Saturday, February 21, 2015

Your Weekly Update

If you're one to fret over falling stock prices, and have been paying attention these past few years, you're keyed on the Fed. That is, you're worried about interest rates. Or, more specifically, you're worried about when the Fed will start raising the fed funds rate (the interest rate at which banks lend to each other on very short-term loans). If that happens to be you, the past couple of weeks felt good as the U.S. economic indicators came in on the soft side. Still showing growth mind you, just a slower pace than had been anticipated. And soft indicators spell uncertainty and low levels of inflation. Hence, no pressure on the Fed to raise interest rates.

But the data are influenced by numerous, if not countless, factors. In terms of inflation, even though we look at it, the core anyway, ex-energy, make no mistake, the price of oil---be it high or low---does, to some degree, bleed through to the pricing of other goods and services. Plus, employment costs---generally a company's largest input---impact the pricing of goods and services to no small degree. I know, you're hearing pundits point out that wages aren't rising (tell that to Walmart). But I'm here to tell you that wages indeed rise as expansions expand and labor market slack contracts. So then, what happens when oil bottoms and wages begin rising? And/or what happens when the monster benefits of lower oil prices to the consumer show up as more demand for other goods and services, and wages begin rising? You got it, folks anticipate higher interest rates, then create them by selling their bonds---and the Fed gets off the dime. Which, to validate your fear---as I've previously addressed---spells potential (short-term at least) trouble for the stock market.

Honestly, and with all due respect, if you're one to fret over falling stock prices, while a seeming lack of inflationary pressures, very low odds of a U.S. recession anytime soon, a potential kicking of Greece's problematic can a few months down the road and Eurozone quantitative easing set to begin next month may fade your fretting for the time being, fretting over falling stock prices is akin to fretting over foul weather. It may not show up in the forecast, but it's always somewhere on the horizon---and forecasters miss more often than they care to confess. In other words, don't fret over falling stock prices, they're normal, essential even.

Current themes:

Central Banks:

As suggested above, recent indicators presumably allow the Fed to remain patient when it comes to  raising the Fed funds rate. This week's release of the minutes from the last FOMC meeting showed that, on net, the committee remains cautious, or dovish, on rates. Janet Yellen's appearance before Congress next week might give us a hint as to whether Fed sentiment has changed after the impressive January jobs report.


West Texas crude dropped around $2/barrel last week as inventories continue to build. The EIA's report showed another 7.7 million barrels added to what is now an 80-year high in inventory. Near-term bullishness for the price of oil finds no support in present supply. It'll of course get there as capacity continues to get cut, just can't say when.

The Consumer:

On the week, Valentine's Day gave a lift to retail sales while mortgage purchase apps dipped 7% and housing starts came in just shy of estimates---at 1.065 million vs 1.07 expected. Year-over-year housing starts are up a very healthy 18.7%. Although the comp was easy, in light of last January's polar vortex. The recent softer data in housing is a bit befuddling. Looking at present household formations, record low mortgage rates and rising consumer confidence, you'd think housing would be booming right about now. Housing-related stocks, up very nicely this year, seem to be discounting something special going forward.

Here's a chart (click on it to enlarge) showing the rise in household formations (folks establishing their own homes [not necessarily buying a house]) in red, the pace of new housing starts (purple, 1.005 mill), new home inventory (green, 218k) and total inventory (white, 1.8 mill) going into this year. As you can see, starts and inventories remain at or below average (and way below the mid-2000s peaks) while household formations have exploded of late. You can see why suddenly the market's bullish on housing-related stocks.

Housing Inventory, Starts and Household Formation

Weekly jobless claims declined by 21,000 and the 4-week average dropped to a comfortable 283,250, the lowest level in about 4 months. Optimism picked up last week as the expectations component of Bloomberg's Consumer Comfort Index logged a 4-year high.


Europe has, in my view, been a dominant force in the market so far this year. The Eurozone economy is finally showing signs of life---that's positive. The ECB is about to start printing money---that's viewed as positive. And it appears that an agreement, pending approval by the folks who write the checks, was reached on Friday that will give Greece a few months to pay its bills and figure out how it's going to convince the Troika (EC, ECB and IMF) that it can do the impossible---fix its fiscal mess. It's impossible, that is, if it's to come by way of receiving more bailout money while not fully engaging in a major, and very painful, overhaul of its economic system. The problem for Alexis Tsipras, the new prime minister, is that he won office by promising to give back all the debt-financed goodies that the previous government had to take away in order to receive enough help to pay the bills. Clearly, the players on both sides fear the near-term consequences of Greece leaving the Euro. Which, in my humble view, is Greece's best chance of ever---well, let's say in the next 75 years or so---working its way out of this mess its gotten itself into.

