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Some not as bad as expected news on the real estate markets, some pretty damn good earnings, a Bernanke assurance that he remains vigilant at the controls of the printing press and the release of the results of the European bank stress tests were enough to move the US stock market higher by 3.5% last week, but the economic outlook really didn’t change significantly. The stress tests were mostly stress free - how do you conduct a European stress test and assume that no European country, not even Greece, defaults on its debts? - and the results entirely predictable. Did anyone really expect to find out Friday that the European banking system was insolvent? Like their US counterparts last year, these tests were open book and graded on a curve and in a testament to how deep is the hole dug by some of these European banks, there were still some failures. But none that weren’t expected; one German bank already in the friendly embrace of the German government, a few Spanish home lenders and amazingly, only one Greek bank.
The retail sales reports last week offered conflicting outlooks with the Goldman report showing a fairly robust year over year gain of 4.2% which they credited to hot weather driving people to the air conditioned malls (don’t people up north have air conditioning in their homes?) while Redbook clocked in with a paltry gain of 2.7% which they also credited to hot weather. One suspects that neither shop really has a clue what drives shoppers to the malls other than cars. Redbook offers the more pessimistic outlook for July, looking for an overall drop of 0.6% and I think it makes sense at this point to assume the pessimists have it right.
Housing starts dropped last month but that falls in the category of duh. Starts fell 5% to an annualized rate of 549K but in a hopeful sign - or a crazy one depending on your view of the real estate market - permits rose 2.1% to an annualized rate of 586K. Still not anywhere near what will eventually be needed to keep up with new household formation but considering the current market, not bad. Existing home sales fell less than expected, down 5.1%, to an annualized rate of 5.37 million and median prices rose 5.2%. Unfortunately, it looks like banks are starting to push those foreclosures out the door as inventory rose to 8.9 months at the current sales pace. Of course the months of supply can be cured in two ways; either a quicker sales pace or fewer actual homes for sale will do the trick. Given the job market neither seems all that likely right now. In another slightly hopeful sign, mortgage applications for purchase rose 3.4% last week while the mini refi boom rolled on with an 8.6% rise in apps.
The other reports from last week were the more worrisome ones. Jobless claims once again disappointed with new claims rising by 37,000 last week to 464K. So much for the hope that we were finally moving toward the magic 400K and less level that last week’s report engendered. Turns out there were some issues with adjusting for the July 4th holiday at the old Labor Department. I’m not sure why these holidays that happen every year seem to consistently surprise the number crunchers over at Labor but someone needs to buy them a calendar with all the holidays clearly marked. I hear that there are some nifty new computer software thingies that will even warn them of these days well in advance so they can plan for them. Get thee to an app store.
The index of leading indicators fell by 0.2% in June and if not for the steep yield curve would have dropped considerably more. Of course, a steep yield curve has in the past been a very reliable indicator of future growth, but one has to wonder about its efficacy in a deleveraging world. In the past a steep yield curve meant big bank profits and a future rise in lending but in today’s world while it still means the former, the latter seems less likely than a day without Lindsay Lohan getting into trouble. Those big bank profits could I guess still be beneficial to the overall economy but only after a large chunk is extracted by management and spent on yacht maintenance or some other service provided by the common folk. In a rather ominous sign, the biggest negatives in the report - factory workweek and vendor performance - point to a slowdown in the only sector showing signs of life - manufacturing.
Stocks showed some life last week with the S&P 500 rising 3.5% while the NASDAQ and Russell 2000 tacked on 4.1% and 6.6% respectively. Part of the explanation for the swift rise is that earnings are once again coming in better than expected and despite a few high profile misses, revenues have been as well. Roughly 75% of companies have beaten on the top line so far this quarter. In addition, companies raising their outlook for future earnings are outpacing those reducing estimates by a margin of 5 to 1. Good earnings will only carry this market so far though as long as the economic outlook continues to worry.
Bernanke delivered his semi-annual genuflection to the clueless politicians sitting on the Senate Banking and House Financial Services committees last week and after scaring the market half to death on Wednesday with remarks about the “unusual uncertainty” about the economic outlook - no one wants a Fed chairman with a cracked crystal ball - he changed his tune Thursday and let everyone know that he stands ready to crank up the printing press lest things get out of hand on the downside. Economic theory tells us that will have no effect in the long run but the long run has been out of fashion for some time now and with an election a few short months away, politicians are focused firmly on their short term prospects for employment.
There is nothing like the prospect of losing one’s job to focus the mind and several Democratic Senators seem to have discovered the supply side of the economy last week and called for the Bush tax rates to be extended for all taxpayers. I’m of the opinion that there are lots of other things that can be done to reduce the budget deficit before tax rate increases are considered so I applaud these former class warrior pols for the flexibility of their beliefs. Ken Rogoff has produced research that indicates that spending cuts are much more effective than tax hikes at reducing deficits and considering Christina Romer and her husband David’s research on the negative effect of higher taxes that seems a more prudent course at this point. Taxes aren’t the only area where previously hyperactive politicians seem to be getting cold feet. Cap and trade got moved to the back burner last week as well.
I have said previously and I continue to believe that if we want companies to hire and invest there needs to be a change in policy toward more pro growth policies. And when crafting these policies, policymakers need to think of small business and particularly startup businesses first and spend less time worrying about the large companies that make all the campaign contributions. That isn’t to say that the policies should be narrowly tailored but rather that they should be about creating a broad framework that allows all size companies to succeed. Much of what has passed for growth policy in the last couple of years has been about maintaining or bailing out existing large companies. It was more a defensive strategy to prevent things from getting worse and I suppose it might have worked to some degree but it isn’t what we need now. We need to move to offense now and start enacting policies that lead to job creation rather than job preservation.
I think a big reason the market rallied last week is that there is a glimmer of hope that Congress is starting to recognize that their actions are having a negative effect on the economy. Everyone in the business community needs a break from new legislation so they can digest what has already been enacted. They need a chance to think and plan for the future and be reasonably sure that that future isn’t about to change too drastically. The most important event last week had nothing to do with Bernanke’s testimony or Apple’s earnings report or anything else cited by the newspapers. The most important event by far was this statement from Joe Biden:
"Now that the heavy lifting is over, we can go out and make our case.”
I think the administration and the Democratic party will have a tough time making that case during the campaign for the midterms and all the polls say the same, but as long as they aren’t in DC at least we will be spared further “heavy lifting”. The burdens this Congress has placed on individual Americans and businesses is indeed a heavy one and at least some are starting to recognize that fact. Hopefully that will lead to better policies in the future and that I think was the message of the market last week.
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