Many economists have been citing that the slowdown in the U.S. is more than the Japanese earthquake disruption. The primary focus has been on the rolling leading economic indicators as they tipped over in the company of falling ISM regional surveys, a spike in unemployment claims, drop in industrial production, and a drop in durable goods. Needless to say, that was a lot of economic damage over the past two months and the market listened well when the ISM non-manufacturing data came in way below consensus on June 1st. The S&P 500 fell like a waterfall from 1345 to 1284 in a few days. It’s June 30th, month and quarter-end, and the market is up 4% week to date. Something must have changed. It’s called a V-spike recovery in Japan ladies and gents as I’ve pounded the table on for the past month. In addition, the safety trade has been unwinding since the Greek and EU-IMF agreement last Thursday with Treasuries and gold rolling over and into stocks.
Let’s Talk V-Spike-Japan
As commentators on CNBC suggested in March, Japan would go through a huge hit to GDP in the first half of the year, but reconstruction and monetary stimulus from the government would likely pull them out of the rut. So the World’s number three economy was put on hold for a month. That would definitely ripple through the world economy a lot more so than a $5 spike in oil during Egypt’s protests. Apple couldn’t supply parts for its iPad. Toyota cut down capacity (Prius Supply Low with Toyota at Half Capacity) because it couldn’t get resin and other small parts. This week, a number of Japanese economic data hit the tape, namely with the PMI number released yesterday.
In Japan, industrial production rose 5.7% month over month in May. That is almost a 40% recovery in the 15.5% drop in March so far in two months. Projections are for another 5.3% rise which would be almost a 74% recovery in industrial production since the earthquake and tsunami. If that’s not a V-spike recovery, then define it for me.
In addition to the big Japanese IP number, retail sales have risen 2.4% month over month in May on top of a 4.1% gain in April. The 6.5% rebound in retail sales is almost a 79% recovery of the drop from the February high - another example of a v-spike recovery.
Why Japan is So Important in U.S. Manufacturing
Remember the week the non-manufacturing ISM fell to 53.5 from 60.4 in the month prior? In that data, manufacturers had drawn heavily on inventory which suggested one of two options: either 1) They knew a soft patch was coming and quickly moved to keep levels down given slowing demand or 2) reflects a shortage tied to Japan. I just don’t see how option one is likely given the ISM manufacturing index was clipping along nicely above 60 for four consecutive months in a row. That’s some incredibly fast reaction time by manufacturers in anticipation of a soft patch were that the case. Option two seems more logical and likely.
U.S. industrial production released on May 17th for April showed flat production. Exclude auto assemblies (which is where we had Japanese part problems) and manufacturing rose 0.2% after a 0.4% rise in March. Looking at May industrial production, IP rose slightly 0.1%. Excluding motor vehicles, manufacturing advanced a robust 0.6% in April. Comments from Ford as mentioned two weeks ago seemed to agree more with “Japan is the problem” when they said they’d sell more Mustangs if they had more V-6 engines. That’s just one example of many U.S. manufacturing companies that had problems getting parts. Two if you include Toyota as mentioned above, and they’re rapidly ramping up capacity in June.
The increase in the jobless claims data shows a steady rise from March until May 5th when the data peaked at 474k. The data has since come down to 428k. While still above 400k, unemployment claims peaked in May and has since leveled below that level at 428k new claims.
Today, the Chicago ISM Business Barometer was announced, showing a rise to 61.1 for June from 56.6 in May. Now this number is a mix of manufacturing and non-manufacturing data so it’s hard to get a read on the root cause of the comeback; however, the rise back to 61.1 suggests a significantly stronger rate of monthly growth. New orders jumped more than 7.5 points and production jumped nearly 11 points to 66.9 which may suggest that Japan supply constraints are easing.
So far, the economic reports that many economists cited when things were rolling over, are being ignored on the reversal. The stock market doesn’t care about what happened last month. Investors have bought stocks on four back-to-back days on positive economics and positive political headlines from Greece and the Eurozone.
Manufacturing Smanufacturing, Inflation is Killing the Consumer and Profits
I won’t argue with that, except that you can’t look at it so one-sidedly. The 85% of Americans that have jobs are getting loans for their new cars at 4%. So prices have risen, yes, thanks to a declining U.S. dollar, but credit has never been this cheap as long as you’re credit-worthy. Consumer discretionary stocks are trading back near the year’s highs with the XLY S&P Select Consumer Discretionary SPDR ETF at .21.
