Reality Check
Joshua M Brown
March 25th, 2012


Yo, pay attention because this past week’s reality check could become important.

So far the only data series that are maintaining their strength as the days stretch out into spring are of the jobs and employment variety.  The manufacturing stuff and the consumer/retail stuff is good, not great.  Q4 earnings were mixed and Q1 earnings, coming any day now, will be announced against the backdrop of $100 oil and $4-plus gasoline for almost the entire reporting period.

The bright spot that was housing appears to be starting to slide again.  Which sucks because the housing “improvement” was an enormous part of the bull case.  Also, seasonally housing is supposed to be kicking ass right now.  But eagle-eyed Joe Weisenthal notes that every single housing market data point this week was punk:

  • Monday: Homebuilder sentiment missed, coming in at 28 vs. expectations of 30.
  • On Tuesday, housing starts came in just below expectations.
  • On Wednesday, mortgage applications for the week fell 7.4%. Also existing home sales came in at an annualized pace of 4.59 million, vs. expectations of 4.61 million.
  • On Thursday, the FHFA house price index showed no gain vs. expectations of 0.%. Last month was revised from a 0.7% gain to just 0.1%.
  • And then today we got New Homes Sales of just 313K vs. expectations of 325K. Also today, the major homebuilder KB Homes reported a big miss, and the stock is getting crushed.

And housing was the least of it.  Stocks hit a post-crisis high on Monday on the news of Apple’s dividend and then dropped pretty much the rest of the week – a very uncharacteristic spate of trading days given how the year has shaped up so far.  On the week, only the Nazz recorded a gain, 0.4%.  In the meantime, the S&P lost half a percent on the week while the Dow 30 dropped a ball-busting 1.2% according to this wrap-up in the FT.  “Hey! Nobody told me these things go down also!”

And those global PMI reports!  Just awful, no way to spin ‘em, chooch.

First we heard from BHP Billiton, the massive mining concern, about weak mineral demand in China.  This was followed by an HSBC Flash PMI reading of 48.1 – the fifth consecutive reading under the all-important 50 level (which indicates contraction as opposed to expansion).  It’s important to remember that HSBC’s PMI survey looks mainly at small and mid-sized enterprises.  This as opposed to the official PMI numbers from the government which cover larger firms that have bigger global trade involvement and better access to bank capital.  Those official stats come out on April 1st and they are usually market-moving, FYI.  The bottom line on China is that anything below 48 implies less than 8% growth – which is a death sentence for all the countries who were hoping to sell into that region.

And worse than China was what we heard out of Germany.  As Randall Forsyth so perfectly puts it in Barron’s this weekend, Germany had finally diversified away from selling to its weakling neighbors in Europe and moved on to exporting more into China – just in time for China to begin rolling over.  The Euro recession is worsening as is China, this is important because of how highly correlated global GDPs are.  Also from the Barron’s piece by Forsyth, a killer quote from RBC’s economists:

“Lest we think the U.S. has the ability to avoid any of the negative reverberations from weak growth outside its borders, remember that the rolling five-year correlation of 32 countries’ GDPs have been on the rise and presently stand at over 90%.”

To recap, we’ve lost housing and some of the momentum in the stock market that’s engendered so much optimism.  We still have Apple but weakness in materials ($XLB), energy ($XLE) and the ($XLI) industrials has gone from being slightly irksome to being full-on Tara Reid-post-breast-implant-embarrassing.  In addition, the China engine that was meant to devour everyone’s goods is sputtering while Germany, the strongest economy in Europe, sinks into recession.

On top of it all, we’re heading into the “sell in may” period of the year – last year they ran and then peaked this market right in the middle of April and began lightening up early, just as the “January Effect” now begins the week before Christmas.

Now of course, April is a rockstar month for stocks generally; from 2001 through 2010, April has witnessed an average S&P 500 appreciation of 2.66%, the single best month of the year.  If you go back 40 years and look at 1971 through 2010, you see an average gain of 1.56% for April, making it the second best month in the calendar for stocks.  And who could forget last April, when stocks in developed markets, including the US, posted phenomenal numbers?  The MSCI World Index of stocks returned a whopping 4.31% in April of 2011.

Check out the below heatmap and try not to burn yourselves on the sizzling hot returns of a year ago:

But that was then and this is now.

Last spring the prospect of a European meltdown was still hazy and we were still getting high on the residue of the winter QE2 session – massive Fed liquidity was still coating our nostrils and coursing through our bloodstream.  But “the guy” isn’t necessarily coming back with more this year – unsinkable gasoline prices and political realities probably have the Fed on hold right now, no matter how many jittery text messages we send him.

