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What "Might" Happen When the Fed Raises Rates?, Why Buy Europe, A Global Economic Game-Changer, and Your Weekly Update...

Piggybacking on the work of Wells's Jim Paulsen, I have run some charts of my own confirming that price to earnings (P/E) multiples tend to contract measurably during Fed rate-tightening cycles---and that the stock market has historically run into trouble at the onset of such cycles. However, it is not unusual for the market to recover early and march higher as the Fed continues to raise rates (those are the charts the bulls are trotting out these days). 

Here's one of my charts (I apologize for its busy-ness). The dark blue line represents the P/E for the S&P 500, the light blue line represents earnings per share and the purple line represents profit margins: click the chart to enlarge


The declining P/E is warranted given higher interest rates. Accelerating profits during some of those cycles (when the market held or advanced) effectively offset the potential fallout from lower P/Es. During a Fed tightening cycle---when P/E's are declining---and profits aren't rising, stock prices will come down hard. My concern this go-round is that profit margins have been expanding, virtually non-stop (note the purple line and white arrows on the graph), for 5+ years and the Fed has yet to begin tightening. Which they generally in the past have done earlier in the profit cycle. On this observation, by itself, we should expect a significant correction to occur when the Fed begins raising rates.

However, there is a counter argument to be made that, by itself, may not avert a 10+% correction, but should provide some comfort to those who fear that the next great bear market lies just around the next turn. The U.S. economy has just begun to accelerate at a pace worthy of your typical expansion. Companies are holding large cash positions, commercial and industrial loan issuance looks healthy, commercial paper issuance is up off its low in March and commercial paper rates remain extremely low. The corporate financing gap (non-residential fixed investment vs corporate profits, i.e., the amount companies must finance for capex [capital expenditures... i.e., investing in plants and equipment]) sits ($87 billion) way below the long-term average of 2% of GDP ($350 billion). Which means there's plenty of room for capex spending going forward. Which leads to economic growth, jobs and future profits. This would be one (there's more) legitimate bull case amid the coming Fed tightening cycle.

All that said, my suspicion (a suspicion, mind you, is not a prediction) is that the Fed will induce a healthy 10-20% pull back in U.S. stocks, should they begin tightening, as expected, during the second half of 2015. But being that great bear markets are things of recessions, and that your conventional pre-recession warning signs in the U.S. are virtually nowhere to be seen, I would be surprised if the U.S. stock market begins a prolonged 20+% sell-off next year. But it absolutely could happen...

I don't anticipate taking any unusual measures, at this juncture, going into next year based on the above. I do, however---as I suggested last week---believe we would be well-served to take advantage of present dynamics in other parts of the world and rotate some of our portfolios away from the U.S.---and into places such as the Eurozone (assuming you're not sufficiently there already).

Here's more on the Eurozone's prospects:

While, granted, the Eurozone economy looks shaky at best, we are beginning to see a few tiny green shoots. Primarily from recent sentiment indicators. Back in March of this year Markit's Composite PMI showed the Eurozone economy growing at a 32-month high pace. Since then things have retrenched. I believe much of the early-year optimism was effectively squashed by the Russia-Ukraine conflict. Although, as I said, there are signs that sentiment is beginning to improve.

In terms of monetary policy, clearly, the ECB---unlike the U.S. Fed---is far from engaging in anything other than further easing in the year ahead. Making for a friendly stock market environment, barring a new recession.

In terms of profit cycles, the Eurozone---unlike the U.S.---is currently nowhere near peak profit margins. And while the S&P 500 Index is trading at 15.9 times next year's earnings (not, btw, scary) the MSCI Euro Index is trading at a P/E on next year's earnings of 13.5. The Eurozone also looks more attractive when we consider price to book value, 1.5 versus 2.7 for the S&P 500.

On the oil market (given last week's action, I have to comment):

Wow! If you had told me back in January that oil would be trading where it is today ($66/barrel for West Texas Crude, $70 for Brent), I bet I could've talked you out of it. And if you didn't buy my argument, I would've cited the predictions of the International Energy Agency, and a host of gurus.

Here's a chart, taken from the International Energy Forum's January 22, 2014 publication "A Comparison of Recent IEA and OPEC Outlooks": click chart to enlarge



The case I was making for energy at the beginning of the year had to do with my guess that where we sit in terms of the U.S. business cycle and the potential for a pickup in global economic growth would support the price of oil against increased North American production. And I was feeling pretty smart around mid-year, as the energy index ETF we use was up two-times the broader market. Today, alas, not so much.

To my, the IEA's, gurus galore and some very unhappy hedge fund managers surprise, the Saudi's aren't doing what the Saudi's do. That is, they're not supporting a falling price by cutting production. In fact, they're doing precisely the opposite: They're pulling it out of the ground at a pace that keeps the price far below their fiscal breakeven number (the number at which oil revenues support their national budget), $106/barrel in 2015. It appears that the Saudi's are hell-bent on gaining back market share by plummeting the price and maintaining it long enough to put the skids on all that North American production (Thursday's decision among OPEC members not to cut production led to a 10% rout of oil prices and a 6+% drubbing of our ETF on Friday). And they're, for now anyway, willing to run a deficit until they achieve their goal. How long can they do it? Well, technically, all things (current pace of production, price, and Saudi foreign reserves) remaining equal, I calculate somewhere between seven and eight years. Would they stick it out that long? I'd say no way. But a year or two could, at a minimum, do a number on future investment in North American oil production.

So should we scream bloody murder? Well, as investors in energy stocks, sure. But as investors in transportation, industrial and consumer cyclical stocks---and as consumers of oil---we should send them a big fat thank you letter! No kidding...

Now that last sentence suggests that what we're experiencing is a global economic game-changer, in a phenomenally good sense. But of course, if the above story is correct, a game-changer this ain't. If the Saudi's truly have the power to price the competition out of the market, ultimately we'll see prices shoot back up as all that production begins to leave the scene. No long-term game-changer there, just a game.

But there's another story to tell that indeed says we're experiencing a global game-changer. Perhaps this isn't about the Saudi's strengthening their grip on world oil, perhaps it's about the Saudi's losing their grip. Truly, given the huge increase in North American production capacity, OPEC doesn't have quite the influence on the price of a barrel of oil that it used to. As Nigeria's Oil Minister, Diezani Alison-Madueke, said after the OPEC meeting last Thursday:

“It’s a toss of the coin as to whether, if we had cut anything at this point in time, we would have seen higher prices.”

Business Insider's Tomas Hirst makes the case and illustrates the pain other less-wealthy OPEC nations are experiencing due to plummeting prices. Here's a snippet:

Previously, OPEC members would agree to cut oil production if falling prices posed a threat. That may now have changed because of the shale oil boom in the US, which has dramatically increased supply.
As Goldman Sachs wrote in a recent note (emphasis added):

"[There is a] realisation that the OPEC reaction function has changed and that the US shale barrel is now likely the first swing barrel ... When Saudi Arabia cut prices to Asia for November delivery it was interpreted as a shift in the Saudi reaction function to a focus on market share. This should have not been a surprise in the new world of shale that has flattened the supply curve, as economic game theory suggests that they should not be the first mover and that the US shale barrel should be the new swing barrel given how easily it can be scaled up and down."

This may explain Saudi Arabia's unusual hints that it is now comfortable with sub-$90-a-barrel oil prices — it doesn't want to admit that its power to shift the price is drying up.

Here's another:

Already this year Venezuela, Nigeria and Russia have burnt through billions of dollars in efforts to support collapsing currencies and flagging economies.

Russian international reserves have plummeted by $90 billion since the start of the year spent mostly in foreign exchange markets trying to prop up the rouble. Despite decades of commitments to diversify its economy, oil still accounts for 10% of the country's GDP and around 50% of federal budget revenue.

Morgan Stanley estimates that "every $10 fall in the oil price means a $32.4 billion fall in oil and gas exports, which is equivalent to about 1.6% of GDP" and around a $19 billion fall in government budget revenues.

Elsewhere Nigeria finally conceded defeat in defending its currency, with the central bank devaluing the naira by 8% and increasing rates sharply on Wednesday. Investors have turned against the currency as Nigeria imports around 80% of the goods it consumers with 95% of its foreign currency earning coming through oil exports. Falling oil prices means the cost of those imports has become a lot steeper.

And for Venezuela the situation is simply dire. According to state-run oil company Petroleos de Venezuela the country looses $700 million for each $1 a barrel decline in oil prices, a cost that the ailing state can ill afford. Adjusted for inflation the country's real GDP remains 2% below its 1970 level and, according to US academics Carmen Reinhart and Kenneth Rogoff, it is now all-but-certain to default on its foreign-currency debt.

Iraq and Iran are also vulnerable to sharp price drops. Production in the former at risk due to the threat of Islamic State militants seizing additional territory, including key oil infrastructure. In November forces loyal to the Iraqi government succeeded in forcing IS militants out of the Baiji refinery in northern Iraq, which the had earlier captured. These risks mean the cost of extraction and refining is high.

