You can observe a lot just by watching, says Yogi. But sometimes all that gets you is more confused. We got a blizzard of information last week, on markets, on the economy, and on policy. Here is my attempt to avoid going snow blind.
Volatility? A 2% movement on major indices amounts to a quiet day. Sometimes the
move together, sometimes apart. Rotation? One day it's defensive ideas such as energy, financials, or drugs. The next day it's tech revividus. Is that rotation? Or is it fibrillation? The market is cycling back and forth, on and off, like a water-logged pump. It's not getting any work done, if by work we mean wealth creation.
Markets now seek value? Or is that cover? Using the
indices, value and growth styles are roughly even with each other on a year-to-date basis. But the pattern within the year is interesting: Value has outperformed since about mid-March, thereby making up its deficit since year-end. A similar pattern pertains when you look at the
, or the
small-cap index, or the
international benchmark. Or against 10-year Treasuries. In each case, with varying degrees of clarity, the S&P 500 underperformed from year-end until mid-March and has outperformed since. My working hypothesis is that money is pulling back from the periphery in its deployment and scurrying back to the core. SPX is hardly the risk-free asset of finance theory, but everything is relative, apparently. Cash has been so discredited by the eternal bull market that managers hardly dare mention it, let alone use it.
Sentiment? Complacency may not quite describe it, but intimidation most certainly does not. The survey conducted by the
American Association of Individual Investors
-- the folks who apparently really run today's markets -- shows improving conviction throughout these past several weeks of turbulence. Other sentiment measures are more ambivalent, but fear is nowhere to be seen in them.
The reaction to last week's numbers was fascinating. The expectations going in for first quarter
Employment Cost Index
reports were for market-unfriendly prints, so the circumstances were right for a sell-on-anticipation buy-on-news result. It should not have been startling if the data had come in as expected and the markets had rallied. But if the ECI and GDP had been stocks, they would have reported blowout quarters. ECI was expected to come in at 0.9% quarterly, with an outlier guess at 1.1%. The actual was 1.4%. Top line GDP was cooler than expected, but that's only because inventories couldn't keep up with final demand. Real final sales grew at a 6.9% annual rate, domestic final sales were up 8.2%, and final sales to the domestic private sector -- households and businesses -- clocked a double-digit 10.2%. This was no better-by-a-penny performance; this was a righteous blowout.
The cost pressures seen in the quarterly nonannualized aggregate ECI numbers were troubling: wage and salary growth at 1.1% and benefits up 2.0% for total comp costs of 1.4%. But that was aggregate. Ignore government for a moment and look only at the private sector; there the numbers are, in order, 1.2%, 2.3% and 1.5%. That last annualizes to roughly 6.0%, which sets a daunting pace for productivity to keep up with in order to prevent an acceleration in unit labor costs. (Is it fair to ignore the government sector here? Ask yourself whether the
, through open-market policy, can do anything to influence developments as it can with the private sector. It is up to legislative and executive branches to exert discipline in the government sector, and in an environment of budget surpluses, I'll give you odds on that.)
Cost pressures may speak of earnings disappointments down the road, but for now the numbers look generally terrific. Confession season was lightly populated and reporting season, by my unsystematic tally, seems to be yet another one of unsurprising positive surprise. But the market is fibrillating. Why should that be? After all, with such robust earnings, shouldn't investors be heartened? It is about fundamentals, after all, and nothing is more fundamental than profits. But we paid exalted multiples for these earnings last year and in prior years when we "discounted" them. To pay for them again would be, what? Absent-minded?
So now the markets are back on Fed-watch. At a bare minimum, the data would seem to reinforce the
Federal Open Market Committee in its current strategy: to hike its Fed funds target at each and every meeting by a boringly predictable 25 basis points. Forward markets are now pricing in more than a certainty of a 25-beep hike at the May 16 meeting; they see roughly a one-in-five chance of 50. Recent CPI, GDP deflator and ECI data are not exactly a "smoking gun" on inflation, but they do constitute the portentous click of a hammer being drawn back.
The rationale for Fed gradualism, expressed by those of us who are not at the FOMC meetings, is that eventually the market will get the message and take a breather for a while. The market's performance lately has involved nothing but heavy breathing, and its failure so far to break the pattern of lower highs and lower lows that has pertained since mid-March might be seen as an indication that it's starting to catch on. But the Fed's problem, displayed garishly in last week's ECI and GDP numbers, is that U.S. households and businesses have not yet even tuned into the message. Subtlety may not be the most effective way to deal with a juggernaut.
Markets right now seem to have a cautious disrespect for the monetary authorities. Sell the euro at any price -- it made a new low of $0.905 last week -- because the
European Central Bank
doesn't have the moxie or the political cover to defend it properly. Trade around the Fed because its regularly scripted policy adjustments can be gamed. That can't last. "There is no kill but overkill" -- a phrase coined by Al Wojnilower to punctuate the futility of temperance in monetary policy -- nags at me. Last week's blowout GDP numbers make me wonder: Does mean reversion apply to the economy too?
Jim Griffin is the chief strategist at Hartford, Conn.-based Aeltus Investment Management, which manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. While Griffin cannot provide investment advice or recommendations, he invites you to comment on his column at