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Still Trying

Kevin Flynn
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www.AvalonAssetMgmt.com

“Come what come may, Time and the hour runs through the roughest day.” – William Shakespeare, Macbeth

In the second half of an NFL playoff game against the Baltimore Ravens last month, the New England Patriots suffered the Ravens to score first and take a 28-14 lead. To no one besides myself and the television, I muttered aloud that “it ain’t over yet.” In the fourth quarter of the Super Bowl championship game, the Patriots faced another serious deficit, this time of ten points. When a friend watching the game alongside of me started to despair, I passed along the same advice.

In recent weeks, I have been making the same remark about the bull market not being over while the stock market endured some heavy weather during another January loss. Like the Patriots, the stock market overcame its reversals and is now at a new high, at least as of Friday’s close on the S&P 500.

If you’re worried I’m about to embark upon some moralizing about sports effort and tie it in with the stock market, have no fear – the platitude dispenser is safely in the off position. The point I would make is that professional players will usually keep trying to win until the numbers are hopeless or the game is over.

So it is with the current bull market. There are times when equities can be quick to jump the gun on fears of an economic slowdown, but bond yields are now so low in this cycle that the fixed-income alternative is mainly a safe-haven play. Profit growth is slowing to a crawl, the economy is not getting any better, but so long as both are still positive – or to use our sports metaphor, there is still time on the clock – equities are going to keep playing.

What about those corporate profits? With about 80% of the S&P having reported their fourth quarter, FactSet’s blended earnings growth rate (estimated plus actual results) is only 3.1%. Estimated results are designed to run low, but getting to 5% growth for S&P profits on the quarter looks like a pretty stiff challenge at this point. We might yet get to 5% growth for all of 2014, down from 6% in 2013.

Falling oil prices have hit the energy sector hard and weighed on overall results, certainly, but no one was criticizing corporate profits in recent years for being boosted by lofty oil prices. What goes around usually comes around in the economic cycle. For decades I have heard excuses about how things are really okay if we just exclude some bleeding stump of a sector that shouldn’t matter all that much to overall health. The damage is always limited to some reasonable-sounding percentage of overall economic activity – six has been a popular number – yet somehow the patient has always ended up dying anyway.

So I am not shocked that stocks ignored a weak January retail sales report (see below) in favor of rallying on some more positive assorted bits – a bounce in oil prices, a possible ceasefire in the Ukraine, a non-negative GDP print in the eurozone. The market will do what it does, keep trying to move higher until the game is over. Other actors are going to maintain their efforts too – oil will keep trying to find a bottom, central banks will keep trying to make up for the inaction of inert legislators, Greece will keep trying to get a better deal and very likely Vladimir Putin is going to keep on trying to annex Ukraine in slow motion.

I can’t predict what Putin, oil, Greece et al will do, but I can predict that the low profit growth we are experiencing is not going to get a boost this quarter, leaving us with little cushion against any moves south by energy, politicians or economic activity. Do expect the market to try to move higher on what good news it can find, but in the event of bad news, be prepared for more serious air pockets in prices that what we’ve seen in the last few years. As Bill Gross has pointed out, there is less liquidity now from the Fed, and that is going to matter too. The game isn’t over yet, but things get more serious in the waning minutes – no game lasts forever.

The Economic Beat

The report of the week was retail sales, though the market reacted little this time around. The November report was better than consensus, occasioning a buying surge in equities, while December (released in January) was decidedly worse, leading to a sell-off. The January report was a disappointment as well, but not as big as December and one painlessly overlooked in favor of more benign factors, one of them being that the figure excluding autos and gasoline had a reported monthly rise of 0.2% (seasonally adjusted).

In the department of keeping it real, the twelve-month sales growth rate actually rose slightly from December to January, from 4.02% to 4.07%. Given the nature of the data and the likelihood of revision, the difference is too trivial to say more than that nothing has changed in the underlying trend. The year-on-year rate of 2.85% (unadjusted) was better than January 2014′s year-year rate of 2.16%, but January 2015 had an extra weekend day in it, a factor partly responsible for the seasonally adjusted headline decline of (-0.8%), or (-0.9%) excluding autos. The ex-auto, ex-gas rate of +0.2% is a pretty weak one, but seemed to feed a theory of consumers slowly transferring their gasoline savings to other categories – or in other words, don’t worry, the money is on the way. Well, maybe. The twelve-month rate for ex-auto, ex-gas went from 3.03% to 2.99%, so the money is taking its time.

The good news from the labor turnover survey (JOLTS) is that the hire rate is at a seven-year high (3.7%, seasonally adjusted) and the openings rate is at its highest (3.5% adjusted) since the beginning of 2001. The series does not have a long history, dating back only to December of 2000, so it’s rash to deduce too much. The year-on-year improvements were impressive in 2014, signaling the economy is still moving along. My sense is that the JOLTS data is mainly a coincident indicator, and the time to pay attention is when the rates start to decline.

The glow of the JOLTS survey lost some of its shine with the weak retail sales report, and a little more with the import-export prices data, which was negative all around. Import prices are down 1.2% excluding petroleum for the last twelve months, 8% overall thanks to petroleum, and export prices down 5.4% overall, or (-2.1%) when excluding agriculture. Falling oil prices do feed through the chain, but the currency battle has been heating up as well. With the strong dollar and weakening currencies of our trading partners, we are importing deflation. The latest producer price index (PPI) comes out Wednesday.

The wholesale sales and inventory data for December was on the weak side, implying more downward pressure on fourth-quarter GDP and first-quarter GDP as inventories continue to work off. I suspect that the difficult New England winter is not going to help this number. We should get a better indication on this from next week’s regional Fed surveys, with New York reporting Tuesday and Philadelphia on Thursday. Neither of the two comprise New England, but they are contiguous and should give a clue, along with the national industrial production report on Wednesday.

Housing begins its monthly slate with the homebuilder sentiment index on Tuesday, and starts data on Wednesday. The FOMC minutes come out Wednesday afternoon, so expect the usual scrutiny on possible escapes from the dreaded potential rate rise of 25 basis points. Lately the Fed seems more intent on its course of a 2015 raise, with the recent labor reports seeming to remove more excuses.

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