Again, lower energy prices---while they haven't helped our portfolio's relative returns this year (at all!)---are, save for the countries who rely heavily on oil exports, a boon to the global economy. As for the beaten up energy exposure in our portfolios, as long as we remain around 10% of equities (it's down to that after the drubbing), I'm not inclined to go chasing this falling knife. Sure, there may be an opportunity here, but 10% in my view is ample under the circumstances.

Here are last week's (US) highlights from my economic journal:

NOVEMBER 24, 2014

THE CHICAGO FED NATIONAL ACTIVITY INDEX came in below expectations, .14 vs .40. An index reading of 0 represents trend. Therefore, a positive reading represents growth above trend. October's disappointment lies in the rate of growth coming in below consensus expectations. The production component, specifically, with regard to a sharp decline in both mining and utility production, accounted for the lion's share of the disappointment. The employment component declined as well as payroll growth came in at 214k in October versus September's 256k.

MARKIT'S FLASH SERVICES PMI came in at a positive 56.3 (above 50 denotes expansion), however that's down from October's 57.1 final reading, and estimates of 57.8. The positives within the survey were employment growth and the business outlook, both at 5-month highs. Weighing on the number was growth in incoming work, now at a 7-month low. However, backlog accumulation remains strong.

DALLAS FED MANUFACTURING SURVEY'S BUSINESS ACTIVITY INDEX came in strong at 10.5, ahead of estimates of 9.0 and matching October's 10.5. THE PRODUCTION INDEX, however, came in noticeably lower than last month's reading, 6.0 versus 13.7. The continued strength in employment [amid mixed yet improving responses to other key components] among the majority of these anecdotal indicators supports my view that the U.S. economy is moving its way toward a better growth trajectory in the coming months. Here's the summary from the Dallas Fed :

Texas factory activity increased again in November, according to business executives responding to the Texas Manufacturing Outlook Survey. The production index, a key measure of state manufacturing conditions, fell from 13.7 to 6, indicating output growth slowed in November.

Other measures of current manufacturing activity also reflected slower growth during the month. The capacity utilization index fell sharply from 18.1 to 9.8. The new orders index also declined notably from 14.2 to 5.6, although more than a quarter of firms continued to note increases in new orders over October levels. The shipments index was 12.1, nearly unchanged from its October reading.

Perceptions of broader business conditions remained positive this month, while outlooks were less optimistic. The general business activity index held steady at a solid reading of 10.5. The company outlook index dropped from 18.2 to 8.8, due to a smaller share of firms noting an improved outlook in November than in October.
Labor market indicators reflected continued employment growth and longer workweeks. The November employment index posted a sixth robust reading, coming in at 9.6. Twenty-one percent of firms reported net hiring, compared with 11 percent reporting net layoffs. The hours worked index slipped from 8.3 to 5.7, indicating a smaller increase in hours worked than last month.

Upward pressures on wages and prices were mixed. The raw materials prices index fell from 19.7 to 15.3, its lowest reading in seven months. The finished goods prices index edged up from 7.1 to 9.7. The wages and benefits index was little changed, at a reading of 23.9, with 76 percent of manufacturers noting no change in wages and benefits this month.

Expectations regarding future business conditions remained optimistic in November. The index of future general business activity rose 5 points to 18.3, while the index of future company outlook held steady at 23.1. Indexes for future manufacturing activity held steady or improved in November.

NOVEMBER 25, 2014

THE ICSC RETAIL REPORT showed a pickup measurably last week. +2.2% vs the previous week. As I stressed, I fully expect retail results to come in very good this season. This indicator supports that view.

THE JOHNSON REDBOOK RETAIL REPORT showed a year-on-year increase of 4.2%, vs 3.9% the previous week.

THE FIRST REVISION OF Q3 GDP came in surprisingly better than anticipated. It was revised up to 3.9%, thanks to consumer spending and non-residential investment (among other things) , from the 3.5% preliminary reading. The consensus expected a revision downward to 3.3% (so did I)... Here's the BEA release:

Real gross domestic product -- the value of the production of goods and services in the United
States, adjusted for price changes -- increased at an annual rate of 3.9 percent in the third quarter of
2014, according to the "second" estimate released by the Bureau of Economic Analysis. In the second
quarter, real GDP increased 4.6 percent.

The GDP estimate released today is based on more complete source data than were available for
the "advance" estimate issued last month. In the advance estimate, the increase in real GDP was 3.5
percent. With the second estimate for the third quarter, private inventory investment decreased less than
previously estimated, and both personal consumption expenditures (PCE) and nonresidential fixed
investment increased more. In contrast, exports increased less than previously estimated (see
"Revisions" on page 3).

The increase in real GDP in the third quarter reflected positive contributions from PCE,
nonresidential fixed investment, federal government spending, exports, residential fixed investment, and
state and local government spending that were partly offset by a negative contribution from private
inventory investment. Imports, which are a subtraction in the calculation of GDP, decreased.

The deceleration in the percent change in real GDP reflected a downturn in private inventory
investment and decelerations in exports, in nonresidential fixed investment, in state and local
government spending, in PCE, and in residential fixed investment that were partly offset by a downturn
in imports and an upturn in federal government spending.

The price index for gross domestic purchases, which measures prices paid by U.S. residents,
increased 1.4 percent in the third quarter, 0.1 percentage point more than in the advance estimate; this
index increased 2.0 percent in the second quarter. Excluding food and energy prices, the price index for
gross domestic purchases increased 1.6 percent in the third quarter, compared with an increase of 1.7
percent in the second.

THE FHFA HOUSE PRICE INDEX showed price appreciation slowing in September, at 0% vs .4% estimate and .4% prior. Year-on-year prices are up 4.3%.

THE CASE-SHILLER HOME PRICE INDEX showed a little strength in September, up .3% versus a decline of .1% in August.

THE CONFERENCE BOARD'S CONSUMER CONFIDENCE INDEX disappointed in November. Coming in at 88.7 vs and estimate of 96.5 and a prior reading of 94.1. My view has been that the consumer, based on lower gas prices and an improving jobs market, not to mention recent equity market action, would continue to drive optimism higher. This reading contrasts, albeit slightly, with that view. Here's Lynn Franco, Director of Economic Indicators at The Conference Board, followed by Econoday's commentary:

Consumer confidence retreated in November, primarily due to reduced optimism in the short-term outlook. Consumers were somewhat less positive about current business conditions and the present state of the job market; moreover, their optimism in the short-term outlook in both areas has waned. However, income expectations were virtually unchanged and gas prices remain low, which should help boost holiday sales.

Econoday:

Positive trends are still intact despite an otherwise weak looking 88.7 November reading for the consumer confidence composite index, down from a downward revised but still a 7-year, recovery best of 94.1 in October. A hidden positive in today's report is little change in jobs-hard-to-get, at 29.2 percent which is historically low for this reading and up only a marginal 2 tenths from October. This reading, which is closely watched, points to steady and favorable conditions for the November labor market.

The jobs-hard-to-get reading is a subcomponent of the present situation component which in total, pulled down mostly by monthly declines in business conditions, fell 3.1 points to 91.3 to indicate month-to-month weakness in consumer activity -- not welcome news for the nation's retailers going into Black Friday.

The second component of the composite index, expectations, fell an even steeper 6.8 points to 87.0 which is the lowest reading since June. The decline here reflects declining confidence in future business conditions and some erosion in the jobs outlook. A positive, however, is strength in the key subcomponent for expectations which is future income. Optimism here held nearly steady. Income expectations turn mostly on the jobs outlook but also on the outlook for the stock market and the housing market.

The ongoing burst lower in gasoline prices is driving down inflation expectations which fell 1 tenth to 5.2 percent, a level that is very low for this particular reading and which will get the attention of Fed policy makers who have been voicing concern that inflation right now needs to turn higher.

This report, due to jobs-hard-to-get as well as future income, is not as bad as it looks, especially given the hard comparisons in the prior spike. The Dow is moving to opening lows following today's report. Watch for the twice monthly consumer sentiment report to be released tomorrow and whether it too will show a fall off from recovery highs.

THE RICHMOND FED MANUFACTURING INDEX showed a softening of manufacturing activity in the fifth region compared to October. Coming in at 4 versus an estimate of 16 and October reading of 20. The last sentence of Econoday's summary below accurately characterizes the recent indicators coming from the manufacturing sector:

Early indications on the November manufacturing sector, on net, point to monthly softness compared to October. The Richmond Fed's index is down very sharply this month, at 4 vs 20. Order readings are very weak with new orders essentially flat compared to October, at plus 1, and with backlogs in contraction, at minus 2. Shipments are also basically flat at 1 while vendor delays eased which is another sign of softness. But manufacturers in the region are still hiring, at 10 though down from 14 in October. Inventories are rising on plan and price pressures are mostly moderating especially for inputs. Recent data from the manufacturing sector have been no better than up and down, much like this report today.

