Week in brief: September 25

September 28, 2015

What do Pope Francis, Chinese President Xi Jinping and Indian Prime Minister Narendra Modi have in common? Each visited the United States last week. Though none could right the direction of flailing equity markets while here. Leaving stocks to traipse the lower depths of their trend lines. Falling amid an acrid assortment of headlines, pessimism and despair.
All of which suggests that, despite our personal opinions, stocks exist beyond the purview of higher powers. While those leading the world's two most populous nations had enough on their plates.
The rationale for dreary investor sentiment? It's a grab bag.
The Fed's diminishing credibility. Declining faith in public officials. Renewed concerns over growth in China and emerging markets. Commodity weakness. Shaken and stirred with a general sense of the other shoes' impending drop.
The Halloween indicator has been activated. For things have gotten spooky.
But why?
On the one hand, bulls think the U.S. economy is fine while the rest of the world is a mess. On the other, bears think the rest of the world is a messy. And the U.S. economy is too.
These counterposing view points are slugging it out every day. Resulting in wild swings as bulls try to assert themselves -- buying what they consider to be bargains -- while bears laugh in their faces, spanking stocks that attempt to move higher.
Capital markets are essentially seeking out prices that represent various domestic and global economic points of view. As the data shifts, so does the conviction of global investors.
For clarity, independent investors must determine just how fast the U.S. economy is actually growing. And does such growth provide enough to counterbalance weakness overseas?
Well, durable goods sales fell last week. Reflecting a pullback in business investment in machinery, electronics and other goods. That figure has fallen five of the previous eight months. Year over year, it has dropped for seven straight months. Simply put, this recovery has not included business investment among its accoutrements. Why? Because corporations abhor increased regulation, tax uncertainty and rising health-care costs.
A simple deduction. With nary an Ivy League economist among us.
Further, recent signs of weakness from the industrial sector also weigh upon growth. Industrial production fell in August. Concurrently, an ISM survey of supply-chain executives found that U.S. manufacturing expanded at a slower pace in August than July. While the purchasing managers index produced its weakest reading since May 2013.
JP Morgan Chase's chief US economist points out that there's "no sense of panic in the way businesses are spending in terms of capital equipment. There's also no sense of exuberance. It's a steady, sober pace of expansion."
The problem with that assessment? That steady, sober pace is all we've gotten for seven years.
The U.S. economy must have enough momentum to maintain its growth trajectory despite weak economic conditions in Europe and Asia. Moreover, the strong dollar has made U.S.-produced goods more expensive for overseas buyers. And as the chart below reveals, there exists a large disparity between the Atlanta Fed's GDP assessments and those of most Wall Street economists. Wall Street is overly optimistic, believes the Atlanta Fed. And so will eventually be forced to tamp down expectations.
The good news? U.S. consumer spending grew briskly in August. Suggesting that strong Q2 spending carried over into Q3. As consumer spending represents more than two-thirds of U.S. economic activity, such news is manna from heaven. Especially so considering that the Q2 economy grew at a robust 3.9 percent annual rate.
All of which leads to one question. Can the U.S. economy continue to grow amid a lack of demand -- both foreign and domestic -- for its manufactured goods, and the labor and wage trends portended by such a lack in appetite?
That remains to be seen. But one historical certainty remains: bull markets rarely die on the wings of pessimism and despair.
Consider the summer of 2000. A few months into what -- in retrospect -- became a torrid bear market, investors remained extremely optimistic. Even though the Nasdaq index had already lost roughly one-third its value.
How about December of 2007? After stocks had risen for five straight years, investor sentiment was lethargic. Expecting markets to move forever higher. Not until the summer of 2008, when some of Wall Street's longest denizens began teetering on the brink of insolvency, did investors realized something was amiss.
The point? Investors have not become lethargic, nor overtly bullish. Not since the current bull market began. Yes, various economic data points are worrisome. True, earnings have been down. But there remain viable explanations for both. So long as that remains the case, and investors continue to shun stocks and eschew optimism, then historical probability remains sternly against the next big market correction.
As of Monday, the year has only 69 trading days remaining. Thus far, no major group of stocks has performed admirably. All U.S. market cap segments are lower. With large caps down -6 percent. Mid-caps lower by -3.5 percent. And small caps off by -5.6 percent. Overseas, developed markets have dropped -6.4 percent. While emerging markets are down -16.7 percent. Long-dated Treasurys are down -1 percent. Junk bonds, down -2.5 percent. Corporates are down -1 percent. Gold is down -2.7 percent. And silver is lower by -4.2 percent.
