Friday, December 19, 2014

"Patient" replaces "Considerable Time", The Fed Rally, Less Scary Credit Spreads, and Your Weekly Update

Over the course of the first twelve trading days in December you received eight Dow triple-digit-down audio commentaries from yours truly. That's a lot! And while plunging oil prices caught the blame, I was making the case that it was more about fear that the fed might soon raise the fed funds rate due to an accelerating U.S. economy. In retrospect, while indeed the market rallied hard after the Fed replaced "considerable time" (with regard to when it will begin normalizing [tightening] monetary policy), with "patient" (as I suggested it might), the previous days' stock prices had in fact moved in lockstep with movements in the price of oil. So perhaps it was, at least to some extent, about oil---or about the impact the energy sector is having on high yield credit spreads, or about how plunging oil, among other things, could result in a Russian default (although Russia has built up quite a balance in foreign reserves since the last time it defaulted on its debt).

Here's an update of the chart I featured in my last commentary comparing the high yield credit spread (purple line) to the S&P 500 (white line). Notice the sharp reversal: click to enlarge

HY spread, spx Dec 18

Last week's commentary explains the logic...

Credit spreads notwithstanding, clearly, traders are now cueing big time on the Fed---a two-day, 700 point, rally in the Dow proves it. Now that doesn't mean that the present market level doesn't make sense---the fundamentals are by no means terrible---but it does speak to what we might expect when the Fed finally begins "normalizing" policy (had they signaled that they stand ready to raise rates soon, we surely would've seen the reverse). The Fed sees its task going forward as preparing the market for the inevitable. Wednesday's replacing of "considerable time" with "patient" was a baby step in that direction.

In the meantime, as you'll notice in this week's economic highlights, the U.S. economy is---on balance---moving right along. Which may bode well for the U.S. stock market for the time being (but no promises).

As for other countries' economies, and markets, several have a bit of catching up to do. Which, along with the plunge in the energy sector, explains the overall lackluster (when compared to select U.S. indices) 2014 results for globally balanced portfolios. The question now would be, with the U.S. economy picking up the pace, and much of the rest of the world struggling to gain traction, does one sacrifice some balance and rotate out of international equities and into what's been working? Well, if you've been reading/listening lately you know my answer. Which is a resounding no. While I make no promises, given stats that I've previously presented, it makes sense to me that over time there's a fair chance we'll see a convergence of results between the performance of the U.S. and other markets.

Here's a graph (normalized to 100) showing the price movement of the S&P 500 (white line), the MSCI Europe, Australia and Far East Index (yellow line) and the MSCI Emerging Markets Index (green line) from the peak prior to the 2008 bear market to present (notice the divergence from Q1 2011 forward). While the S&P has regained its prior peak level plus 40%, the rest of the world, again, has some catching up to do. click to enlarge

spx, eur, em from prior peak

If, as I expect, we ultimately see a reversion to the norm, the question is, will it be the result of the U.S. market declining faster than other markets, other markets rising faster than the U.S. or a meeting in the middle? In two of those scenarios foreign markets rise. Time will tell...

Here are the U.S. highlights from last week's economic journal:

DECEMBER 15, 2014

THE EMPIRE STATE MANUFACTURING INDEX surprisingly contracted this month. In fact it's the first negative reading since January of 2013. New orders, unfilled orders and shipments all showed declines. One bright spot was the employment component, which has been the consistent case among most of the anecdotal reports. It'll be interesting to see how other regions stack up going forward.

Contrary to the NY regional read on manufacturing, the U.S. INDUSTRIAL PRODUCTION number, +1.3%, came in noticeably above the consensus estimate, +.7%. Capacity utilization is back to its long-term average of 80%. As the Fed's opening paragraph in the release suggests, this was a strong report:
Industrial production increased 1.3 percent in November after edging up in October; output is now reported to have risen at a faster pace over the period from June through October than previously published. In November, manufacturing output increased 1.1 percent, with widespread gains among industries. The rise in factory output was well above its average monthly pace of 0.3 percent over the previous five months and was its largest gain since February. In November, the output of utilities jumped 5.1 percent, as weather that was colder than usual for the month boosted demand for heating. The index for mining decreased 0.1 percent. At 106.7 percent of its 2007 average, total industrial production in November was 5.2 percent above its year-earlier level. Capacity utilization for the industrial sector increased 0.8 percentage point in November to 80.1 percent, a rate equal to its long-run (1972–2013) average.

THE NAHB HOUSING MARKET INDEX, while the number was below consensus (57 vs 59), shows builder confidence remaining strong. This is the 6th straight reading above 50 (expansion range). Expectations for future sales, as well as current sales, was very high...