THE STATE STREET INVESTOR CONFIDENCE INDEX declined slightly to 114, from 115.8 prior. The European component is up big time to a record 141.9, although the strength was centered only in the UK. Relatively weak North American and Asian sentiment effectively offset the strength in the European component.

NOVEMBER 26, 2014

THE MBA PURCHASE APPLICATIONS INDEX has been the definition of volatile of late. After a 12% surge in this index tracking new purchase mortgage apps the prior week, it dropped 10% last week. The 4-week average shows a negative trend.

REFINANCE APPS dropped .4%, after a .6% decline the prior week...

DURABLE GOODS ORDERS, while looking good on the headline number, showed underlying weakness in several key areas. If I had to zero in on one component as being key going forward it would be capital goods, ex-defense. Which showed a contracting of .8% for shipments and .1% for new orders. Year-on-year, however, showed increases of 5.0% and 9.7% respectively. In the aggregate, the month-on-month result, ex-transportation, was -.9%, year-over-year +6.4%... Transportation and defense orders are what essentially created the positive headline number. As I type, industrials ore off .23% on the day, while transports are up .04% --- the overall market's flat on the day.

WEEKLY UNEMPLOYMENT CLAIMS came in at 313k. The first reading above 300k in several weeks. There were no special factors cited in the report. The 4-week moving average (the metric to watch in this volatile series) is at its highest level since September, yet remains at an historically comfortable 294k. A positive was a decline in continuing claims which fell 17,000 to 2.316 million. The 4-week continuing claims number dropped 18k to 2.352 million. Lastly, and positively, the unemployment rate for insured workers dropped 1 tenth to 1.7%, the lowest level since 11/2000.

The consumer's situation continues to, albeit slightly, improve. THE BEA'S PERSONAL INCOME AND OUTLAYS REPORT for October shows personal income growing .2% month-on-month, 4.1% year-on-year... As for outlays, consumer spending grew .2% over September, 3.6% over the past year. And as for inflation, the Fed's favored indicator, the PERSONAL CONSUMPTION EXPENDITURS (OR PCE) PRICE DEFLATOR shows a core (ex-food and energy) increase of 1.6% over the past year. With food and energy inflation running at a 1.4% year-on-year rate. I wonder what the naysayers (I've been one myself) who complain about the core number understating inflation because it omits food and energy are saying now?? I should add, being that clients are now privy to these notes, that we should remain watchful with regard to inflation in the years to come---as global central banks continue to follow ultra-easy monetary policy... As for the moment, however, clearly, inflation is not a worry...

THE CHICAGO PURCHASING MANAGERS INDEX continues to signal a nice rate of expansion. Econoday sums it up nicely:

Chicago purchasers continue to report outsized rates of monthly growth, at a composite index of 60.8 this month vs an even greater outsized 66.2 in October. New orders fell 11.7 but are still at 61.9. Production also slowed but still remains robust while inventory growth slowed after October's 41-year high. One clear negative is a slowing in employment to its lowest level since March. It's hard to make much of this report where the readings are so high. Note that this report covers all sectors of the Chicago economy.

While Conference Board's Consumer Confidence Index (released yesterday) reflected a bit of waning optimism, THE BLOOMBERG CONSUMER COMFORT index climbed last week to its highest level since 12/2007. Which is much more consistent with my view with regard to the consumer going forward. Here's Bloomberg:

Consumer sentiment in the U.S. climbed last week to the highest level since December 2007 as Americans grew more upbeat about the state of the economy, their financial well-being and the buying climate.

The Bloomberg Comfort Index advanced to 40.7 for the period ended Nov. 23 from 38.5, according to a report today. All three components improved last week, with the gauge of views on whether it's a good time to shop rising to a seven-year high.
Labor market gains, record stock values and gas prices at four-year lows are boosting household sentiment in time for the holiday-shopping season. Fatter paychecks for lower-income earners would help households across all income brackets to make more purchases.

Another reading indicating that the consumer is feeling pretty good about life is today's release of THE UNIVERSITY OF MICHIGAN CONSUMER CONFIDENCE INDEX which increased to 88.8, its highest level since July 2007. Basically the same obvious drivers---stronger job growth, cheaper fuel, a rising stock market---are influencing consumer attitudes heading into the shopping season.

NEW HOME SALES disappointed in October, coming in at 458k, vs an estimate of 470k. September's reading was revised to 467k. As Econoday states below, this is a volatile series:

New home sales are soft but sellers are getting their prices, at least in October. New home sales came in at a lower-than-expected 458,000 pace vs 455,000 in September which has been revised 12,000 lower. August, which was originally reported at 504,000, has been revised down a second time, 13,000 lower in today's report to 453,000. The combined 25,000 in today's downward revisions paint a weaker-than-expected picture of the new home market.

This report is often volatile and volatility really appears in price data which show a 16.5 percent surge in the median price to a record $305,000. The year-on-year rate, which had dipped into the negative column in September, is suddenly at plus 15.4 percent. More thorough but less timely data on home prices in yesterday's Case-Shiller and FHFA reports offer no hint of a sudden acceleration in pricing power.

THE PENDING HOME SALES INDEX, like the new home index, was generally uninspiring for October. Pending home sales fell 1.1% after rising .6% in September.

THE EIA PETROLEUM STATUS REPORT shows inventories rising for crude oil and gasoline, +1.9 million barrels and 1.8 mill respctively. While distillates inventories declined by 2.1 million barrels.

Weekly Update...

As you may have noticed, you’re receiving far fewer emails from me these days. I assure you it’s not, as one client quipped, because I’m spending all of my time on the golf course. I honestly can’t remember the last time I played golf. Well, honestly, I can. It’s just that it was so horrifying that I’ve been trying to block it out of my mind ever since. The fact is—at least for the time being—I’ve decided to dispense with the commentary on global politics, except when I feel it holds near-term pertinence to your portfolio, and steer your attention solely to markets and economics. And I’m hoping that less frequency will inspire you to travel with me (read my commentaries) into the end of this year and beyond—as I offer my insights into the data that will dictate our portfolio recommendations going forward.

On those occasions when I fall off the wagon (it'll happen) and rant on about some senator proposing a taxpayer-funded goodie---disguised as something other than sheer thievery--- for a crony, I'll give you fair warning in the teaser. Otherwise, you're safe clicking the "click here to continue" link.

Your weekly update:

We began last week with news that Japan has fallen, by textbook definition (two consecutive quarters of negative GDP), into recession. After contracting by 7.2% in Q2, the world's third largest economy defied economists' estimates (the consensus had it growing at an annualized 2.1%) and delivered a negative 1.6%. U.S. stock index futures sold off on the news. But upon realizing that Japan has been no big contributor to global economic growth of late, traders bid the major averages a few basis points higher by the close on Monday. By the week's end, the Dow was up .99%, the S&P 500 1.16% and the Nasdaq .52%. As for Japan's market, by the end of the week---bolstered by Prime Minister Shinzo Abe's announcement that a pending sales tax hike will be delayed by 18 months---it had recouped almost all of Monday's 3% drubbing, ending the week down .76%.

As for the U.S. economy, as you'll see below, last week's data supports my view that, while still a considerable ways from robust, it is on as firm a footing as we've seen during this recovery. In my last update I suggested that growing optimism for the U.S. economy would ultimately equate to a pickup in capex spending (an essential ingredient in a healthy expansion). The latest Empire State Manufacturing Survey (see below) supported that view, which, by the way, would be bullish for the tech and industrial sectors.

Weekly retail sales continue to come in relatively soft. However, as I've been suggesting the past few weeks, I'll be surprised if the presently high consumer sentiment readings, lower gas prices and improving jobs picture don't equate to a robust holiday shopping season.

Beyond the above, manufacturing's mixed (but good on balance), housing seems to be improving a bit, inflation's tame, the Fed's dovish, and foreigners are buying U.S. securities like they're going out of style. Oh, and Q3 earnings have come in quite good: With 487 of the S&P 500 companies thus far reporting, 79% beat analyst's estimates on 9.1% year-on-year growth. The top line was pretty good in terms of surprises, with 60% beating estimates. Growth was okay at 4% year-on-year.

The international scene:

While the Fed is done for now with QE (printing dollars and buying treasuries and mortgage backed securities), the Bank of Japan, the ECB and The Peoples Bank of China (just lowered its benchmark interest rate for the first time in two years) are doing their darnedest to devalue their respective currencies (bolster their exports).  Stocks across the globe popped (Europe's especially) higher on Friday on news that China was cutting interest rates and that Draghi was willing to buy all manner of bonds to create a little inflation in Europe.

