Monday, April 22, 2013 - Airplanes, Austerity, and Flying Bulls

Airplanes, Austerity, and Flying Bulls

by Sinclair Noe

DOW + 19 = 14,567
SPX + 7= 1562
NAS + 27 = 3233
10 YR YLD - .01 = 1.70%
OIL + .80 = 88.81
GOLD + 19.80 = 1427.30
SILV + .12 = 23.51

It's Monday but it's a better Monday than last Monday. No bombings to report today, at least not in our country.

Over the weekend, the cover story on Barron's magazine featured a cartoon drawing of a bull on a pogo stick, leaping through the air. You may recall that 6 months ago, Barron's poll of big money, institutional investors were bearish on the market; that was about 1,000 points ago. Now they're bullish. This would be a contrary indicator. But not today. Today, the bulls were buying the dips. The market started negative but finished positive. It’s all about momentum. Many fundamentally-oriented investors have been licking their wounds. And the nature of momentum-driven investing is that it can work longer than more sober-minded souls would think possible.

An open question is the odd continued rise of stock prices even as corporate earnings weaken. Why are investors paying more for companies whose earnings are declining in aggregate? In normal bull markets, you see a new leadership group emerge, and late in cycle, investors increasingly favor conservative stocks. This time the leaders are defensive plays, high quality companies that pay healthy dividends. While bulls say that this is predictable given ZIPR, we’ve had ZIPR for years now.
When this disconnect ends is anyone’s guess. But markets like this suggest that even more caution than usual is warranted.

The National Association of Realtors reported existing home sales slipped 0.6 percent last month to a seasonally adjusted annual rate of 4.92 million units. The supply of existing homes on the market for sale rose 1.6 percent during the month to 1.93 million, which represented 4.7 months' supply at March's sales pace, up from 4.6 in February.

That's is way below the 6 months' worth normally considered as an ideal balance between demand and supply. A year earlier, the inventory of unsold homes was 2.32 million, a 6.2 months' supply. More homes are expected to go on the market next month ahead of the summer buying season, so it might just be seasonal or it might signal that tight inventory is crimping demand, or it might signal that there is a real drag on housing.

It's earnings reporting season. Caterpillar reported this morning, with earnings of $1.31 per share; they missed estimates. In a statement the company expressed optimism on domestic housing, but said a 50% reduction in mining related businesses and little to no inventory build going into summer planting season will hurt results. For 2013, Caterpillar lowered its forecasts for both earnings and revenue to the low-end of the previous range.

Netflix posted better than expected earnings, and jumped about 20% in price.

Tomorrow, we'll get the Apple earnings. Over the past six months, Wall Street has gone from thinking that Apple can do no wrong to thinking that there's no way Apple will ever again do anything right. The stock has collapsed from a high of $702 to a recent low of $390 last week. Apple's results in the December quarter disappointed many analysts, and the company's outlook for the first quarter was muted. After a steady flow of news reports suggesting that first-quarter sales have not gone well, as well as Apple's failure to release any new products so far this year, many on Wall Street think that Apple will miss even its low guidance for the quarter.

The government is expected to report Friday that the economy expanded at a relatively healthy 3% clip in the first three months of 2013 after an anemic 0.4% gain in the fourth quarter. But don’t put too much stock into the mostly backward-looking report on gross domestic product. The signs of another midyear slowdown are already evident in softer consumer spending, a barely growing manufacturing industry and a slower pace of private-sector hiring. The same seesaw pattern also occurred in 2012 and 2011; and this year we can add in the effects of the fiscal cliff and the sequester. Consumers are finally feeling the bite from an increase in taxes earlier in the year and a round of federal budget cuts should pinch harder. The cuts only started to take effect in mid-March, and the biggest impact is likely to be felt in the next few months. Best case is for a continuation of an uneven recovery.

