Seeking Confirmation, Big Inventory Build, Lousy Durable Orders, Dollar Worries

One might look at the price action on Thursday and see disappointment. I'm not so sure that this is the takeaway. I see the gap higher opening for the S&P 500 for a second straight day. I see the sharp selloff into the afternoon, with the brief short covering into the closing bell... for a second straight day. Fact is that over last week and into this week, which covers eight trading sessions, six of the openings (including the entire East Coast morning), regardless of direction, were indeed nothing more than head fakes. Ever feel like we're being played? Like a Stradivarius?

Let this sink in. Equity markets reversed on Monday quite dramatically... from frightening lows. The S&P 500, Nasdaq Composite and Dow Industrials all by the close that day had recaptured last Friday's low (and closing level). That put traders and investors in the position of looking for what we call confirmation of that late Monday rally, or its outright failure. Over the past three sessions, there has been a lot of give and take, a lot of volatility, but neither confirmation nor failure of what Monday offered.

What would confirmation look like? Couldn't be simpler. We would need the headline indexes, even just one (S&P 500 or Nasdaq Composite; the Dow Industrials are too narrow and not followed by enough money to count here), but preferably both, to rally above Monday's close on elevated (majority advancing) trading volume. Failure would be a close below Monday's lows. The S&P 500 has returned three straight red daily candles, yet the low of each session has been found slightly higher than it had been the day prior. This is what that looks like....

Not only that, but the high-volume day of the week to this point has been the "up" day. Though it does not feel like it, these are short-term technical positives that could potentially be part of what we call "base building" should Monday's lows continue to hold and should we get that sought-after confirmation to the upside.

The Nasdaq Composite offered us a bit more volatility, leading large-caps in both directions, but as you see, even with the higher beta of the Nasdaq, there is still neither confirmation nor failure.

Incredibly, traders and investors have had to traverse a week that contained a much-anticipated Federal Open Market Committee (FOMC) policy statement and a bevy of high-profile large-cap quarterly earnings results, including what are probably the two most important (for capital flows) of any earnings season, Microsoft (MSFT) on Tuesday night and Apple (AAPL) Thursday last night. Both companies did a tremendous job in tackling supply chain and logistics issues and both performed marvelously almost across the board.

Oh, the marketplace also had to get past some odd-looking, headline-level macroeconomic data. Let's have a look, shall we?

Economic Stunner

On Thursday morning, the Bureau of Economic Analysis released its first estimate for fourth-quarter GDP. Let's take an inside look at quarter-over-quarter, seasonally adjusted and annualized fourth-quarter economic growth of 6.9% that crushed expectations that were for the most part in the 5% to 5.5% range. We all knew that growth had slowed significantly in December and expected that to have more of an impact upon the headline than it did.

There is no doubt that personal consumption (+3.3%) dragged on the quarter as consumption of goods stalled completely (+0.5%). Consumption of services (+4.7%) was stronger than goods for a second straight quarter. Government spending was a net negative for the fourth quarter. Federal spending (-4.0%) contracted as did state & local spending (-2.2%). Exports were strong (+24.4%), but so were imports (+17.7%) as cross-border trade recovered into the holiday season. Gross domestic purchases grew 14%.

The most interesting line, however, is line 7 on table 1. Gross Private Domestic Investment, which covers a lot, including buildings, intellectual rights, business spending and so on. What this line, which printed up 32% for the quarter, was mostly composed of for these three past months was inventory building.

This means that retailers, wholesalers and manufacturers, knowing there were supply chain and logistics issues, were proactive in stocking up on what they could stock up on going into the holidays. Do you know how much of that 6.9 percentage point print was attributed solely to inventory buying? That's right - 4.9 percentage points. The U.S. economy grew an even 2% ex-inventories for the fourth quarter.

Now, of course, it's unfair to make some kind of blanket statement like that, diminishing fourth-quarter economic performance. There is always going to be some inventory building and it does count as economic activity, it does promote velocity. That said, it also places an asterisk on fourth-quarter 2021, and quite possibly endangers headline economic growth moving forward.