Among developed markets, the Eurozone currently has my attention the most. Back in January 2013, I was telling clients that, while I was making no market prediction, I was comfortable with the U.S. stock market from a valuation perspective. And, as you'll recall, 2013 was a phenomenally good year for your portfolio. But, again, I was not making that prediction, I just happened to be comfortable with U.S. stocks at the time. (Here's an article I dug up from back then where I touched on that sentiment). And while---with the U.S. economy at last showing possibly sustainable signs of life---I probably should be equally sanguine on our market today, I'm actually feeling a little more comfortable (from a forward rate of return standpoint [not necessarily from a relative risk standpoint]) with European equities at the moment (as strange as that may seem amid the present state of the European economy). You see, valuations among Europe's markets---based on next year's estimated earnings---reflect a noticeable discount to the U.S. market. And while the U.S. Central Bank is on the cusp of (albeit slightly) tightening monetary policy, the ECB is moving firmly in the opposite direction. Now, as you may know, my economic rearing makes me no believer in the notion that nations can print away their long-term problems. As a watcher of markets, however, I know that traders are indeed believers. And, frankly, QE or not, I'm guessing that Europe's teeter totter economies will, on balance, settle into a better growth trajectory as next year unfolds.

Not to say that by upping our exposure to European stocks we'll realize out-sized returns in 2015, or that, in the event of a bear market, owning attractively-valued foreign securities will lessen the pain (could exacerbate it), it makes sense to me to own Europe at these levels. I am, of course, assuming that "we" remain long-term investors (patient, that is) and are very comfortable with volatility.

Here are last week's (U.S.) highlights from my economic journal:

NOVEMBER 17, 2014

THE EMPIRE STATE MANUFACTURING SURVEY showed New York's manufacturing sector gaining in the general index, new orders, shipments and employment. A good showing, all in all... However, the 10.16 came in below the 11.1 estimate... While the current conditions component came in below the estimates, expectations improved to the highest level in two years. Also, and big in my estimation, plans for capex and technology spending increased nicely - also to a two-year high.

INDUSTRIAL PRODUCTION declined .1% in October, vs a .2% estimate. Mining and utilities, -.9% and -.7% respectively, brought down the overall results... Manufacturing gained .3%, nondurables up .3%, durables up .1%. Among durables machinery posted the largest gain, 1.3%...

CAPACITY UTILIZATION RATE dropped to 78.9% in October... Not a good sign, however signals that inflation does not pose a near-term economic threat --- and substantiates some Fed members' concerns over too-low inflation.

 

NOVEMBER 18, 2014

THE ICSC RETAIL SALES REPORT rose a modest .2% over the previous week. Up 2.2% year-over-year. Anything but robust, but I remain optimistic going into the Xmas season.

THE JOHNSON REDBOOK RETAIL SALES REPORT improved slightly on a year-over-year basis, up 3.9%, vs 3.8% last week.

THE PRODUCER PRICE INDEX FOR OCTOBER showed a higher level of inflation at the producer level than analysts expected, .2% vs -.1%... Year-over-year, excluding food and energy, PPI final demand was up 1.7%. I.e., inflation, at the producer level, remains relatively benign at this point.

THE NAHB HOUSING MARKET INDEX came in stronger than expected, 58 vs 55. While the housing market remains somewhat uninspiring, a few recent indicators are hinting at an improving trend. This one in particular... From Econoday's summary:

Improvement in the jobs market together with low mortgage rates are raising sentiment among the nation's homebuilders whose housing market index is up 4 points this month to 58 which, outside of September's 59, is the best reading of the year and of the recovery. Gains appear through the three components led by a 5 point gain in current sales to 62 which points to strength for November new home sales. Future sales are up 2 points to 66 with the traffic component, which continues to lag, up 4 points to 45. Regional data show wide gains led this month by the Northeast which is now in positive ground at 51 (readings over 50 indicate month-to-month growth).

E-COMMERCE SALES grew last quarter to 4.9%, from 4.0% in Q2. E-commerce currently accounts for 6.6% of total retail sales... Which is a new record...

THE TREASURY DEPT REPORTED A RECORD INFLOW OF FOREIGN CAPITAL TO US MARKETS. Here's Econoday's summary:

Very heavy foreign buying of US Treasuries as well as agency and corporate bonds fed a very robust net inflow of $164.3 billion in long term securities during September. Net foreign buying of Treasuries totaled $48.2 billion in the month with agency buying at $21.0 billion and corporate bonds at $20.7 billion. Foreign accounts were also buyers of US equities at a net $4.4 billion which is a respectable gain for this category.

Adding to the month's unusual inflow was unusually heavy selling of foreign long term securities by US accounts, at $70.1 billion (details for this reading are not available).

Turning back to foreign buying of Treasuries, Mainland China remains the top holder at $1.27 trillion followed by Japan at $1.22 trillion. Belgium remains a distant third at $354 billion followed by Caribbean Banking Centers at $312 billion.

Strong foreign investment in US securities is an important positive for the economy and helps to offset the nation's trade and government imbalances.

 

NOVEMBER 19, 2014

MBA PURCHASE APPLICATIONS spiked 12% week over week. That's a big move... The year over year rate, which has remained stubbornly in double-digit negative, is down 6%. Recent data show signs of life in the housing market.

HOUSING STARTS came in below estimates at 1.009 million, vs 1.038 estimate and 1.017 prior. Or 2.8% below September's number. Housing permits, however, gained 4.8%, on top of September's 2.8%. While not all the data is encouraging, clearly, there's improvement.

CRUDE INVENTORIES grew 2.6 million barrels last week. Gasoline inventories grew by 1.8m. Distillates declined by 2.8m.

FOMC MINUTES FROM OCTOBER MEETING reiterated the "data dependency" of the inevitable rate decision (but that should go without saying). There is some division in terms of the use of "considerable time", with regard to the first Fed Funds hike. They are taking seriously the headwinds out of Europe and Asia and still see the jobs market as sluggish, despite the recent drop in unemployment. They are not the least bit concerned over the potential for rising inflation. In fact, they're a bit worried about too low inflation. Clearly, the majority is in no rush to raise rates.

 

NOVEMBER 20, 2014

CPI FOR OCTOBER was flat, 0%, after rising .1% in September. Core CPI (ex-food and energy) was up .2%. Year over year up 1.7%, same as September. Comfortable below the Fed's 2% target.

WEEKLY JOBLESS CLAIMS remain low at 291k.

FLASH MANUFACTURING PMI showed a slowing in growth to 54.7 from 55.9 in October. Slowing output and new orders were the big negatives in the report. Employment, once again, was a positive. Price pressure for raw materials eased to the slowest pace in 1.5 years. Manufacturing indicators have been coming in somewhat mixed of late... this report contrasts with the very positive ISM manufacturing report. The one virtually across the board constant has been the improving employment outlook.

THE BLOOMBERG CONSUMER CONFIDENCE INDEX continues to show rising optimism, coming in at 38.5, it's highest level since January 2008.

THE PHILADELPHIA FED SURVEY came in hugely above expectations, at 40.8 vs 18.0 estimate and 20.7 prior. That's in sharp contrast to this morning's Flash PMI. Here's Econoday:

Spectacular strength is being reported this month from the Mid-Atlantic manufacturing sector where the general business conditions has surged to 40.8, almost doubling October's very strong growth of 20.7. The gain is backed by new orders which are at 35.7 vs October's 17.3. Shipments are at 31.9 vs 16.6 with employment nearly doubling, to 22.4 vs 12.1. November's numbers are total standouts for this report which goes back nearly 50 years.

And despite the surge in demand, price pressures, due to falling oil prices, are easing. Inventories look lean and delivery times are up, two other indications of general strength.

This report could not contrast more against this morning's PMI flash report where growth rates slowed significantly. Anecdotal reports on the manufacturing sector should be averaged together. It's still too early in the month to get a convincing assessment.

EXISTING HOME SALES seem to be improving modestly, up 1.5% in October, after being up 2.5% in September. Year over year up 2.5%. Housing, overall, is beginning to look up...

THE INDEX OF ECONOMIC INDICATORS is signaling a pickup in economic growth going forward, up .9% vs .5% estimate, and .7% increase in September. Low interest rates, low unemployment claims and housing permits were big positives in the index, offsetting the October weakness in the stock market. Not so rosy were the coincident and lagging indicators which came in at +.1% and -.1% respectively. But of course it's the forward look we're most interested in.

NAT GAS INVENTORIES declined by 17bcf last week.

 

NOVEMBER 21, 2014

KANSAS CITY FED MANUFACTURING INDEX came in better than anticipated, 7 vs 6...  THE COMPOSITE INDEX came in at 9 vs 3 prior.

 

About buybacks --- AND --- Your Weekly Update

When you buy a share of stock you own a piece of a company. And you therefore own a piece of a company’s earnings. Your wish is that the company you own generates more earnings per share going forward (pushing your share price higher) than it did when you purchased the stock. That’s it, bottom line! Whether that company earns more per share in a given year due to an increase in sales, or productivity, or both—or due to it buying back its own stock from other shareholders (results in the same dollar amount of earnings being divided among a fewer number of outstanding shares [i.e., more for you]) should be of little concern to you. Right?

Well, yeah, and, well, nah. You probably wouldn't want your per share earnings to grow primarily due to share buybacks every year. You'd probably want your company to actually make a little money providing something folks are eager to buy. Besides, it has to generate some cash every now and again with which to---every now and again---buy back its shares. Yes, I know, many companies borrow to finance buybacks---but who'd lend to a company that doesn't make money?

