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[after slicing one of the Black Knight's arms off] King Arthur: Now stand aside, worthy adversary. Black Knight: ‘Tis but a scratch. King Arthur: A scratch? Your arm’s off. Black Knight: No it isn’t. King Arthur: What’s that, then? Black Knight: [after a pause] I’ve had worse. King Arthur: You liar. Black Knight: Come on ya pansy.
That scene from Monty Python and the Holy Grail came to mind last week as the US dollar surprised almost everyone by staging a rally and in the process knocked the stuffing out of the commodity markets. To paraphrase another Monty Python bit, maybe the dollar isn’t dead just yet. Like Mark Twain, reports of its demise may have been greatly exaggerated. On the other hand I can’t help but remember the Dead Parrot skit so maybe it’s just an interlude before the dollar is finally declared dead and US citizens demand a full refund.
The carnage in the commodity sector was the big news last week as everything from silver to crude oil experienced a rapid reversal of recent fortunes. Stocks were down a bit on the week as well but by less than 2% in the S&P 500 although some markets outside the US took bigger hits. Countries dependent on high commodity prices such as Russia, Canada and Brazil were all the worse for wear by Friday.
Commodities were hit by a series of conflicting blows last week. First was the weakening of US economic data such as the ISM non manufacturing index Tuesday and jobless claims on Thursday. Weaker growth means less demand for commodities but also might mean a weaker dollar. Second was the more dovish statement by the ECB released Thursday which seemed to indicate they are less inclined to raise rates which knocked the Euro down and the dollar higher. Third was the better than expected US employment report Friday along with rumors that Greece might lose the Euro and go back to printing up reams of Drachmas to pay off their debts.
The conflicting information is no less worrisome for stock market investors even if the sell off last week was mild. Markets have been able to march higher over the last few months despite a plethora of potentially dangerous developments. Emerging market countries are fighting an inflation problem with tighter monetary policy which could threaten US exports if growth slows there. Europe is facing an ongoing debt problem that I don’t believe can be resolved without some form of default in several countries. Portugal, Ireland and Greece have no hope of paying off their Euro denominated debts in full and any haircut will have pretty dramatic consequences for European banks. And in an interconnected world that probably means at least some problems for US banks as well.
In addition to those concerns, we’ve had to deal with the increasing unrest in the Middle East that could threaten oil supplies. The obvious good news on that front last week was that the Navy SEALs sent Osama bin Laden back to the end of the Karma line where hopefully he can spend a few lifetimes atoning for the many sins of his most recent incarnation. How that might affect other bad guys in the Middle East is hard to say but it does send a message that the US has the capability and more importantly, the will to deal with people who threaten our way of life.
The threat to stocks from all this turmoil is that uncertainty over the economic outlook is likely to rise. The economy is just muddling along as it is and there is already a degree of anxiety about the end of QE II. If doubts about future economic growth rise as we move into June, it seems unlikely investors will stick around to see how things go when the Fed eases off the monetary accelerator. It appears that some are already getting a jump on things as bonds continue to rally despite the looming exit of the Fed from that market.
We’ve been sitting on a considerable allocation to cash so a growth scare that knocks stocks into a full blow correction is just what the doctor ordered as far as I’m concerned. I still find a lot to worry about but the rise in the dollar last week - if it can be sustained - gives me hope that we can muddle through this patch with just a correction rather than a return to bear market status. Lower commodity prices are a good thing for the economy and it should be noted that the correlation between commodity prices and economic growth is not significant. In fact, it is more often true that good economic growth is associated with lower commodity prices not higher. I suspect we’ll need a budget deal to sustain a higher dollar but there seems to be some movement toward a deal recently so I am hopeful if not exactly confident.
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Despite what appears to be new concerns about economic growth, the actual data last week continued its mixed ways. There was some decent data and some awful data just as we’ve seen over the last year. For some reason traders this week decided to emphasize the negative but really there hasn’t been much change. I’ve been arguing for the last few months that the latest growth spurt was peaking and that appears to be exactly what is happening. That doesn’t mean we are about to fall off a cliff and I don’t think that will happen but stocks and commodities were obviously expecting an acceleration that doesn’t now appear likely.