What we do not have good numbers for is how timely this inventory building was. Did some of it miss the market? We know that retail sales haven't been particularly strong. We know that certain items become obsolete if not used quickly. Will demand change as interest rates rise and fiscal support for both households and businesses ebbs? Lastly, will increased inventory building persist as routine business practice as global logistics remain difficult? Or does increased stock suppress the demand for such activity over the next six months? Guess we'll know more when we know more. I do see the elevated fourth quarter "growth" as a direct threat to first-half 2022 economic performance, and I hope that our voting members at the Federal Open Market Committee understand that this is not the kind of growth that green lights a more hawkish policy posture beyond what has been signaled.

On That Note...

While the Bureau of Economic Analysis was putting fourth-quarter GDP data to the tape, the Census Bureau was simultaneously releasing December data for Durable Goods Orders. To put it mildly, December was awful. New orders, which were expected to contract, fell short of those expectations., at -0.9% month over month. Ex-Transportation orders, the number swings to +0.4% month over month, which hits consensus. Whispers, though, were higher. Ex-Defense, the number prints at +0.1%. That was a severe miss. The street was looking for 1.0%+ on that metric. In all, Core Capital Goods Orders, which is seen by economists as a proxy for private sector business spending, hit the tape at 0.0% month-over-month performance. That's right, flat. Expectations were for 0.4%. Some economists were looking for more. No one I follow was below 0.3% for this line. In other words, the Omicron variant of the SARS-CoV-2 virus, which really only cropped up in South Africa around Thanksgiving, had a tremendous negative impact on economic activity by year's end.

Fair Warning

Beyond equity markets, I see two markets being immediately impacted by the Fed chairman's news conference on Wednesday afternoon, which was perceived as considerably more hawkish than was the actual statement or the additional page published that was meant to lay out some ground rules for the eventual implementation of quantitative tightening, so that "we" won't be surprised by any action taken.

The first is US dollar valuations. I have received several questions from readers concerning inconsistent or even in some cases sagging commodity prices since Wednesday afternoon. Both the US Dollar Index (DXY) and The Wall Street Journal Dollar Index, which measure the home team's fiat currency against a basket of reserve currency peers, reached their highest points since early summer 2020 on Thursday and have continued to trade higher overnight.

This obviously puts US exporters and US multinational corporations in a more difficult place in early 2022 than they had been in prior. This also puts emerging and frontier economy nations and foreign businesses that have borrowed in US dollar terms in a tough spot. In short, this really is not a positive development either at home or abroad. While global markets are pricing in future rate hikes both in the US and the UK, the Bank of Canada has stutter-stepped, while tighter monetary policy across the eurozone is certainly no sure thing. Don't even look at the Bank of Japan or the People's Bank of China.

Forward-looking US policy is also forcing some flattening of the US Treasury yield curve. While the Three-Month/10-Year yield spread has only started to contract and remains almost healthy looking....

.... the spread between the yields of the Two-Year Note and the 10-Year Note ...

.... is now at its narrowest since October 2020. Not quite yet super-unhealthy compared to where we have been in recent years, but certainly trending in a dangerous direction. Remember, both these spreads inverted in August 2019. While true that none of us foresaw the pandemic, the US (and the entire planet) did enter into economic contraction by early 2020. The two spreads have always been key indicators of brewing trouble, and remain so.

Note to Readers: I have run up against the limits of both time and space. I will need to give Apple (which I do need to cover for you) its own piece at Real Money and Real Money Pro. I'll see you shortly.

Economics (All Times Eastern)

08:30 - Personal Income (Dec):Expecting 0.5% m/m, Last 0.4% m/m.

08:30 - Consumer Spending (Dec): Expecting -0.5% m/m, Last 0.6% m/m.

08:30 - PCE Price Index (Dec):Expecting 5.8% y/y, Last 5.7% y/y.

08:30 - Core PCE Price Index (Dec):Expecting 4.8% y/y, Last 4.7% y/y.

08:30 - Employment Cost Index (Q4):Expecting 1.2 q/q, Last 1.3 q/q.

10:00 - U of M Consumer Sentiment (Jan-F):Flashed 68.8.

13:00 - Baker Hughes Oil Rig Count (Weekly):Last 491.

The Fed (All Times Eastern)

No public appearances scheduled.

Today's Earnings Highlights (Consensus EPS Expectations)

Before the Open: (CAT) (2.26), (CVX) (3.14), (LHX) (3.26), (SYF) (1.41)

At the time of publication, Guilfoyle was long MSFT, AAPL and CVX equity.