I hear that Yanis Varoufakis, Greece's new finance minister, is considered an expert in game theory (he's written a number of books on the subject). I wonder how good he is at the game kick-the-can. For that's the only game he and Tsipras---being that they want to stay in the Euro and remain in office---can play at the moment. Let's call it "semantic kick-the-can". For, to not anger the electorate, they have to get more aid while insisting that it's not more bailout.

On to Russia: Hundreds in Ukraine have died since last Sunday's "ceasefire". Clearly, there's more playing out of this horrific game to come. At the moment, given recent economic indicators, the Eurozone seems to be overcoming the ill effects of retaliatory sanctions from Russia. As long as the prospects for a bargain remain, I expect Eurozone sentiment (picking up of late) will remain relatively positive. Enough said for now...

Q4 Earnings (here I’ll simply update the numbers to last week’s paragraph):

Of the 440 of the S&P 500 companies having thus far reported, an impressive 74% have bested analysts’ expectations. On the revenue side, 56% did better than expected. The rate of growth however has been nothing to write home about, 4.4% and 1.2% respectively. Of course the energy sector, seeing declines of 20% and 15% in earnings and revenue respectively, is no small influence on the overall numbers.

The Stock Market:

Here's a look at the year-to-date results for the major U.S. indices, and the non-US indices using index ETFs as our proxies (according to Morningstar and Ycharts):

Dow Jones Industrials:  +2.20%

S&P 500:  +2.82%

NASDAQ Comp:  +4.84%

EFA (Europe, Australia and Far East):  +6.89%

FEZ (Eurozone):  +6.38%

VWO (Emerging Markets):  +4.08%

Sector ETFs:

Here’s a look at the year-to-date results for a number of sector ETFs:


XLB (MATERIALS):  +6.94%

IYH (HEATHCARE):  +5.54%


XLK (TECH):  +4.19%



XLE (ENERGY):  +1.75%

IYT (TRANSP):  +0.01%


XLU (UTILITIES):  -3.15%

To put the inevitable (volatility and down markets) into perspective, allow me to repeat last week’s comments:
In last weekend’s commentary I attempted to put a rough January into proper perspective by urging you to view the stock market as an “antifragile” (benefits from stress) entity. Again, periodic market downturns are an essential aspect of the long-term investing process. As I stated in our year-end letter, and several commentaries since, I expect financial markets in 2015 to exhibit the kind of volatility that will challenge the resolve of many a short-term investor. Good thing you and I think long-term!

One additional note on volatility: The past couple of weeks I’ve shared with you the very short-term results for markets and sectors. I do this with a bit of hesitation, as I in no way want to give the impression that you, nor I for that matter, should base our long-term investment decisions on short-term movements in markets or their sectors. It can, however, serve as a reference point for how the markets are, or are not, responding to the data (which is why I, as a professional, track the short-term). As you may have noticed, my beginning of the year optimism over non-US and the housing sector (to name two), and pessimism over utilities, appears to be justified by recent results. I need to strongly (very strongly!) emphasize that I was not predicting what we’ve experienced these few short weeks into 2015. My optimism or concerns are based on factors such as valuations, trends, monetary policy and cyclicality—and my comfort in making allocation recommendations rests on the view that our clients are not short-minded investors (it can take awhile, if at all, for the market to reward what I believe to be good fundamental logic) who mistakenly believe that any human being possesses a capacity for market timing. Some people get lucky from time to time, but without exception, market timers are wrong far more often than they are right. The path to long-term investment success is fraught with bumps and potholes. The ones who successfully make the journey take it slow and never over-compensate when steering through and around the inevitable obstacles along  the way.


The Bond Market:

Despite softer economic news, rates continued to creep higher the past couple of weeks. The yield on the 10-year treasury bond rose .12% last week to 2.11%. Here I'll express my concerns once again with my message from two weeks ago (plus, see my comments on Treasury International Capital in the February 18th economic notes below):
As I suggested above, complacency can be a very dangerous thing. In my view U.S. bond investors have been the definition of complacent for a very long time. And who can blame them when the U.S. economy, until recently, has delivered probably the most sluggish expansion in its history and the rest of the developed world is sporting interest rates near zero, or below. I.e., there’s been little risk of inflation here at home, and the U.S. treasury has offered the most attractive yields among the world’s safest debt issuers. Not to mention how the strengthening dollar has enticed foreign investors into the U.S. bond market.

