Retail Sales, CPI and the Taper

Real retail sales kept growing at a good pace in Q4, while the available data on Durable Goods (October and November) suggests a slight slowdown but still a healthy pace. No wonder y/y growth in GDP is accelerating.

Meanwhile the slowdown in Core CPI has stopped but no clear turn to the upside is visible yet.

With economic activity still strong and CPI seemingly stabilizing, the Fed can still find excuses to continue tapering.

Employment - further slowdown expected

Further slowdown expected for the pace of growth in employment.

New Orders Index- strong but peaking

I have written already about the fact that the New Orders Index (component of the ISM PMI) is at peak levels but this time I wanted to show it another way, plotted as a quarterly 3-month average against the GDP. I am planning to show similar charts for other important economic indicators in the future.The red bar in the chart is based on an estimate for Q4 GDP.

So, it is peaking but this does not mean much for the economic expansion. Even lower levels still represent growth.

On the other hand, peaking also means strong and the stock market and the dollar will anticipate the continuation of tapering. This means a larger correction for the S&P500 soon.

To Taper or Not to Taper

I think it's time for an ACH (click for an introduction to ACH) on the much discussed tapering issue, more so, as it looks likely to be announced at the December 17-18 meeting (by tapering I also mean the communication that precedes the actual slowdown in QE).

So the hypotheses are:

H1 - the Fed will taper at the December meeting;
H2 - the Fed will not taper at the December meeting.

Here is a matrix with a score measuringmy judgement on how much each piece of evidence invalidates each hypothesis.


                             Evidence                                                       H1                     H2
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E1 - the economic indicators have been strong lately
and the Fed wanted to start tapering in September                       +                      -0.75

E2 - the latest GDP report has been strong but only
due to rising inventory                                                                -0.25                    +

E3 - the Fed has not started to communicate its
possible tapering intentions yet                                                   -0.75                   +

E4 - a slowdown in Q4 is expected                                             -0.25                    +

E5 - Bernanke could take upon himself the responsibility
to announce the taper                                                                    +                   -0.5

E6 - the December meeting is followed by a press
conference, a good opportunity to start tapering                              +                   -0.75
communication

E7 - the stock market has risen and the bond market
was flat after the strong NFP report, which could                            +                    -0.5
encourage the officials to start tapering sooner

E9 - inflation is still trending lower                                                -0.5                    +

E10 - the 7% unemployment threshold, which
has been mentioned by Bernanke early 2013, has                           +                     -0.5
been reached        
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                                                            Total                              -1.75               -3.00


Conclusion:

H1 is less invalidated, so it wins. The mechanical conclusion of the analysis is that the Fed will start at least communicating the taper at the next meeting.

What should be seen if, indeed, the Fed were to taper? I would guess that some early signaling by Fed officials (today there are three such speeches) but also the markets could anticipate such a decision somehow - the markets were not taken by surprise in September when tapering was postponed even if everybody was ready for it to happen.

Lastly, the conclusion of this analysis is not to be taken for granted. This framework is more of a way to put arguments in order and to see the pivotal ones. Expressing conviction in probabilities is much better. In this case, I would say there is a 60% chance for the Fed to start at least communicating the tapering.

Intermediate Term Top

Here is a chart of the weekly S&P 500.

I measured all the bull uplegs and the intermediate term corrections. Generally, twenty-and-something percent uplegs are followed by shorter ones. Measuring from the June low, the latest bull leg has already been 16% long, so, since the market is up against the 1800 resistance, and already committed above it, I think a drop has to happen very soon. The following correction would be somewhere between 7 and 10 % long.

New Orders Index

"Anyone who has studied markets half-seriously learns not to associate vigorous economic activity with stock market bottoms, but with stock market tops."

     Will Rahal.


Here is an up to date chart of the New Orders Index.

In the vein of the opening quote, it is hard to be bullish over the intermediate term given this chart. I do not think we can talk of a bull market top yet but a larger correction is not out of the question soon. Meanwhile, the short term looks good, with 1800 as next stop.

Employment

The average rate of growth in private payrolls has slowed down steadily during the last months to a level that may mark an inflection point. Any lower than this and the economic expansion is in peril, similar to 2007. We could see a bounce from here, the most likely scenario, but it could tip the Fed towards tapering early next year.