I bring this up because over the past year U.S. companies have bought back their own stock to the tune of over $500 billion worth---that's close to a new record. All this proactive boosting of per share earnings gives fodder to the bears who'd have you believe that your portfolio's comeback from the '09 lows rests on a house of cards. Their story goes that firms are foregoing capital investment to artificially boost their share prices---often at the behest of execs whose compensation is largely based on earnings-per-share targets. Or upon the insistence of activist billionaire shareholders looking to make a quick buck during the post-buyback-announcement rally.

Me? I'm agnostic when it comes to buybacks (Sure, maybe IBM's overdone it and has consequently fallen behind the innovation curve. Meaning, maybe its long-term vision has given way to quarterly bottom line myopia---a lesson for others perhaps). I simply see buybacks as phenomena to consider when gauging the market: I expect it to occur when cash levels are high and interest rates are low---which generally characterizes periods of uncertainty. And when a company's reluctant to expand while maintaining a heavy cash balance---and sees its own stock as a bargain---why not buy back a few shares? It'll surely make for happy shareholders.

I've made the case for many months that a key ingredient to a truly healthy expansion has been sorely missing during this one---capex spending (businesses investing in capital [expanding]), that is. And while this year's surveys have come in lukewarm on capex, I suspect that amid growing optimism (at least for the U.S. economy), jobs (perhaps a sign of a pick up in capex) and, surely, a great deal of pent up demand, we'll begin seeing a turn in that direction in the not-too-distant future. Maybe...

The following highlights from my last week's (U.S.) economic journal show continued strength in employment, capex optimism among small businesses, down and up (chronologically) retail results, a blah mortgage market, comfortable inventories and an optimistic consumer. While I wouldn't uncork the bubbly just yet, all in, things are looking up:

NOVEMBER 10, 2014

THE CONFERENCE BOARD EMPLOYMENT TREND INDEX for October came in very strong at 123.09. Here's from the Conference Board release:

The index now stands at 123.09, up from 121.91 (an upward revision) in September. This represents a 7.7 percent gain in the ETI compared to a year ago.

“The Employment Trends Index continues to increase rapidly, with all eight components improving in October,” said Gad Levanon, Managing Director of Macroeconomic and Labor Market Research at The Conference Board. “The index is signaling solid job growth through the winter. As a result, we could see the unemployment rate reach its natural rate of 5.5 percent by early Spring.”

NOVEMBER 11, 2014

NFIB SMALL BUSINESS OPTIMISM INDEX gained .8 points over the prior month. Worth noting is the expectation of greater capex spending going forward. The employment component gained as well. Overall, however, the tone remains cautious.

THE ICSC CHAIN STORE SALES weekly report shows strength, 1.5% compared to the prior week -1.6%.. Year-over-year: 2.1% vs 1.8% prior. Better, but still nothing to get excited about.

THE JOHNSON REDBOOK month-over-month retail results show a surprising 1% decline versus a .2% rise the prior week. Year-over-year results showed a slight softening compared to the prior week (3.8% from 3.9%). While 3.5% to 4% is the norm during a healthy expansion, the recent trend is uninspiring. I remain optimistic on the retail sector for Q4.

NOVEMBER 12, 2014

THE MBA NEW PURCHASE APPLICATION INDEX rose by 1% over last week and remains 11% lower on a year-over-year basis. Housing has not been, by a long shot, a leading sector during the course of the current expansion. The slow pace amid such a low interest rate environment speaks to the hangover, or post traumatic stress, from the 2008 recession/housing depression. Going forward, demographics favor the housing market in the U.S. In the near-term, so do jobs, consumer sentiment and perhaps energy prices. Recent optimism, and earnings results, among homebuilders signals the potential for an acceleration going forward.

REFINANCE APPLICATIONS last week, bucked the recent strong trend with an 11% decline versus the prior week.

THE ATLANTA FED BUSINESS INFLATION EXPECTATIONS suggest that firms see slightly higher inflation going forward: 2% vs 1.9% in October.

WHOLESALE INVENTORIES rose .3% in September, while wholesale sales rose .2%... The inventory to sales ratio remains at a very comfortable 1.19...

NOVEMBER 13, 2014

WEEKLY JOBLESS CLAIMS came in higher than expected at 290k... still, below 300k is bullish for the jobs market...

THE BLOOMBERG CONSUMER COMFORT INDEX shows an optimistic American consumer, while there is some hesitation that might question my expectation of a robust Christmas retail season... Here's Bloomberg:

Americans' views of the economy climbed last week to the highest level in almost seven years as the labor market strengthened and gasoline prices kept falling.

A Bloomberg measure of perceptions about the world's largest economy increased to 28.9 in the period ended Nov. 9, the highest read since January 2008, from 27.4. The weekly consumer comfort index, which also accounts for views of the buying climate and personal finances, was little changed at 38.2.

The cheapest gas since the end of 2010, more employment opportunities and record equity prices are helping bolster households' perceptions. At the same time, limited wage growth is reining optimism about finances and whether it's a good time to buy as the holiday-shopping season gets under way.

THE SEPTEMBER JOLTS (JOB OPENINGS AND LABOR TURNOVER) REPORT showed that there were 4.7 million job openings at the end of September. Little changed from the 4.8 million August read. The hires level increased to 5.0 million from 4.7 million in August. This was the highest level since December 2007. There were 4.8 million separations in September, vs 4.5 million in August. The quits rate increased to 2.8 million, from 2.5 million in August. The quits rate for September was 2.0%. A rising number of quits is a bullish sign for the jobs market, in that workers generally don't up and quit unless they have some better in the offing or believe strongly that they can walk into better employment elsewhere. In fact, this is a factor featured on Janet Yellen's Labor Market Dashboard. The pre-recession quits rate was 2.1%.... it had dropped to 1.3% amid the 2008 recession...

CRUDE OIL INVENTORIES declined by 1.735 million barrels last week. Clearly, refineries picking up the pace after maintenance season is impacting inventories. Distillates were down 2.0 million while gasoline rose 1.805 million...

NOVEMBER 14, 2014

THE CENSUS BUREAU'S RETAIL SALES number was a bit better than anticipated. Of course gas prices reduced the results for service stations, but you'd expect an offset as folks spent those savings elsewhere. Overall, including autos and gasoline, retail sales rose .3% in October. Ex-autos and gas they rose .6%, vs a .5% consensus estimate.

THE UNIVERSITY OF MICHIGAN CONSUMER SENTIMENT INDEX's preliminary November number spiked to 89.4 vs the consensus estimate of 87.5 and prior reading of 86.9. This, as I continue to repeat, along with lower gas prices and better jobs numbers makes me optimistic about the Christmas shopping season.

BUSINESS INVENTORIES rose slightly: up .3% in September. I would attribute this small build more to optimism going into year-end, and less so to miscalculating demand. The all-important inventory to sales ratio held steady at .1.3%.

NAT GAS INVENTORIES rose 40 bcf last week.

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Weekly Market/Economic Update

"The 12 months following mid-term elections have been up the last 17 times in a row"

"The third year of a presidential term is usually a good year"

"The market gains with a democrat in the Whitehouse while republicans control Congress"

That's a small sampling of the arguments the bulls were making last week for why you want to own stocks going forward. While I have no problem with Tuesday's results, in my opinion those market extrapolations are all a bunch of, well, bull. Not that the data aren't real, it's just that they're not useful. Tell me the whys, relate them to politics, then show me how they're lined up the same this time around---then maybe (but probably not) I'll produce a chart and send it out to my clients. But the thing is the whys (unless you can change my mind) in my view have little, if anything, to do with those characters who were cagey enough to promise more stuff to the right group of voters than did their competition. So, please, disregard any notion you may have that the outcome of Tuesday's election in any way assures green arrows for your portfolio going forward. In fact, I can think of nothing more frightening than the notion that our investment success lies in the hands of professional glad-handers, regardless of the side of the aisle they hail from (yeah, I know, there will be a few winners [friends of the winners] and losers resulting from any change in "power"). But we never invest based on our politics. We invest on fundamentals. Yes! I am the worst cynic when it comes to politics.

So, about the market: As I've reported, and as you've noticed, the major averages (but not all sectors [energy]) have come roaring back after the recent almost correction. Apparently the market isn't ready to deliver the real thing, be it a 10-20% correction or a 20%+ bear market. I can speculate as to why. I can cite the missing retail investor (they typically pour in at the very end, and they---at this point---remain mostly absent), seasonality (November and December have been positive historically), very good earnings and earnings growth, under-performing professional investors playing catch up, lower energy prices, no U.S. recession in sight, accommodative central banks, coming share buy-backs, the "rule of 20" (20 minus the inflation rate equals fair value) has the S&P anywhere from 9% to 20% (depending on the inflation metric you use and whether you're talking 2014 or 2015 projected earnings) undervalued---as does the discounted cash flow method (10% by my calculation), etc. But I can turn all that on its head and couch low oil prices as a signal that the global economy is weakening by the minute, and that, therefore, the assumed earnings growth rates embedded in all those valuation calculations will not be achieved. I can tell you that this market has been so Fed-dependent that it won't know what to do with itself when, at last, the Fed starts pushing up on short-term rates. That while Warren Buffett says he likes the market here, the valuation indicator he once said is by far the most legitimate (total market cap to GDP) reads scarily high, etc. Bottom line---save for a little logical (well-supported) sector/regional rotation every now and then---never invest your long-term money based on anyone's short-term guess.

