E-piphany

Earthquakes in China! Volcanoes in Iceland canceling flights from Europe! Mysterious fireballs streaking across the night sky!

Maybe, just maybe, this is what finally ends the bull market in stocks: the End of the World. I knew there was something that could do it (perhaps perceiving this risk, stocks only rallied 0.1% today).

Trend changes happen from time to time, of course, with no apparent trigger at all – at some point, the portfolio of potential risks simply begins to outweigh, at the current price, the prospects for future gain. The portfolio of risks for stocks as well as bonds continues to grow; for stocks, after earnings season, we will actually add the new worry “next quarter may not be as rosy” but in the meantime here is a small list of worries:

• How long can the Treasury keep selling debt at a pace of a couple trillion per year (1+ trillion in new money)
• How much will the Volcker rule reducing liquidity (you know, it’s quite difficult to merely cross a block trade of 20 million shares without taking some prop risk. I’m just sayin’),
• Greece/Portugal/Ireland/Italy/Spain
• The prospect of higher taxes next year
• A Fed error: tightening
• A Fed error: not tightening
• Commercial real estate
• The unemployment rate
• The fact that the GSEs are increasing their combined debt again (FNM+FRE debt at 1.6 trillion at end of Feb, 1.67 trillion now, a few months after Congress removed the cap on the guarantee)
• Technical resistance on major stock indices (see Chart below, source Bloomberg)
• Frickin’ exploding mountains and UFOs

Resistance? Weak, but one more worry

Although it is tempting, I won’t throw “Initial Claims” in there, because although the 484k today was 44k above expectations, and looks suspiciously like Claims is just oscillating in a range between 450 and 485k (see Chart below, source Bloomberg), the BLS says that last week’s surprise and this week’s surprise are both due to Easter week vacation distortions. If that is true, then over the next couple of weeks the combined 60-65k surprise will be unwound. If we do not see a 3 handle, or at least low 400s, then we can revisit then.

Sure looks like noise, but we ought to know soon.

The rest of the data was strong enough. Industrial Production appeared weak at +0.1%, but that was mainly due to a plunge in utilities output. Factory output, which is the piece we care more about, was +0.9%, which is a healthy rise. Empire Manufacturing, too, was strong (31.86 vs 24.00 expected), although it’s a volatile series, and Philly Fed was as-expected at 20.2. the NAHB Housing Market Index rose to near recent highs, which isn’t of great importance but Housing Starts is tomorrow.

Rates fell slightly, with 10y yields down to 3.84%, but interestingly inflation swaps rose: 1y CPI was +9bps and 2y was +6bps. That’s a big move in a quiet market. Maybe that’s another concern. Although for my money, I’m going with frickin’ UFOs.

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An update on a prior commentary:

On March 28th I wrote a piece about the current value in long TIPS (link here) in which I noted that in the long run, real GDP-per-capita grows at around a 2% pace; so therefore should corporate earnings if they are a consistent share of the economy; and therefore so should stock price indices. In the January/February Financial Analysts Journal one of the authors of the original observation I was updating – Bradford Cornell – concluded that over the long run, investors should anticipate real returns on common stock to average no more than about 4 percent, which was approximately 2% real growth plus dividends. But he said something else that is interesting since some of the comments I received after I wrote that piece suggested that there were biases I was missing (which if true would imply higher returns for stocks…no one argued for lower). Cornell points out a bias that works in the other direction. According to his summary in the CFA Digest, “…in the long run, real earnings can grow at a rate no faster than real GDP. Those real earnings, however, are the real earnings for the economy as a whole. The real earnings growth that existing investors can expect may be less because of dilution that occurs when new shares are issued, primarily by start-ups.” Good point.

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On Friday, the increasingly-optimistic consensus (that may be another worry?) pegs Housing Starts at 610k, rising from 575k. As I have pointed out on occasion, 600k is a significant level for this series to exceed, but a far cry indeed from the old levels over 2mm units per year prior to the bust. Also out tomorrow is the University of Michigan confidence index (Consensus: 75.0 from 73.6); the forecasts would represent a high for the recovery to date.

I don’t see any proximate triggers for an equity selloff, or for that matter for a bond selloff. But I don’t think the risks are balanced. I believe that for very different reasons, the tail risk on both of them is to lower prices. I can argue higher-price scenarios for both of them, but I just don’t find them plausible. But who knows, if the Men In Black come and flashy-thing me, I might just forget all my worries and learn to love the rally.