We got our rebound and sell-off last week; now it's time for
another rinse and repeat. If that sounds like the European crisis,
it's not that much of a coincidence.
The near-term direction of the market is typically made up of
momentum; reigning directional perceptions and the comparison of
real data versus the perceptions; and how far the market may be
tilted towards one side.
Looking at economic events, the recent data has not been
terribly encouraging. The global slowdown is widely built into
investor perceptions, and there has been little to move them off
that stance. Purchasing-manager data from the eurozone and Germany
were worse than already-dreary estimates, and the latest earnings
results from US companies such as
presented a consistent pattern of lowered guidance from management
that centered on Europe and its effect on global trade. "Global
headwinds" may be the phrase of the week.
The most recent domestic data has been mixed, allowing the major
indices to stay within their trading range. All the companies
referenced above, for example, reported respectable domestic
results. The Chicago Fed's national activity index improved
somewhat, though it is still negative, and the new Markit "flash"
manufacturing PMI showed a manufacturing sector still hanging in
there as slightly expansionary.
) reported encouraging earnings and revenue.
Against that, the Richmond Fed business survey showed a sharp
deceleration in activity, and home sales were softer than expected
in both the existing and new home categories. The extraordinary
tightness of credit continues to hang over the sector, and the
headlines seem to be putting some additional caution into the
buying public - mortgage purchase applications have been shrinking
in recent weeks.
Despite this, non-economic events are going to favor stock
prices in the short term. The equity market is in an oversold
condition, the Treasury market in an overbought condition, and
sentiment indicators are at levels that suggest imminent reversal.
The end of the month approaches, and efforts to move back up to the
top of the trading range could get start getting underway as early
as today (Thursday). The Fed's FOMC policy statement is due next
Wednesday August 1st, and sentiment is again shifting towards hope
for additional accommodation. Even if the latter doesn't arrive,
traders will look to play the lead-in rally. Any weakness in
Thursday's jobless claims or durable goods reports will only fuel
The most volatile hurdle to cross between now and the Fed
meeting next week is Friday's release of the first estimate for
second-quarter GDP. The estimate range seems particularly wide,
ranging from 0.0% to 2.4%. The consensus appears to have fallen to
about 1.2% (annualized) from 1.5% only a week ago. UPS CEO Scott
Davis projected a second-half growth rate for GDP of just 1.0%
during the company's earnings presentation on Wednesday.
Clearly, the bar has been set low. The headline number that the
market will focus on is "real" GDP, or GDP adjusted for inflation.
That calculation depends on the quarterly GDP price deflator, which
periodically produces surprisingly low results (the deflator is a
subtraction in the calculation).
Such results have usually come in the fourth quarter of recent
years, but the second quarter of 2009 did produce a negative
number. The price indices for personal consumption expenditures
((PCE)), which are also calculated by the Bureau of Economic
Analysis ((BEA)), the agency responsible for the GDP estimate, have
been falling for several months, leading to a consensus estimate of
1.6% for the second-quarter GDP deflator that closely matches the
BEA's most recent PCE data.
However, the price of oil fell nearly 20% in the second quarter,
and could be a major swing factor in the GDP deflator estimate. The
PCE deflators do not always correlate with the GDP deflator - in
the fourth quarter of 2011, for example, the average PCE price
index was about 2.6% (annualized), but the reported GDP deflator
was only 0.8%.
This leads us to infer a higher-than-usual chance for a surprise
in Friday's initial estimate. The numbers most likely to produce a
rally are either a low number of 1.0% or less - thus "guaranteeing"
Fed action in trader eyes - or a high, positive surprise number
close to 2.0% that indicates the economy is doing better than
expected. Numbers in between are more difficult to handicap, with
our thinking being that an intermediate number is likely to create
an initial swing that could easily reverse.
The flip side is that a market rally is likely to produce the
opposite of what traders want. Should the indices move back up near
the top of the trading range, it will make a much better case for
the Fed to wait, especially on political grounds, until September
before making its next call. However, that potential disappointment
is a problem for August, and until then the prices will be set by
short-term tactical trading. Money managers will be very reluctant
to go against the possibility of another month-end melt-up and be
left behind in the performance derbies - they will not fade the
The dynamic does leave the door wide open for another August
fade, similar to last year. As we said, though, that is a problem
to worry about later. If 2012 continues to imitate 2011's price
action through next month and produce a significant drop, take
consolation in the thought that at least it would create more
pressure on central banks to act - and here we are really thinking
of the European Central Bank - and most of all, on politicians both
here and across the Atlantic. We fear that only sustained ugliness
will be able to get them off the sidelines.
I am long [[F]].
Team Management Discusses Q4 2012 Results -
Earnings Call Transcript