Saturday, November 1, 2014

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!

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