The data started the week on a positive note as the ISM Manufacturing survey showed continued robust growth in manufacturing coming in at 60.4. Growth of new orders and production continued to slow however, supporting our peaking scenario. More positive was inventory accumulation and employment which remained at elevated levels. Prices continued to be a problem but with the commodity rout last week, that might start to fade a bit. Factory orders released Tuesday seemed to confirm the ISM trend. Orders rose 3% and were pretty evenly distributed among durables and non durables. Shipments were up a very strong 5.4%. This report isn’t adjusted for inflation though so some of the gains are no doubt due to price pass throughs.
In some unexpected good news, construction spending rose in March. It wasn’t much - 1.4% - but it was the second month in a row of gains. Much of the gain was in private residential spending which I think was probably concentrated in the multi-family sector. Private non-residential and public spending were also higher but by smaller amounts. Construction may be making a bottom here thanks to the multi-family market. Apartment vacancies are very low and there is a need for more rental housing. It looks like household formation is starting to bounce back and as it gets back toward the trend of 1 million per year, building will have to pick up. That may be starting now.
Retail reports were generally positive on the week with the exception of the Goldman report. Goldman reported same store sales down 0.8% on the week but up 2.8% year over year. The Redbook version and chain store sales reported later in the week were more positive. Redbook showed a year over year gain of 5.5% and chains generally reported better same store sales. All of the data was however distorted by the Easter holiday so we’ll get a better read on things later in the month. Revolving credit did expand by $6 billion in March though and part of that was increased credit card use. While that isn’t what I’d like to see long term, it does seem to support higher spending near term.
The two most negative reports of the week were the ISM non Manufacturing survey and initial jobless claims. The ISM fell hard from 57.3 to 52.8 as new order growth slowed. Employment growth also slowed and is barely positive month to month. Supplier deliveries slowed and input prices remain elevated. Jobless claims was the biggest negative surprise, rising 43,000 to 474k. There were a number of excuses offered for the poor numbers from a new emergency benefit plan in Oregon to the timing of spring break in New York, but frankly this just extends the trend I’ve been reporting for the last month. Claims are highly correlated with the stock market so this is something that needs watching carefully.
Luckily, the claims data was a bit of an outlier in a week filled with hints and better data on employment. Challenger reported layoffs at 36,490 in April which is an historically low number although not much of an improvement from last year. The Monster index increased to 145 from 136 and Monster says the recruiting is widespread across industries (By the way, Alhambra is hiring. We are looking for investment advisor representatives with an existing book of business. Send resumes to me at: jyc3@alhambrapartners.com). ADP reported 179k private sector jobs which was down from last month’s upwardly revised 207k. Yes, it was down but still a solid gain.
The official employment report Friday showed a gain of 268k in private sector jobs and a net of 244k as government continued to reduce employment. February and March were revised higher by a total of 46k. The gains were spread across a wide range of industries including a gain of 29k in manufacturing and 5k in construction. Yes, construction. As I said above, it appears that multi-family construction is picking up with household formation which would be very good news for GDP growth if sustained. Overall, it was a solid report but curb your enthusiasm as there were some negatives too. Wages rose a nearly imperceptible 0.1% and hours worked were unchanged. The household survey showed a drop of 190k jobs as the unemployment rate ticked back up to 9%. Temporary help also declined a bit. The household survey like all economic reports is volatile though so I don’t want to read too much into the rise in the unemployment rate. Overall, the jobs picture improved last month and that is good news.
The US economy is still not hitting on all cylinders but neither does it appear to be getting significantly worse. In fact, if the dollar rises and then stabilizes a bit, knocking down commodity prices in the process, one can make a pretty bullish case for the US economy. We may go through a growth scare in the near term but overall, things continue to improve.
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