So, about the (U.S.) economy: As you'll notice in the highlights below, last week was a mixed bag for economic indicators. While the general trend remains positive (particularly for employment), recent stats suggest a mild deceleration in the overall rate of growth. We may see the coming GDP revisions for Q3 come slightly off that 3.5% preliminary read. In terms of third-quarter earnings, as I type, 447 of the S&P 500 companies have reported and (according to Bloomberg) 80% beat analysts' estimates, with the earnings growth rate coming in at 9.43%. That's a very good showing! In terms of revenue, 60% beat estimates with a growth rate of 4%. That's just okay. The contrast between earnings and revenue growth speaks to an abundance of share buybacks (companies buying up their own shares, which reduces shares outstanding and, therefore, boosts per share earnings) and productivity---but mostly share buybacks of late.

So, about economies outside the U.S.: While, in terms of trend, the U.S. remains the place to be in the global economy---after two years (assuming no huge non-U.S. out-performance over the next two months) of our non-US exposure hurting our relative (to U.S. indices) performance---I'm seeing some encouraging signs beneath the scary headlines: For example, the Bank of International Settlements reports that the period between end-December 2013 and end-March 2014 (its reports come with a bit of a time lag) saw the first substantial increase in quarterly cross-border money flow since late 2011 (that's a bullish sign). Particularly to emerging markets, and particularly to China. Even the euro area saw an increase in cross-border lending, ending a streak of seven consecutive quarterly declines. Plus, the Baltic Dry Index (tracks the cost of shipping raw materials over the seas) has spiked 50% higher over the past few weeks. This makes one think seriously about emerging markets and materials going forward. Oh, and not to mention, valuations in many foreign markets are reminiscent (some even cheaper) of U.S. stocks at the beginning of 2013...

There's always more to report, but in the interest of your time, me keeping your attention, and me having something else to write about next week, I'll leave you for now with the (U.S.) highlights from last week's economic journal:

 

NOVEMBER 3, 2014

MOTOR VEHICLE SALES barely budged in October. Econoday:

Sales of cars and light trucks firmed very slightly in October, to a 16.5 million annual pace vs 16.4 million in September. Sales of North American-made vehicles led October, rising to a 13.3 million rate from September's 13.2 million. Foreign-made sales slowed slightly to 3.2 million. These results point to little change for the motor vehicle component of the October retail sales report.

GALLUP CONSUMER SPENDING averaged $89/day in October vs $87 in September. While about the same as last October, the Gallup number remains well above the lower levels of the current expansion.

THE MARKIT PMI MANUFACTURING INDEX reads soft for October, with an overall reading at 55.9 vs 57.5 for September. New business ran at its slowest pace since January. Backlog orders were the slowest since January as well. Production the same. Jobs, however, remain the consistent positive indicator across virtually all of these surveys.  The report cites "robust job growth" in jobs...

THE ISM MANUFACTURING INDEX came in at a surprisingly (given related October surveys) outstanding 59.0 vs 56.6 in September. The new orders component came in at a huge 65.8. This denotes increasing business across the supply chain going forward.  Backlog orders were up as well. The production component came in very strong at 64.8, while inventories rose slightly. Prices moderated. Here's what the survey's respondents are saying:

"Holiday orders are exceeding seasonal forecasts. Customers are demanding additional quantities above prior orders. Fuel costs and other positive signals appear to be creating demand above normal." (Food, Beverage & Tobacco Products)

"Weakness in commodity prices very positive on our business." (Fabricated Metal Products)

"We continue to see strong demand across multiple sectors." (Transportation Equipment)

"Business steady and strong." (Furniture & Related Products)

"Another strong month in terms of business growth." (Computer & Electronic Products)

"Most business segments are seeing an upward trend in orders — mostly from existing customers, but also some new customers. Transportation continues to be a major issue." (Chemical Products)

"Conditions are still basically flat." (Printing & Related Support Activities)

"Production is oversupplying demand, and prices have softened." (Wood Products)

"Outer body material changes in the auto industry means new equipment and manufacturing growth." (Machinery)

"Business conditions are good; sales and production volumes are generally increasing." (Miscellaneous Manufacturing)

CONSTRUCTION SPENDING came down in September for public outlays and private nonresidential. Private residential was up for the month. Overall construction spending declined .4%, vs a 6% estimate. Year-over-year spending was up 2.9% vs 4.4% in September.

NOVEMBER 4, 2014

ICSC SAME-STORE SALES, much to my surprise, were off 1.6% last week. Year-over-year up 2.8% (traditionally run +3.5 to 4.0% during expansions). I am expecting a noticeable pick up in these numbers going forward. The report blames unseasonably warm weather holding back sales, as folks would normally be stocking up on fall/winter apparel right about now. The report sees sales picking up as the weather cools off. I'm expecting the much-improved jobs market, lower gas prices and recent reads on consumer optimism to translate to a very good retail season.

Consumer sentiment is indeed looking up. Per the following re: THE GALLUP US ECONOMIC CONFIDENCE INDEX from Econoday:

Gallup's October Economic Confidence Index jumped to a monthly reading of minus 12 in October -- the most positive score since the minus 12 of July 2013. However it was lower than the record high of minus 7 in May 2013. The three-point increase from September is the largest monthly improvement seen this year so far.

In October, 22 percent said the economy is "excellent" or "good," while 32 percent said it is poor. This resulted in a current conditions dimension score of minus 10, the highest current conditions score since February 2008. Meanwhile, 41 percent of Americans said the economy is getting better, while 54 percent said it is getting worse. This resulted in an economic outlook score of minus 13 -- the best outlook score since January.

The confidence of both upper-income Americans (plus 2) and middle- and lower-income Americans (minus 14) reached levels in October that have not been seen since July 2013. Upper-income Americans had a particularly large climb in confidence, gaining eight index points from the previous month and reaching positive territory.

While the TRADE DEFICIT never bothers me in the least, the data can be telling in terms of global demand. The gap expanded in September as exports declined and imports were unchanged.

THE JOHNSON REDBOOK read on retail slowed, along with ICSC's, last week. The report notes Halloween falling on a Friday as a diversion away from shopping on items non-Halloween related. The year-over-year growth came in at 3.9%, vs 4.4% the prior week. Still showing a range that denotes economic expansion.

The manufacturing sector has gotten tougher to gauge of late when considering the contrast between anecdotal samples such as yesterday's ISM (very strong) and Markit's PMI (softening) and the very mixed reads from the regional surveys themselves vs. the hard data such as FACTORY ORDERS which came in -.6%. It'll be interesting to see in the months to come if the hard data squares with the optimism shown in some of the surveys. The jobs component of the surveys has accurately foretold of better jobs numbers of late. This Friday's number will be very interesting...

NOVEMBER 5, 2014

THE ADP EMPLOYMENT REPORT showed the expected 230,000 new jobs. Which makes perfect sense given the indications coming from various surveys.

MORTGAGE NEW PURCHASE APPS finally rose a bit last week, +3%. Refinances have been strong since the recent drop in rates, but new purchases have been stubborn. I expect to see a better trend going forward given recent trends in jobs growth and consumer sentiment.

THE ISM NON-MANUFACTURING INDEX shows continued solid expansion in service industries, although the month-over-month pace slowed in October. However, the employment component once again showed strength, delivering its third highest read over the survey's 17-year history. Here's what the respondents are saying:

"Business is steady with new product launches." (Information)

"The general business outlook is favorable. Approaching 2015 with cautious optimism." (Finance & Insurance)

"Healthcare market continues to see challenges and uncertainty." (Health Care & Social Assistance)

"Economy appears to be slowing. Fears of ISIS, Ebola, etc." (Professional, Scientific & Technical Services)

"It appears that customers are beginning to engage which is producing sales. Not where we want to be, but continuing to see improvement." (Retail Trade)

"Sales very sporadic. It’s up and down weekly." (Accommodation & Food Services)

"Business activity remains robust here." (Utilities)

"The past few months have been record months for us in terms of sales, but we are seeing margin pressure." (Wholesale Trade)

CRUDE OIL INVENTORIES saw a slower build last week, .5 million barrels, as refineries are picking up production after their maintenance season.

NOVEMBER 6, 2014

CHAIN STORE SALES went the fate of other retail indicators in October. The report showed slowing in year over year sales growth. Warm weather hurting the sale of fall goods gets the blame... I'm fully expecting to see retail rebound in the coming weeks based on lower gas prices, an improving jobs picture and growing consumer optimism.

