April is historically the best month of the year for the Dow Jones Industrials and the second best month for the S&P 500. But historical norms should be thrown out the window, right after the kitchen sink. Very little about the current environment resembles past situations. We’re sailing uncharted waters.
Market distortions such as the meteoric rise in the dollar and collapse of oil take time to play out. When prices of key assets and key commodities move as fast as they have, equilibriums are disrupted and it takes time for both companies and investors to acclimate. The full force of these effects has yet to manifest, but we’re seeing significant shifts in various economic indicators.
Before we get into the indicators that are showing signs of deterioration, it’s important to note that weakness is not universal.
Earlier last week we found out that personal incomes rose 0.4% in February. This was the fourth increase in the last five months. Disposable personal income also rose by 0.4%. But whether it’s a result of another cold winter, or continued “lessons learned” from the financial crisis, consumer spending has not risen in line with incomes.
Consumer spending rose only 0.1% last month, and this followed a decline in January. Spending is a major component of GDP and so this points towards a weak GDP reading for the first quarter. At the moment, most forecasts for first quarter GDP sit near 1.4%. The caveat here is that we saw a similar effect play out last year; GDP in the first quarter of 2014 contracted by 2.1%, but rebounded in the second quarter to 4.6% and hit 5% in the third quarter.
Personal income rising at a faster rate than consumer spending signals increased savings, and that’s what we’re seeing. The savings rate last month rose to 5.8%, the third straight monthly increase.
I’m of the opinion that money saved is of equal if not greater value than money spent. Sure, the economy won’t be as “robust” and corporate profits may suffer temporarily, but American consumers have long been walking a tightrope with no net. A higher level of savings across the population signals a greater ability to weather adversities like economic downturns or job cuts without severely cutting back on spending.
Also on the positive side, pending home sales hit the highest level in nearly two years. Pending home sales were up 3.1% in February, a sign that continued low rates are helping to facilitate home ownership.
The demand for homes continues to push home prices mildly higher. The Case-Shiller home price index released last Tuesday showed home prices have risen by 4.5% over the last year. Last month saw overall prices in the 20-city composite rising by 0.9%.
In somewhat of an odd twist, consumer confidence, as measured by The Conference Board, rose to its second highest level in seven years. This result does not match a separate measure of consumer sentiment, put out by the University of Michigan, which fell in March for the second straight month.
Consumers are often less informed than their business executive counterparts, and businesses are more concerned about the prospects ahead. Business investment has declined for six months straight, and various readings on manufacturing continue to decline.
Recall that a strong dollar makes imports cheaper, which incentivizes companies to import rather than produce. It also curbs exports, which suppresses domestic production. Last week, the Chicago Purchasing Managers Index (PMI) came in at 46.3. It was an increase from 45.8 in February, but any reading below 50 signals contraction instead of expansion.
That reading was further validated with a weaker than expected ISM (Institute for Supply Management) reading on manufacturing. The manufacturing ISM for March was 51.5%, still signaling expansion, but represented the fifth straight decline. What that means is that the pace of expansion, as measured by the ISM, is falling, and if that trend continues, we will soon see this index signaling contraction as well.
Interestingly, and as you might expect, manufacturing elsewhere is picking up. Eurozone manufacturing activity hit the fast pace in 10 months. Coincidence? I don’t think so.
It seems we’ve moved back into a bad news is good news environment regarding equity markets. As always this has to do with gaming the Fed’s moves.
I remain cautiously optimistic about conditions and market performance ahead. Even though the market hasn’t gone anywhere for the last three months, it remains a bull market.
We’ve been digesting and acclimating to some major changes across financial markets. The fact that investors have taken these developments in stride, and averages still sit near their all-time highs, is a good sign. We may be in the later stages of the expansionary phase of the business cycle, but conditions remain expansionary and there are no imminent signs of a recession on the horizon.
A quick look at market technicals backs up this cautious but hopeful outlook. The S&P 500 appears to be tracing out a short-term symmetrical triangle pattern, which most technical analysts consider a continuation pattern. This means the period of consolidation is likely to be followed by a breakout in the direction of the prior trend (up).
If we see prices repeatedly touch or fall through the 2040 level, it will be a much more bearish sign. A drop below 2040 (red dashed line) will indicate a short-term series of lower highs and lower lows. If the 2040 level is touched repeatedly and subsequent rallies fade in strength, the pattern will become more indicative of a descending triangle, which is also bearish, suggesting the eventual breakout will be to the downside.
A chart of the Russell 2000, representing small-cap companies also signals bullishness. Price action remains inside its three-month channel which has been rising steeply. A break through the lower trend line near 1240 will put us on alert, but it wouldn’t surprise me to see some consolidation in this index after its recent run.
The following is an excerpt of Richard Russell's Dow Theory Letters. To receive their daily updates and research, click here to subscribe.
