Some Cold Water In The Face Of A Manic-Depressive Market That Has Overdosed On Lithium
In an amusing turn demonstrating just how manic-depressive the market has become, stocks have gone from fearing an all out onslaught in Europe, to complete euphoria, based on a favorable ADP payroll number (which in the past several months had been broadly ignored due to its consensus misses). What is even more stunning is how the two main rumors that forced the market to surge: that Trichet was commencing a debt monetization program (refuted) and that the IMF would increase its funding contributions to Europe (mysteriously leaked by a "source" in the administration to Reuters, then also promptly refuted but only after it had already raised stocks another 50 bps) ended up being false. In the meantime we got an initial claims number that was weaker than expected, and an ISM that missed consensus, and a pending home sales that was so low it could only go higher, and which will likely result in half of the transactions falling due to the spike in mortgage rates. But hey: at least Goldman managed to boost the value of the stock portion of its bonuses, after the firm upgraded the economy, but more importantly, all banks, itself most certainly included.
It is yesterday's ISM that we wanted to focus on. Much as we hate to rain on the parade, we (unlike Princeton educated Ph.D. economists) continue to firmly believe that the market does not make the economy, especially when even your cab driver knows it is all a ponzi scheme (or, rather, it's a buy the dip scheme). As John Lohman, and David Rosenberg subsequently, remind us, the spread between the inventory and the new orders components of the manufacturing ISM came at a spread unseen in over 30 years, and a phenomenon which without fail leads to at least a sub 50 print in the ISM, if not outright (re)recession.
Here is how Rosenberg described this variance:
The U.S. ISM manufacturing index that came out yesterday, it actually came in below expected (bucking the regional indicators and dipping to 56.6 from 56.9). And with the sag in orders and pickup in inventories, the components were less than impressive. As today’s LEX column points out in the FT, when ISM orders slip below the inventory sub-index, “this usually indicates an oncoming recession...a return to sub-50 ISM readings cannot be ruled out...there is still the possibility that the V turns into the first half of a W.”
Hey, don’t shoot the messenger (even if we concur)!
That goes double for us. The magic of inventories is that just like China, one can accumulate all the goods needed (on cheap credit) but at some point these have to be sold. Just ask GM, which has now stuffed enough cars at its dealers that it won't be able to unclog channels for quarters (buy hey, the IPO is a resounding propaganda success). The main growth driver of the economy, and more importantly, of that new global economic dynamo - China, is and continues to be inventory accumulation. So when orders plunge and inventories surge, no matter how hard one spins it, it is impossible to reach a different conclusion that something will snap eventually. How long before it does? It all depends on credit procurement. If Bernanke keeps real rates negative, it is possible that on the first chart below, the Inventory-Order differential (red line) may hit all time lows in a few months, even as the ISM hits all time highs. And we have no doubts that the spinsters on a ratings-challenged CNBC will spend no time to present the data as positive. We once again will beg to differ. But in the global game of extend and pretend, where as we speculated earlier, even a modest downdraft in stocks now has the potential to bring down entire banks due to the pledging of equity securities with various central banks (definitely at the Fed, and most certainly in Europe), it is the Fed's only job now to keep the S&P hyperinflated.
Below is the chart of the ISM and its orders less inventories component:
And the same chart showing just how far the differential has dropped: there are only a few times in history when the 3MMA has dropped below zero. Each and every one of those times was accompanied by an ISM sub-50 contraction.
So please pardon us while we remain completely unconvinced that like the amusing cartoon yesterday made all to clear, the only thing this market is chasing is its tail. As market historians know all too well, in the period between 1930 and 1939, and during the Japanese two lost decades, stocks had so many 50%+ headfakes it is difficult to count. And never before was the entire world on the verge of global bankruptcy, when the only recourse was to devalue currencies with impunity, leaving increasingly more to create their own gold standard by purchasing ever more physical gold. So those who wish to chase this ponzi higher, are welcome to do so: it is only fitting that the previous post talks about Barney Madoff. We wonder how many of the people invested with Madoff would have pulled their money the day, month, year or decade before the ponzi was discovered had they known they would all lose everything. But such is human psychology: chasing momentum and inflection points, in a broken market, supervised by corrupt regulators, and ultimately determined by central bankers however, is not for us.
We can only wish the best of luck to those who do enjoy tossing live grenades.