If you’re running three sheets to the wind right now, you may want to ask yourself what it is you think is about to happen in the near-term.  I just went over the bull case as laid out in five major bullet points from JPMorgan and it has gotten more idiotic, not less, hinging as it does on the fact that “there’s nowhere else to put your money”.

If what we’ve just seen since last Monday represents the start of a new trend, it will be hard for the buyers to maintain their excitement.

We’re watching the market internals and technicals closely, casting a wary glance on housing and global PMIs and hanging onto the jobs trend as pretty much the only major positive at the moment.

So there’s your reality check.  Do with it what you will.

Category: Investing, Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

10 Responses to “Reality Check”

  1. Sechel says:

    Something to consider…. How many of these jobs were the result of warm weather. The results may be an anomaly.

  2. rd says:

    Rising employment is good but if the new jobs people are getting to replace the ones they lost in 2009 are paying only half as much, then retail and housing will continue to suck. The disposable income numbers are probably more important than unemployment given the structural change in employment that has been going on for the past couple of decades.

    Much of the S&P 500 are international companies with half of their revenues and profits coming from overseas growth. Lack of growth overseas does not bode well for increasing profits and margins.

  3. ToNYC says:

    Reality Check last week:

    1)MF Global’s Edith O’Brian’s CHA letter e-mail makes the Bloomberg light of day with JPM Dimon receiving the loot in London.

    2)BATS fiasco IPO disrobed by NANEX. HFT being the touchstone of SEC and SRO incompetence and human nature impossibility.

    3)Spain 10yr making a second try at the high fives.

  4. doodie says:

    If all you that is sustaining your belief here is the improvement in the jobs numbers, you might watch out. Hussman presents a chart that shows unemployment claims declining right through the 1987 crash:

  5. RW says:

    Brown’s concerns are valid (so are Montier’s and Hussman’s) but we are still in a situation where the earnings yield on equities is nearly 5% whereas the real yield on 10-year treasuries is zero or a hair less; e.g., A better era for global equities by Gavyn Davies (ht Brad DeLong).

    The case for reversion to the mean in profit margins and a serious downturn in equity prices remains plausible except, as Davies notes, continuing labor arbitrage and a large output gap argue for greater support of profits than normal. There are signs that is changing but to the degree that establishes support for profit margins then equity returns clearly look more favorable than bonds from an investing standpoint, at least in the intermediate term.

    I remain hedged but am net long as I have been for several years (“miserably long” as our host commented, a neat turn of phrase that captures my feelings pretty nicely going all the way back to 1999 when the “stealth bear” caught my attention).

    NB: Hussman makes a good case that his method of estimating equity returns and calculating risk premia is superior and that there is scant reason to believe we are seeing a return to a secular bull on that basis. But even if we accept his projected 10-year total return on the S&P of 4% that means we still have an equity return of nearly 5% over the 10-year T-note in real terms; 5% real return in a ZIRP world is not easy for an investor to resist, at least when there is enough liquidity to buy it and the carry is cheap.

  6. blackjaquekerouac says:

    looking for a sell off to pick up some quality on the cheap. the case for equities remains intact given the “low interest rates forever” backdrop and courtesy of The Bernank’s “solution to the liquidity trap.” Obviously anything that attacks the absurdly high price of oil is a must: Waste Management comes to mind. The obscenely high yielding AT&T comes to mind as a way to get some yield as well. Rare earth stock molycorp is another we will be looking at. i’d also like to see some public announcements from the oil majors about rolling out the natural gas energy infrastructure in the USA…with a plan to do so for the whole world for that matter. the buzz would do wonders for increasing demand for their energy solutions–and i think would put a solid floor in equities to power through to the end of the year. an “energy summit at the White House” would be the ideal scenario. Good luck on that one i imagine!

  7. boveri says:

    I gotta go with RWs input above. Boils down to “don’t fight the Fed” and profits will still be pretty good.

    Also, Joshua Brown is incorrect saying the market pecked in mid-month of April last year. The peak was at the endo of the month and May only declined moderately.

    Also housing was not as bleak as painted by Brown – housing permits improved for one.

    Finally, it is hardly idiotic for JPM to believe “there’s nowhere else [better] to put your money”

  8. crunched says:

    I already knew all of this because I read Zero Hedge. I didn’t waste time letting CNBC or those in the blogosphere who are mere CNBC satellites, blow smoke up my ass for the past month.

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  10. [...] Reality Check Big Picture. [...]