THE CHALLENGER JOB CUTS REPORT for October went against the grain of the majority of job related stats of late, showing a layoff count substantially higher than September's (51,183 vs 30,477)... Although September's number did represent a 14-year low.

WEEKLY JOBLESS CLAIMS came in below expectations at 278,000. The 4-week moving average of 279,000 marks a 14-year low and speaks volumes about the improving jobs market.

PRODUCTIVITY grew in Q3 at an annualized 2.0% rate. That's roughly the long-term average for the U.S. Year-over-year productivity grew .9%...

UNIT LABOR COSTS rose .3%, as hourly compensation came in at +2.3% against productivity growth of 2%... I suspect we'll see wages continue to trend higher going forward.

THE BLOOMBERG CONSUMER COMFORT INDEX rose last week to its second-highest level in the past 6 years... 38.1. Which, taken with the improved jobs and wages market, and lower gas prices, speaks to my optimism toward consumer discretionary stocks going forward.

NAT GAS STORAGE rose 91 bcf last week. Higher inventory builds translate to lower pricing...

NOVEMBER 7, 2014

THE BLS NON-FARM PAYROLLS REPORT showed an increase of 214k, vs estimates of 231k... I would've had the number higher as well, but, nevertheless, north of 200k is a good number... the unemployment rate dropped to 5.8%... From the report:

Total nonfarm payroll employment increased by 214,000 in October, in line with the average monthly gain of 222,000 over the prior 12 months. In October, job growth occurred in food services and drinking places, retail trade, and health care.

Food services and drinking places added 42,000 jobs in October, compared with an average gain of 26,000 jobs per month over the prior 12 months.

Employment in retail trade rose by 27,000 in October. Within the industry, employment grew in general merchandise stores (+12,000) and automobile dealers (+4,000). Retail trade has added 249,000 jobs over the past year.

Health care added 25,000 jobs in October, about in line with the prior 12-monthaverage gain of 21,000 jobs per month. In October, employment rose in ambulatory health care services (+19,000).

Employment in professional and business services continued to trend up over the month (+37,000).  Over the prior 12 months, job gains averaged 56,000 per month. In October, employment continued to trend up in temporary help services (+15,000) and in computer systems design and related services (+7,000).

In October, manufacturing employment continued on an upward trend (+15,000). Within the industry, job gains occurred in machinery (+5,000), furniture and related products (+4,000), and semiconductors and electronic components (+2,000). Over the year, manufacturing has added 170,000 jobs, largely in durable goods.

Employment also continued to trend up in transportation and warehousing (+13,000) and construction (+12,000).

Employment in other major industries, including mining and logging, wholesale trade, information, financial activities, and government, showed little change over the month.

In October, the average workweek for all employees on private nonfarm payrolls edged up by 0.1 hour to 34.6 hours. The manufacturing workweek was unchanged at 40.8 hours, and factory overtime edged down by 0.1 hour to 3.4 hours. The average workweek for production and nonsupervisory employees on private nonfarm payrolls edged up by 0.1 hour to 33.8 hours. (See tables B-2 and B-7.)

Average hourly earnings for all employees on private nonfarm payrolls rose by 3 cents to $24.57 in October. Over the year, average hourly earnings have risen by 2.0 percent. In October, average hourly earnings of private-sector production and nonsupervisory employees increased by 4 cents to $20.70. (See tables B-3 and B-8.)

The change in total nonfarm payroll employment for August was revised from +180,000 to +203,000, and the change for September was revised from +248,000 to +256,000. With these revisions, employment gains in August and September combined were 31,000 more than previously reported.

CONSUMER CREDIT rose $15.9 billion in October. However it's skewed to non-revolving credit ($14.5 billion). That's not the best news for the retail sector in the near-term. It'll be interesting to see how this plays out over the next couple of months. I'm firmly in the camp that expects a very good retail season nonetheless...

Desperate Managers and the Market --- AND --- An Economic Update

Some 46% of active mutual fund managers have under-performed their benchmarks thus far this year, while (many) hedge funds are still struggling mightily to justify their amazingly high fees (the industry, in fact, just lost the California Public Employees Retirement System as a client [citing a desire to reduce costs and complexity]). I suspect that the next two months are career-critical for no small number of the pros who answer to some of the largest investment institutions in the world. You think maybe the amazing bounce from the almost correction of the past few weeks has a little to do with these blokes diving in in hopes of making up lost ground ahead of what are often the best two months of the year? I do…

But why would they think that the recent sell-off was yet another chance to buy a dip and grab a few basis points to the upside---particularly when we're talking record highs in U.S. stocks, scary lows in the Euro Zone economies, and all the other frightening headline stuff that has dominated the news of late? Well, good question. I suspect it has something to do with earnings (see below), with the fact that November and December tend to be big months for share buybacks (my chart comparing share buyback activity to the S&P 500 shows virtually perfect positive correlation), with an okay-looking U.S. economy, and with a sense that while the U.S. Fed just stopped QE and did not promise zero interest rates till the second coming, other central banks are on the verge of stepping up and trying to print themselves a recovery. Japan, by the way (announcing a printing program that involves the buying of stocks and REITs, along with bonds) delivered big time on Friday. Fund/hedge fund-manager optimism (I'm seeing marked declines in short interest and the equity put/call ratio [measures of near-term bets on a falling market]) may also have to do with the prospects for the Christmas shopping season. And considering the recent plunge in gas prices, the pick up in job growth and overall consumer sentiment (see below), I can see why. Oh and, as you'll see below, wages may be gaining a little traction as well.

Yep---while you should never bet on the market short-term---I can see why one might be optimistic about the short-term for the U.S. stock market. As for the longer-term, I like to look at the world from, well, a world---or global---perspective. In terms of the U.S., I've been giving you the weekly highlights on the U.S. from my economic journal---which tells you I'm feeling pretty good about the U.S. these days (although stuff can change in a hurry). As for Europe, well, it's more or less a mess. As for China, if they tell the truth it doesn't look like they'll hit their 7.5% growth target for this year. China's a special case. I just finished an interesting book "Markets Over Mao" that describes how China's economy has been able to grow despite, rather than because of, its political structure. As it turns out, China's private sector is where the lion's share of the growth has come from, and its officials are embarking on reforms that will move its economy in a more market-oriented direction going forward. The result will be a more consumer-driven, service-oriented, economy in the years to come. And while this maturation process stands in the way of the heydays of double digit growth fueled by manufacturing (unsustainable anyway), longer-term we should be encouraged by these developments. As for Japan, as I reported above, its current plan is to devalue its way to prosperity. While the global markets are loving it for now, it'll be very interesting to see how it all plays out down the road. I don't suspect that Japan's Asian export competition appreciates it at all. Back to Europe: I've stated here before that we should be on the lookout for the ECB to adopt American-style QE in the not-too-distant future---their political hurdles notwithstanding. And make no mistake, last week's move by the Japanese Central Bank puts a big heap of added pressure on Germany to concede to Draghi (the ECB president)'s wishes. Should that occur don't be surprised if you see an out-sized upward reaction in European (and other countries') stocks at the outset. 

Here are the highlights from last week's journal:

OCTOBER 27, 2014

To my surprise, MARKIT'S FLASH SERVICES PMI showed slowing growth, as the index declined to a 6-month low of 57.3. While above 50 denotes sold growth, the index has trended lower over the past few months. New business growth was at a 3-month low and business confidence dipped to a 2-year low. Job creation, however, remains the one consistent positive indicator across most surveys, sticking at a 3-month high again this month. Unfinished work and backlog accumulation are both solid. Again, not a positive recent trend, but still signals a growing service sector.

PENDING HOME SALES INDEX came in up .3%, vs a .8% estimate and down 1% in last month. An improving jobs market, lower home prices and low mortgage rates are showing up in an, albeit slowly, improving housing market.

THE DALLAS FED MANUFACTURING SURVEY shows Texas factory activity growing. The new orders index came in at a 6-month high. Perceptions of business conditions shows up as optimistic. The outlook index reached its highest level in 6 months. The labor market components show continued employment growth and longer workweeks. The raw materials prices were about the same as September. The finished goods prices index remained unmoved as well. While this all sounds positive, and is, the overall business activity index came in slightly below the prior month's reading (10.5 vs 10.8) and missed the 11.5 consensus estimate. The production index, while showing positive at 13.7, was a noticeable deceleration from last month's 17.6...

CORPORATE EARNINGS AND REVENUE have been coming in strong during Q3 reporting season. With 221 of the S&P 500 companies having reported, 79% exceeded earnings estimates and 61% beat their revenue estimates. Earnings growth has been good at 8.78%, revenue growth has been relatively modest at 4.72%.

OCTOBER 28, 2014

THE ICSC RETAIL REPORT registered a week-over-week gain, up .3% vs -.3% prior. YOY is up 2.8%... Again, not by any means a robust expansion read, but the trend's in a positive direction. The report mentions an expectation that the holiday shopping season will be "strongly benefited" by lower gas prices.