DECEMBER 16, 2014

THE ICSC RETAIL REPORT showed a week over week spike of 3%, however, year over year it fell to a 1.1% pace. This speaks to the shopper's timing this year vs last, and supports the notion that the next few days will be pretty robust...

THE JOHNSON REDBOOK RETAIL REPORT showed sales improving to a 4.2% year over year pace. That's a typical pace during economic expansions...

HOUSING STARTS came in at 1.028 million, below the consensus by .01 million and off the revised prior month rate of 1.045 million.  Permits also declined, coming in at 1.035 million versus 1.080 million the prior month. November's decline followed a positive October. On net, activity has been trending just slightly positive of late...

MARKIT'S FLASH MANUFACTURING PMI INDEX came in above 50 (which denotes expansion) but, at 53.7, it was less than the consensus estimate and less than last month's 54.7. This represents the slowest growth in 11 months. Cost inflation, reflecting oil, is at a 19 month low. While November was a very good month in the sector, December's early indications are showing a slowing of the pace...

DECEMBER 17, 2014

MBA PURCHASE APPLICATIONS dropped a big 7% last week, despite falling mortgage rates... While consumer confidence is riding high, it's clearly not showing yet in the housing related results...

CPI came in lower than expected in November... The month over month change was -.3%. Year over year CPI is running at 1.7%, ex food and energy... With food and energy, it's running at 1.3%... This would be ammunition for the Fed to continue it's easy policy stance.

THE CURRENT ACCOUNT DEFICIT came in at -100.3 billion in Q3... While some economists place importance on the trade deficit... I don't... The fact that last quarter's number surprised to the upside speaks to the relative strength of the U.S. consumer, and the dollar itself...

THE EIA PETROLEUM STATUS REPORT shows a draw of .8 million barrels last week. That's good news for those looking for oil's rout to bottom. Gasoline inventories however rose by 5.3 million barrels. That's good news for folks who drive cars. Distillate inventories rose .2 million barrels. Refineries are running at a high 93.5% of capacity... I look for an easing in refinery production going forward.

THE FOMC MEETING ANNOUNCEMENT indeed omitted "considerable period". However, the word "patient" appeared instead. Now let's see, if one feels one needs patience, then one believes that what one's waiting for may not materialize for a considerable period. Hmm... Today we saw the Fed take the ultimate baby step toward readying the markets for the inevitable tightening cycle to come... The stock market rallied hard on the Fed's soothing words...

DECEMBER 18, 2014

JOBLESS CLAIMS came in at a low 289k last week. The 4-week average is now 298,750. Continuing claims last week came in at 2.373 million, which is down a substantial 147k from the prior week. although that merely reverses the prior week's 148,000 surge... All in all, the employment picture has brightened measurably in the U.S....

MARKIT'S FLASH SERVICES PMI, like Tuesday's manufacturing survey, registered an expansionary number, 53.6. But, just like the Manufacturing PMI, the results show a slowing of the growth rate from the prior month's read. In fact, the index peaked in June and has slowed over the past 6 months.

BLOOMERG'S WEEKLY CONSUMER COMFORT INDEX continues, as do virtually all other recent sentiment surveys, to show a substantial pickup in consumer optimism over the economy going forward. Last week's 41.7 was the best reading in seven years.

THE PHILADELPHIA FED SURVEY continues to show strong growth in the Philly Fed region, but not quite as strong as Novembers big jump. Ex-November, the reading is the best since 3/11. Here's a slice of Econoday's commentary:
The Philly Fed's general conditions index slowed to 24.5 from 40.8 in November. Outside of November, the latest reading is the strongest since March 2011.

But details in the report do show across-the-board slowing including for new orders, at 15.7 vs November's 35.7, unfilled orders at 1.5 vs 7.1, employment at 7.2 vs 22.4, and shipments, at 16.1 vs November's 31.9. It was this 31.9 reading that first signaled what proved to be a great month for manufacturers based on Monday's November industrial production report where the manufacturing component surged 1.1 percent.

But November looks to be an impossible comparison for the manufacturing sector this month though the rate of growth is still very strong. Other details in today's report include steady and muted readings for prices and a steady reading for inventories. The 6-month outlook remains very strong though once again less strong than November, at 51.9 vs 57.7.

THE INDEX OF LEADING ECONOMIC INDICATORS shows very strong near-term rates of growth, .6% for November. This supports the notion that the U.S. economy has found its footing going into 2015...

NAT GAS INVENTORIES fell 64 bcf last week. That's two consecutive weeks of decline.

DECEMBER 19, 2014


THE KANSAS CITY FED MANUFACTURING INDEX gave a better read for December than did other regional surveys. Manufacturing activity in the Tenth District expanded moderately and future expectations remained at healthy levels.

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