Phoenix earlier this week, one gentleman asked me at the outset to please not mention the fiscal cliff. “I’m sick of hearing about it.” I found that interesting because, as I traveled around the country this fall and asked audiences, most didn’t even know what the fiscal cliff was. Right now, volume is very low, and the market is being moved by the utterances of just a few politicians. The Obama administration’s opening proposal at yesterday’s so-called gathering was described as being so far from something Republicans would accept that the odds the White House does not intend to make an offer serious enough to result in deal before year-end has risen substantially. JP Morgan said one Republican source called the offer’s 4-to-1 ratio of tax increases to entitlement cuts a “joke,’’ “insult” and “complete break from reality.” The dichotomy between what consumers and businesses think about going over the cliff is striking. Pew Research Center findings show that roughly half of Americans think going over the cliff will have little or no impact on their finances. (Santa should love that). Meanwhile, businesses are much more skeptical—ISI notes almost 50% of companies in its survey have altered plans because of the fiscal cliff.
The phrase “fiscal cliff” was mentioned 12 times in the Fed’s Beige Book, as contacts in a number of districts expressed concern and uncertainty even as the economy continued to expand at a “measured pace.’’ There was modest improvement in real estate and auto activity for much of the country. Single family housing markets improved in most districts, the Chicago and Minneapolis districts reported agricultural production was not as significantly affected by the drought as previously expected, and the Fed said Hurricane Sandy’s impact was “minimal and localized in mainly coastal areas.’’ Wage and price increases also were reported as little changed, rising modestly. But reports on manufacturing were less than encouraging as seven of 12 districts reported slowing or contracting activity. That’s consistent with the various regional manufacturing gauges that also have been mixed. Dallas, Empire and Philly Fed readings indicated at least a fifth of the nation’s manufacturing output contracted in November, while Richmond and Chicago gauges pointed to expanding activity though future orders were constrained. It’s as if the sector is in a holding pattern until the dust clears on what Washington will do, a concern for the market, but which consumers don’t yet appear to be sharing. Monday, for example, saw the biggest online sales day in history (see below) and the lowest NYSE trading volume for a Monday after Thanksgiving since 1996.
Led by a Congressional Budget Office warning, a consensus of economic forecasters is coming around to the view we may see a recession ahead due to the cliff. We want to strap ourselves in for next week’s jobs report as much of the economic data coming out this week (see below) led many to lower growth estimates for the fourth quarter, some even below 1%. RDQ Economics says that while it is impossible to strip out the effects of Sandy, the starting point for the fourth quarter is troubling for GDP. Weak growth reinforces the view that the economy can’t withstand going over the cliff without falling into recession. If there is a recession, research shows that, using an average of the 11 recessions in the post-World War II era as a guide, the S&P 500 peaks 7.4 months prior to its start, declines 30% over 15 months and recovers its prior peak 18 months after the trough. The last 10% of the total market decline occurs over five months and is recovered about two months after the bottom. Assuming the Sept. 14 peak in the S&P was the peak in this cyclical bull, and using the relatively mild ’53-’54 recession as a guide to what we may experience barring a legislative miracle, would suggest the economy enters a recession in April, with the S&P bottoming around 1,250 in May. This is quite possible even if the cliff is reduced by half. How many times did I say “cliff’’ in this writing? Oh well, I couldn’t contain myself or the Phoenix adviser, either.
Housing has gone from a big drag to one of a few catalysts October pending home sales rose an above-consensus 18% year-over-year, lifting the future sales gauge to its highest since April 2010, when sales got a lift from a temporary tax credit. Case Shiller and FHFA data showed prices continuing to rise—the largest annual Case Shiller gain was in Phoenix, up 20%! (As I write this on my sun-drenched 80-degree hotel patio in Phoenix, I don’t wonder. Every time I visit I wish I lived here.) Mortgage purchase applications also moved sharply above their Q3 average the past three weeks. October new home sales did slip but it appears Sandy played a role as sales in the Northeast slumping 32%. Still, at 1.76 million units, the supply of new homes is only modestly above July’s historic low. And the number of homes for sale normalized for the number of potential buyers is a record low by a wide margin.
Is that Santa I see? The National Retail Federation said Thanksgiving weekend retail sales reached $59 billion, up 12.1% over 2011, helping ease but not fully offset Sandy’s sting, which caused most major chains to post disappointing sales for the month and consumer spending to slip. ComScore said online sales for Black Friday topped $1 billion for the first time and Cyber Monday sales hit $1.5 billion, up 17% from a year ago and the biggest Internet shopping day in history. ISI proprietary retailers’ surveys over the weekend weren’t as bullish, falling short of expectations. But historically, there’s only a loose correlation between Thanksgiving weekend sales and the entire holiday sales season. And shoppers appear to be entering the season in their best mood in years—the Conference Board’s confidence gauge hit a four-year high this month. Ho, ho, ho! What cliff??
It’s risky to be too bearish right now More than half of historical annual market returns come from the November-January quarter. Years with strong starts that suffered pullbacks in September-October, like this year, were 1971, ’78, ’79, ’86, ’87 and ’89, when the average November-January return was 6.8%. The latest weekly number of outright bears from the AAII poll also offers a contrarian positive: at 48.8%, it is its highest in 16 months.
Discouraging details behind upwardly revised Q3 GDP … The increase from 2% to 2.7% real growth was driven by a large upward revision to nonfarm inventories, which rose at their fastest pace in two years. A rising inventory build often is a harbinger of slower growth. Real final sales to private domestic purchasers were revised down to their weakest rate since ’09’s fourth quarter, with softer growth in transport, computers and “other equipment’’—consistent with the very soft tone to capital goods orders and shipments. For this reason, we should be worried about the fiscal cliff. (There’s that word again.) The economy is not healthy enough to withstand the significant negative impact that higher taxes will have on economic activity. Deutsche Bank believes real GDP at the most will grow just 1.3% this quarter.
... And behind durable goods’ upside October surprise Orders were surprisingly strong on the month, with the headline number flat versus expectations for a 0.4% decline and orders ex-transportation up sharply for a second consecutive month. Core orders—ex-transportation and defense and a proxy for business investment—also rose 1.7%. However, monthly revisions are common, and the annualized change in core orders is down 11.3% over the past three months. October’s core shipments also slipped 0.4%, the fourth consecutive drop, indicating businesses are holding off until a resolution to the cliff. (And again.)
It’s risky to be too bullish right now Even though Q3 earnings fell 3.6% year-over-year, Wall Street is calling for earnings growth to rebound to 9% in Q4. Historically, it has been rare for earnings to post negative growth for just a quarter. Since 1953, earnings growth has turned negative 18 times—all but three of those instances marked periods of sustained negative/flat earnings growth, with the average being 3.4 quarters before a return to positive growth.
Cliff notes The tax take of GDP by the federal government has been remarkably steady at 18% from the time of Johnson to G.W. Bush. This suggests that individuals and businesses respond to tax-law changes with efforts to smooth their tax payments. Thus, a strategy for reducing the deficit tilted toward tax hikes could easily fail because it would weigh on GDP growth and probably not raise the government's tax take.
More cliff notes Ned Davis Research notes Wall Street forecasters don’t have a good record of predicting recessions, but the Conference Board’s leading indicators do and they just hit a new high. And one of Ned Davis’ favorite indicators is the stock market; it can turn on a dime but, right now, it’s not consistent with a recession.
Forget the iPad, I want UGGs ISI’s proprietary survey of more than 600 teenagers found that while 43% of responses said Apple was a “must-have item” for the holidays, apparel/footwear/accessories bumped electronics as the top category on their wish list, replacing electronics.