THE JOHNSON REDBOOK shows a stronger retail sector than does ICSC, with a 4.4% year-over-year growth rate, vs 4.1% last week. Above 4 is solidly in the range that denotes economic expansion.
The Census Bureau's ADVANCE REPORT ON DURABLE GOODS registered a decline of $3.2 billion or 1.3% for September (total $241.6 billion). The biggest disappointment for me was the decline in nondefense capital goods orders, down 5.4%. This does not support the notion than capex is on the rise. Another negative (although some would credit the following to a result of optimism) is another increase in inventories of manufactured durable goods. Generally speaking, lean or steady, as opposed to growing, inventories are desirable as it assures constant production as demand picks up. That said, companies will do their best to anticipate and manage their inventories accordingly. On the bright side was the current indicator that is shipments, which increased $.1 billion, after a 1.8% increase in August. Fabricated metal products were responsible for the increase. Unfilled orders were up as well, by $3.8 billion, which is encouraging in terms of going forward production---the increase was led by transportation equipment. I should note that there tends to be much volatility in the monthly durable goods numbers.

THE CASE-SHILLER HOME PRICE INDEX registered a decline for the 4th consecutive month. -.1%, vs a +.1% estimate and -.5% prior.

THE CONFERENCE BOARD'S CONSUMER CONFIDENCE INDEX jumped hugely to 94.5, from a revised 89.0 in September. The expectations component jumped 8.6 points to 95. This plus the improving jobs market plus lower gas prices makes me quite optimistic for the coming retail season.

THE RICHMOND FED MANUFACTURING INDEX bucked the October softening trend with a substantial jump to 20 vs 14 in September. New orders and backlogs were especially strong. The shipments and employment growth components were up nicely as well. Unlike the Durable Goods Report, inventories declined, which is a good thing.

OCTOBER 29, 2014

MBA MORTGAGE PURCHASE APPLICATIONS week-over-week show a decline of 5% for the second straight week. A disappointment to say the least. Refinances, however, responded big time to the drop in rates, up 23%...

THE EIA PETROLEUM STATUS REPORT shows a continued build in crude inventory. Econoday credits the fall refinery maintenance season:
Refineries, switching to winter-grade fuels from summer-grade fuels, are in their fall maintenance season and are cutting back output which is putting upward pressure on oil inventories. Inventories of crude oil rose 2.1 million barrels in the October 24 week for the 4th build in a row. This build, however, is the lowest of the run and was held down by a big drop in oil imports during the week.
Refineries, which typically operate at over 90 percent of capacity, operated at only 86.6 percent of capacity in the latest week. Lower output made for draws in gasoline inventories, down 1.2 million barrels, and a big draw for distillate inventories, down 5.3 million.
Supplies in the wholesale sector now look thin and will need to be restocked which points to increased refinery output ahead. Gasoline wholesale supplies are down 1.1 percent year-on-year with distillate supplies down 4.0 percent.
The switch to winter-grade fuels is winding down which should help keep oil inventories down in the weeks ahead. WTI is down about 25 cents to $82.25 following today's report.

THE FOMC COMPLETED ITS 2-DAY POLICY MEETING and announced the end to QE and reiterated its "considerable period" before pushing up interest rates. However, they sounded a noticeably upbeat tone on the economy and employment.

OCTOBER 30, 2014

Q3 ADVANCE GDP READING came in at 3.5%, down from the 4.6% Q2 read, but higher than the 3.0% consensus estimate. Here's Econoday's commentary:

Third quarter GDP growth decelerated after a second quarter jump related to make up activity after the first quarter decline due to atypically adverse winter weather. The advance estimate for the third quarter posted at a moderately healthy 3.5 percent annualized, following 4.6 percent boost in the second quarter. The median forecast was for 3.0 percent.


Final sales of domestic product increased a healthy 4.2 percent after gaining 3.2 percent in the second quarter. Final sales to domestic purchasers rose 2.7 percent in the third quarter, compared to 3.4 percent in the second quarter.


The increase in real GDP in the third quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, nonresidential fixed investment, federal government spending, and state and local government spending that were partly offset by a negative contribution from private inventory investment. Imports, which are a subtraction in the calculation of GDP, decreased.


GDP data are still being affected by the atypically severe winter weather in the first quarter as the third quarter returns to normal conditions after a second quarter recovery. The notable negative for the third quarter was a drop in inventory investment and a slowdown in consumer spending growth. Both were strong in the second quarter. The deceleration in the percent change in real GDP reflected a downturn in private inventory investment and decelerations in PCE, in nonresidential fixed investment, in exports, in state and local government spending, and in residential fixed investment that were partly offset by a downturn in imports and an upturn in federal government spending.


On the price front, the chain-weighted price index decelerated to 1.3 percent annualized from 2.1 percent in the second quarter. Analysts projected 1.4 percent. The core chain index, excluding food and energy, eased to 1.6 percent from 1.8 percent in the second quarter.


Overall, economic growth is somewhat better than expected. This is good news for company profits as reflected in recently better-than-expected earnings on average. But the third quarter GDP figure will raise debate within the Fed on moving forward or not the first increase in the fed funds rate.

As noted in the above summary the GDP PRICE INDEX came in low at 1.3%, vs 2.0% estimate and 2.1% prior.

INITIAL JOBLESS CLAIMS remain comfortably below 300k, at 287k... The 4-week average sits at 281k...

THE BLOOMBERG CONSUMER COMFORT INDEX reads positively. From Bloomberg:

Consumer sentiment in the U.S. held last week near the highest level of 2014 as employment opportunities kept Americans upbeat about the economy.


The Bloomberg Consumer Comfort Index eased to 37.2 in the period ended Oct. 26 from 37.7 a week earlier. The measure reached a high this year of 37.9 in April. A gauge of attitudes about the world’s largest economy was the second-strongest since January 2008.

An improving labor market and the cheapest gasoline prices since late 2010 are brightening households’ spirits as the holiday shopping season approaches. Job growth that’s accompanied by a pickup in worker pay would help propel sentiment further and spur spending into next year.

 

NAT GAS STORAGE rose by 87bcf, vs 85 estimate and 94 prior...

OCTOBER 31, 2014

PERSONAL INCOME AND OUTLAYS increased while spending declined (due, to no small degree, to auto sales and of course lower gas prices).

THE PCE DEFLATOR (the Fed's preferred inflation measure) came in year-over-year at 1.4% headline and 1.5% core... remaining very tame. Here's Econoday's commentary:
Personal income continues a modest uptrend but spending slipped on volatile auto sales and lower gasoline prices. Personal income advanced 0.2 percent in September, following a 0.3 percent gain in August. Analysts projected a 0.3 percent gain for September. The wages & salaries component increased 0.2 percent, following a 0.5 percent boost the prior month. Averaging the wage gains leaves consumer basic income moderately healthy.
Analysts botched their forecast for spending for September-and for no apparent reason. Personal spending declined 0.2 percent after jumping 0.5 percent in August. The latest figure came in below market expectations for a 0.1 percent rise. Weakness was in the durables component which fell 2.0 percent after a 2.1 percent jump in August, reflecting swings in auto sales. Lower gasoline prices pulled down on nondurables. Nondurables spending declined 0.3 percent after falling 0.4 percent in August. Services firmed 0.2 percent, following a 0.5 percent spike in August.

PCE inflation remains soft. The September figure matched expectations for a 0.1 percent increase and followed a dip of 0.1 percent in August. Core PCE inflation rose 0.1 percent in September, following a gain of 0.1 percent in August and equaling expectations.
On a year-ago basis, headline PCE inflation held steady at 1.4 percent in September. Year-ago core inflation was 1.5 percent in both September and August. The Fed doves will not be in a rush to boost policy rates early next year.
Today's report shows continued moderate growth in income. Spending has been volatile on a monthly basis and the September numbers should not have been a surprise.

THE EMPLOYMENT COST INDEX jumped another .7% in Q3 (second straight .7% quarter). The two largest increases of the recovery... The wages and salaries component grew .8%, following a .6% rise in Q2... Clearly, the Fed was justified in its hawkier (not quite promising a zero fed funds rate into eternity) than expected language last week.
While the manufacturing sector has been sending a few mixed signals of late, the CHICAGO PMI reading ---covers both manufacturing and service sectors---left little doubt that things are improving in the surrounding area. The index leaped 5.7 points to 66.2 for its best showing this year. And the gains came from the most important areas: New orders at a 1-year high, backlogs and production both up. Employment---the one component sending consistently better signals across sectors---came it at its best level since November of last year...

THE UNIVERSITY OF MICHIGAN CONSUMER SENTIMENT INDEX came in at its highest level since July 2007, at 86.9. The expectations component jumped big time, which signals confidence in the jobs outlook. The current conditions component remains near post-recession highs as well. Inflation expectations have been effectively muted by lower gas prices...

Q3 CORPORATE EARNINGS are coming in very strong. 80% of S&P 500 companies reported thus far beat analyst's estimates. Plus, earnings YOY growth rate is 10+%... Revenue growth, however, comes in at 3.8%---A whole lot of financial engineering going on!