Nothing has worked. And most have become oversold.
Market historians may note the similarities between this year and 2011. Both years began with seven months of sideways, go-nowhere trend lines. Followed by steep declines in August. In 2011, the S&P 500 bounced off August lows, then rolled over and made a lower low at September's end.
On September 28th of 2011, the S&P 500 was down 8.47 percent on the year. Incredibly, following last Monday's close, the S&P 500 was was down 8.51 percent year to date. Should the correlation continue, the index should break beneath the August lows in the days ahead. In 2011, the market hit its low on October 3rd, having declined -12.6 percent, before surging higher to finish the flat for the year.
If that pattern repeats? Markets would stumble into October. Then stabilize, and head higher. However, don't expect a 2011 redux. That year's rebound was catalyzed by an improvement in the eurozone's debt situation. This year, D.C. will treat us to the possibility of another government shutdown. We'll likely see weaker earnings. And commodities will continue to fall.
Bulls would love to see an analog of 2011. And anything is possible. But chances grow less likely each day that bears maintain control.
Bottom line? Bull-market corrections are normal. We had not experience one for more than three years. Making this one feel particularly bad. Whenever prices fall, things look scary. Then, stocks bounce. Only to fall again and retest the lows. Nine of eleven dramatic bull-market drops since 1950 have seen this retest occur within a few percentage points, and within five weeks, of the previous low. This could be happening now. And that would place its end by sometime next week. Throughout these events, the media punditocracy crows about the risks of investing. Scaring investors. Even as lows form and bottoms are created. Leaving indexes to spring off them when investors least expect it.
That doesn't mean that things can't get worse. They can. Which is why investors must maintain contingency plans. Still, history reminds us that situations such as the recent market tumult more often serve as speed bumps than bull killers.
The Good
Nike reported excellent sales in China... Eurozone banks are well capitalized... Odds of a government shutdown declined following Boehner's resignation... September's final Michigan Consumer Sentiment survey beat expectations (while still being pretty soft)... New home sales beat expectations... Bearish investor sentiment reached new highs - a contrarian positive...
The Bad
Caterpillar, and other companies tied to Chinese manufacturing, continue to struggle... CFOs see markets as overvalued, a Duke survey says... Durable goods orders declined and missed expectations... Existing home sales beat expectations...
The Ugly
Volkswagen's massive deception. Obviously bad for the company. But what are the ramifications for the German economy, of which 17 percent is derived from autos? Have competitors committed similar offenses? Auto sales have been among the economic bright spots. So we abhor any bad news serving to delay purchases.
Boehner: Let's See How You Guys Do without Me
John Boehner had enough. The Speaker of the House announced Friday that he'd step down from his post. Take some time to relax. Work on his tan.
The Speaker had become quite unpopular. Particularly among the more conservative wing of his own party. Though he retained many fans. Including moderate House Republicans. The Capitol Hill media. Senate Leader Mitch McConnell. And, believe it or not, President Barack Obama as well as Boehner's opposite, California Representative Nancy Pelosi.
On most issues, Boehner was every bit as conservative as his conservative critics. In fact, he wanted to defund Planned Parenthood. To repeal the Affordable Care Act. To eliminate the Iran nuclear deal. Only, unlike his critics, Boehner's position demanded a sense of realism entwined with a political accommodation. How else could he navigate around the Senate's Harry Reid. Let alone President Obama's omnipresent veto.
Boehner received little credit for holding his caucus together. Despite staunch differences. While the government shut down briefly, Pandora's Box did not dispel any of the disasters that might have spewed forth. His critics will assail him for allowing Obama to run roughshod on issues like Syria, immigration, Iran, and spending. Let his replacement try to do better.
Hillary Clinton will likely be the biggest beneficiary of Boehner's resignation. As it allows her to position the GOP as divisive, unorganized and incapable of effective leadership. Of course, the media will comply. Creating a narrative that will define the political coverage in Q4. Moreover, this narrative will serve to divert much of the coverage from Clinton's e-mail controversy and falling political standing.
In the end, conservative Republicans may have gotten what they wanted. While the rest of the party picks up the tab.
Weekly Results
Major markets finished mixed last week. The DJIA lost 0.43%, the S&P 500 fell 1.36%, and the Nasdaq slid 2.92%. Small cap stocks lost 3.49%. And the 10-year Treasury bond yield rose 3 basis points to 2.17%. Gold added $6.87 per ounce, or 0.60%.

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