Today was the first day of the sequester hitting airports, as the nation's largest airports dealt with the onset of furloughs for FAA air-traffic controllers. Reports of late takeoffs at O’Hare, Atlanta’s Hartsfield-Jackson Atlanta International, New York’s LaGuardia, Los Angeles International and Charlotte-Douglas International in Charlotte, N.C., were widespread. In many cases, planes left the gate, only to sit on the tarmac for extended periods of time, while many flights were cancelled. Flights into cities such as Washington and New York were delayed by more than two hours as a result of the furloughs. Flight delays and cancellations at one airport can have a ricochet effect throughout the rest of the country, messing up arrivals and connections.

Pimco’s Bill Gross, the manager of the world’s largest bond fund, is the latest to trash a focus on austerity by British and euro-zone officials, telling the Financial Times that moving to cut debt too fast instead risks wrecking an economic recovery rather than righting the fiscal ship.

“The U.K. and almost all of Europe have erred in terms of believing that austerity, fiscal austerity in the short term, is the way to produce real growth. It is not,” Gross said. “You’ve got to spend money.”

 Gross says it was a mistake to think bond markets were calling on governments to embark on a round of severe fiscal belt-tightening. “In the long term it is important to be fiscal and austere,” Gross said. “It is important to have a relatively average or low rate of debt to GDP. The question in terms of the long term and the short term is how quickly to do it.”

Of course, last week, there was a major brouhaha about the academic research of Rogoff and Reinhart, who in 2010 put forth the idea that when a country reaches 90% debt to GDP it willl inevitably result in economic contraction. Last week, three economists presented a follow-up which showed Rogoff and Reinhart had flawed assumptions and basic math errors in their research. The idea that there’s a debt-to-GDP threshold that is true for every country, falls apart.

The “moral of this story is that it is an illusion to expect that the complicated relationship between public debt and GDP growth will always and everywhere be the same.” The idea that there is a stable relationship between debt and growth across time and places, independent of weak economies, is now behind us.

The timing of these developments is interesting. Right now there’s a serious effort to rethink the move to austerity. Between the developments in Japan and the IMF’s efforts in Europe and England, the common wisdom will soon be that austerity as a solution was oversold, with all the toxic side effects hidden. The question next will be how to turn that into political power.

France and Spain fell short of their budget deficit goals last year and rather than imposing even more draconian measures, the European Commission signals an end to sharp spending cuts.

The EU's statistics office Eurostat said France posted a deficit of 4.8 percent of economic output, higher than its 4.5 percent target. Spain's shortfall was the largest in the EU. Despite cuts and tax increases, Spain's budget shortfall was 7.1 percent, excluding bank recapitalization, higher than the government's 6.98 percent official year-end reading and well above Madrid's original target of 6.3 percent.

With budget cuts blamed for a second straight year of recession, the EU's top economics official Olli Rehn indicated over the weekend that more flexibility on tough economic targets was needed. European Commission President Jose Manuel Barroso, said today that austerity had reached its natural limits of popular support, saying: "A policy to be successful not only has to be properly designed, it has to have the minimum of political and social support."

Budget cuts have been at the center of the euro zone's strategy to overcome a three-year public debt crisis but they are also blamed for a damaging cycle where governments cut back, companies lay off staff, Europeans buy less and young people have little hope of finding a job. Crippling levels of unemployment and outbreaks of violence in southern Europe are now forcing a rethink, with the focus shifting to economic growth strategies.

It is not yet clear just how big a policy shift EU policymakers are planning.

From the Wall Street Journal:

Troubles overseas are threatening the US recovery for the fourth year in a row. This time it’s weakening economies abroad, rather than tumbling financial markets, signaling turbulence ahead.

US exports of goods to the European Union are declining outright. Growth in overall US exports has been sputtering for months, after a three-year postrecession surge. And major US companies are reporting increasingly disappointing overseas outlooks tied to the recession-plagued euro zone and slowing growth in other leading economies such as China.

The renewed fears of a global slowdown come after months of hope that a stronger recovery was finally taking shape.