So let’s put Japan aside for a moment. What about non-manufacturing? If Japan part supply issues aren’t the problem, and we really are going into a soft patch due to higher prices, or possibly rolling over into another recession, then shouldn’t the other 75% of our economy show that? In the same week the manufacturing ISM number dropped to 53.5, the non-manufacturing ISM number rose to 54.6 from 52.8. The market moved up early on the news June 3rd, but there was enough damage in jobless claims and in manufacturing that the psychological and technical damage in the market had already been done and investors turned bearish; so bearish, in fact, that we reached summer 2010 “double dip” levels in bearish sentiment (as mentioned over the past two weeks in my wrap ups).
What about retail sales? Weren’t they down for May? Yes they were, down 0.2% largely due to autos. Exclude auto sales and sales advanced 0.3% in May. Year over year, May sales came in at a 7.7% increase. That doesn’t sound like a recession statistic to me. This number should be watched rather closely upon the next release. Tomorrow’s auto sales should give helpful hints.
So tomorrow we have Auto sales and the ISM manufacturing index report. The argument at hand is whether April and May’s drop in the ISM manufacturing number was related to Japan and whether the economic soft-patch will continue in the short-term. As mentioned above retail sales (excluding autos) and non-manufacturing is doing just fine, even with elevated prices so that argument is missing something. Remember that last week’s capital goods orders rebounded up 1.9%; however the monthly durable goods is a very volatile monthly indicator and last month’s 3.6% decline was revised higher to only a 2.7% decline. I think if you want to get a real read on how things are going, take a look at the Dow Jones Transport Index or listen to FedEx last week. They’re shipping goods just fine and guided higher for the rest of the year.
Economic data out of Japan suggests a V-spike recovery there, and comments from Toyota suggest that capacity is coming back. Guess what happens when supply is artificially kept low (in this case naturally due to acts of God such as an earthquake in Japan and flooding/tornadoes in the U.S. affecting construction and crops)? Demand is left wanting. It gets pent up. A V-spike in Japan should V-spike U.S. manufacturing. The U.S. dollar remains at ultra low levels. We should be able to export just fine as soon as we get the parts we need. iPads and Priuses will sell like hotcakes.
Long-term Economics
Today’s wrap up was just an accumulation of all of the recent economic data surrounding Japan and the U.S. regarding manufacturing and non-manufacturing. There are many other long-term macro factors that need to be discussed but they are outside the scope of this paper. Flow of Funds data from the Fed continues to show that residential and commercial debt is contracting while government debt growth is decelerating. The can may only be kicked down the road for so long. Eventually, the U.S. will have its Greek moment and there won’t be anybody left to increase debt leverage. The U.S. savings rate has begun to decline again, but we don’t have the housing cash ATM we had in the last recession to tap into when that savings rate hits 0. We’re moving onto the third year in a normal 4-year cyclical bull market, and stocks are starting to look tired when you view a 3-year weekly chart.
Looking at the markets technically, I’ve mentioned for two weeks now that we were at contrarian extremes in sentiment. The market was oversold and due a bounce. The bullish divergence in momentum versus the lower Treasury yield suggested a bottom there as I noted last week. Last Wednesday marked a short-term top in the safety trade with gold and the 30-year Treasury price peaking. Both have since dropped due to resolution in Greece (for now) debt issues and positive economic data this week.
The market has rallied four consecutive days in a row on moderate volume and breadth and is now overbought in the short-term with 91% of stocks in the S&P 500 above their 10-day moving average. Institutional companies I talk to who have access to order flow data I do not believe that investors are renting this market using derivatives and leveraged ETFs. I agree because I did just that last week on June 15th. It’s logical these same participants who are renting the market will get out the moment the market hits some technical resistance, if not here than likely at 1340.
The S&P 500 is at intermediate-term resistance as of today near its declining trendline and the 50-day moving average. It’s logical that we get some profit taking with 91% of the S&P 500 above its 10-day moving average. I think it all depends on how the market reacts to tomorrow’s ISM and auto news. The intermediate-term indicator still has some room before becoming overbought, with only 54% of the S&P 500 trading above its 50-day moving average. We could get some profit-taking around this price level, find support above 1300, and make another move towards 1340 which might finally place the market in an intermediate-term overbought level. At this point, there will be a lot of uncertainty as to the market’s direction but, as I’ve been saying since April, this market is in a trading zone. So get trading and be careful getting married to anything in your portfolio in this market. If the market breaks above 1340, then maybe we’ll have something more to talk about.
Sector rotation went defensive in May with consumer staples, healthcare, and utilities showing relative strength and market performance. That paradigm started shifting last week when the risk-on trade began making a bounce ahead of the Fed meeting. That trend has continued throughout this week. Today, the market outperformance was in industrials, energy, technology, and materials. The defensives underperformed. It’s a good sign when the market rallies that the defensive sectors are underperforming.
