Weekly Update: Enjoying the Santa Claus Rally as long as the Scrooge doesn't show up
At this writing, there is no deal between the White House and Congress on averting the fiscal cliff—an outcome that’s definitely not priced into the markets. In fact, the past few days suggest positions may be hardening. House Speaker Boehner’s ‘Plan B,’ which entails tax hikes only for incomes above $1 million, was shot down as “unbalanced’’ by Obama and Senate Majority Leader Harry Reid. Never mind it’s essentially the same deal pushed last May by House Minority Leader Nancy Pelosi; she now says that was just a ploy to smoke out an offer from House Republicans and that House Democrats will reject Plan B. This morning—as it appeared a vote on Plan B could be heading to the House for a late-night and likely successful vote despite the likelihood of defeat in the Senate—it was House Majority Leader Eric Cantor who was calling the White House’s plan for tax hikes on incomes above $400,000 “unbalanced’’ because it proposes taxes which are higher than spending cuts.
So goes the political brinkmanship as the cliff moves ever closer. Of course, as we’ve noted before, such talks tend to go up to the last minute, so there’s still time. But the differences seem significant. Bank of America notes that on the spending side, gimmicky cuts like indexing entitlements to the chain CPI, as is included in Obama’s proposal, can only yield small spending cuts, while on the revenue side, raising the top tax bracket to households with income over $400,000 increases 10-year revenues by less than $400 billion. The IRS warned Congress that two-thirds of tax returns could be delayed in 2013 if Washington doesn't resolve the fiscal cliff. One reason is that the IRS would have to make major programming changes for the expansion of the Alternative Minimum Tax (AMT) if a deal is not reached.
The most likely and worrying scenario is that the payroll tax rates move higher to 6.2% from 4.2%, reducing first-quarter 2013 consumer firepower by around 4% annualized. Investors have always demanded a higher risk premium whenever growth rates have weakened. This is why whenever retail sales falter, the forward P/E of equities moves lower and equities lose momentum. The good news is the market’s rally has been broadening; the NYSE Advance/Decline Line made new highs this week. Moreover, the January seasonal backdrop is typically favorable, with the average S&P 500 return since 1950 at 1.1%. Finally, the Wall of Worry remains deliciously high. Unrelenting equity liquidation by individual investors pushed year-to-date outflows through last Friday to $154 billion, the second largest on record. The S&P has clearly broken up through the key 1430 resistance level, having rebounded over 100 points from the post-election lows. This is causing performance anxiety to creep into the tape as equities continue to rally and people reach for stocks and sectors with higher betas. It is a beautiful Wall of Worry—as long as Congress or the White House doesn’t become Scrooge.
Housing may be this year’s biggest gift to the economy December homebuilders’ sentiment report provided further evidence that the residential construction market is gaining significant traction. The index rose to a 6½-year high and has jumped 26 points in the past year, the largest gain in any 12-month period since the index began in 1985. Importantly, the gauge’s gain has been broad-based: present conditions, future sales and buyers’ traffic have all improved significantly over the past year. The index is highly predictive of housing starts (90% correlation between the two series), with a lead on the former of approximately six months. Based on history, the current level of the NAHB index is consistent with annual housing starts of 1.6 million, roughly double the current year-to-date average, though the latter slipped on a slightly larger-than-expected drop in November housing starts. Building permits, however, were stronger than forecast and are up 27% year-over-year, the strongest annualized pace since 2008. November’s existing home sales also were much stronger than forecasts. With sales continuing to rise at a double-digit year-over-year pace, and with the FHFA price index rising a ninth straight month in October, there’s little doubt that housing’s recovery is picking up momentum as we head into the New Year.
The surprise increase in third-quarter GDP isn’t likely to be a gift that keeps giving Real GDP for the July-September period was revised up again to an above-consensus 3.1%, lifting the average growth rate thus far this year to 2.1%, ahead of the Fed's most recent estimate of 1.7%-1.8%. Details of the report were solid, with final sales accounting for the entire gain rather than higher inventory accumulation. However, this picture of accelerating growth is not supported by income, output, business surveys or hours-worked data. Nonetheless, these numbers suggest no recession, and if the fiscal cliff could be resolved, continued moderate growth in 2013.
A pickup in China would be a nice stocking stuffer ISI’s proprietary China sales survey for the current week recorded its biggest jump in nearly three years, and the Shanghai Composite surged last week on state plans to buy equities. Moreover, according to data compiled by Oil Market Intelligence, the 12-month average of world oil demand rose to a record high last month, led by a surge of demand in China to a record high and more than offsetting a fallback in demand among the OECD’s 34 advanced economies to the last recession’s low.
Manufacturing’s mixed bag New York’s Empire index hit a post-recession low in December and has now been in negative territory five straight months. The components were as weak as the worse-than-expected headline, as new orders, unfilled orders, employment and the average workweek all fell and production slowed. There was a silver lining: the six-month outlook improved. December’s Philly Fed manufacturing gauge surprised the other way, moving well back into expansion territory with its best reading since April on increases in new orders, shipments and employment. While the two reports may have been impacted by Sandy, the nonetheless reflected the uncertain state of manufacturing, which has slowed since summer but has pockets of regional strength.
Leading indicators see slowdown The Conference Board’s monthly gauge fell 0.2% in November. The biggest negative contributors were jobless claims, which were distorted by Sandy, and the ISM’s new orders component. The indicators are in line with the latest Blue Chip consensus forecast for fourth-quarter GDP, which was recently reduced to 1.7%. But the conviction behind that forecast remains iffy while the Street sees how, or if, the White House and Congress resolve the fiscal cliff.
Cliff-dive’s impact could be long lasting According to a recent survey of CFOs by Fuqua, going over the cliff will lead to dramatic slowdowns in hiring and business spending in 2013 and will continue to hurt firms for years to come. Capital spending already has been slowing dramatically, threatening growth next year even if a deal is reached, and bank lending has been slowing since June and is only growing at an anemic 2.6% year-over-year pace.
I wonder what my husband will give me for Christmas? This week, I traveled in Baltimore and Annapolis with my wholesaler Max, and we were talking about what the ideal Christmas present would be. I said another puppy would be the greatest gift, a friend for my Anthony. And I might call him Max. I can’t do it, though, because my friend informed me that the most common name for both dogs and cats is Max. But you seldom meet an Anthony!
I love the smell of a fresh-cut tree Despite all the newfangled artificial versions, sales of live Christmas tree have been running about 5% ahead of the year-ago pace, continuing the trend of the past two years.
I’m going to wish you a Merry Christmas now just in case the Mayan calendar is right The Mayans are predicting that the apocalypse will happen tomorrow (Friday, Dec. 21). This forecast was made more than 5,000 years ago, so let’s hope there’s a tracking error in our favor.