So what might alter the debt investor’s paradigm and inspire him to give up his treasury bonds? Well, it could be a number of things. Not the least of which would be signs that the U.S. economy is gaining momentum and that the Fed will have to begin raising interest rates sooner than later. Bond prices took it in the chin last week as the yield on the 10-year treasury jumped from 1.66% to 1.95% (that’s a 17% increase). Another excuse would be a sudden decline in the dollar (I know, that contradicts the present economic backdrop and the prospects for higher interest rates. But the consensus lives in that camp, and the consensus is very often wrong). Should, let’s say, the Eurozone begin to show real signs of life and, thus, the Euro begin to gain against the dollar, we could see money fly out of treasuries in a big way as those carry-traders (they borrow in low-yielding, declining currencies and invest in higher yielding, strengthening currencies) rush to exit their positions: A reversal in the currency exchange trend can be a killer (say you borrowed 1 Euro and lent it in the U.S. at a $1.12 exchange rate. If the dollar moves to $1.20/Euro, you no longer have enough dollars to pay back your Euro loan).

Suffice it to say that the bond market (as well as other interest-rate-sensitive sectors [think utilities]) is in a precarious position these days. Short-term rates at zero while the economy is gaining momentum is an utterly unsustainable scenario.


Here are last week’s U.S. economic highlights:

FEBRUARY 17, 2015

THE EMPIRE STATE MANUFACTURING SURVEY shows modest growth in the New York region. The outlook component fell noticeably while the current conditions component declined only slightly. Shipments were strong enough, up 14.12, best since September. However, new orders growth came in basically flat... The employment component remained solid, coming in at 10.11 vs 13.68 and 8.33 in January and December respectively. One interesting, and contradictory, point worth making is that despite the decline in sentiment, plans for expansion jumped from 14.74 to 32.58, for the largest one-month increase since April 2009...

THE NAHB HOMEBUILDERS INDEX declined from 57 in January to 55 this month. However, that's still a bullish read (above 50). The traffic component was down (weather perhaps). The expectations and present sales components both came in strong at 60 and 60.

Homebuilder optimism is reflected in their expectations for sales acceleration going forward. They expect to sell 572,000 new homes this year, vs 435,000 last, and for 2016 they expect sales to surge to 807,000...

E-COMMERCE RETAIL SALES reflect the surprising slowdown we've seen of late in the overall retail sector. The Q4 quarter-to-quarter growth in sales was 2.3%, vs 3.6% and 5.0% in the two previous quarters. Nonetheless, e-commerce's share of total retail sales inched up 1/10th of a % to 6.7%. Year-over-year, e-commerce sales rose 14.6% in the fourth quarter. Down from 15.8% in each of the two prior quarters. The gain is about 3 times greater than waht we've seen in core retail sales, up 5% year-on-year in Q4...


FEBRUARY 18, 2015

MBA PURCHASE APPLICATIONS continue to surprise me, as, last week, they posted their second consecutive weekly loss. Refinances dropped 16%, while new purchase mortgage apps declined by 7%, matching the previous week's decline. Mortgage rates have been on the rise the past couple of weeks, but the decline amid other strong housing-related indicators is a mystery. Of course weekly numbers can be noisy, and I do expect, given other data, to see these numbers improve as 2015 unfolds.

HOUSING STARTS slipped in January, although the 1.065 million was close to the 1.07 consensus estimate. The year-over-year pace is a healthy 18.7%. Again, if I'm right on the fundamentals, we'll see these stats improve going forward.

PPI-FD (final demand) illustrates the sharp drop in energy prices. Down .8% in January, vs a consensus estimate of -.5%. Ex-food and energy, inflation dipped .1%. PPI-FD for services rose 1.9% on year-on-year basis.

THE JOHNSON REDBOOK RETAIL REPORT rose as expected during the Valentine's Day week. Up 3.2% vs a 2.1% increase the prior week. Still not robust, and not reflecting recent consumer sentiment. The report notes that heavy weather has held down early sales of sporting goods in the Northeast.

INDUSTRIAL PRODUCTION rose modestly in January, up .2% versus decreasing .3% in December. The consensus estimate, however, was for a .4% increase. The capacity utilization rate remains at a non-inflation-threatening 79.4%.

THE FOMC MINUTES FOR THE JANUARY MEETING told of the ongoing debate among the members with regard to when to raise interest rates and how to signal it to the markets. Econoday does a good job of summing it up:
The Fed minutes for the January FOMC minutes indicated that the Fed had increased debate but still remains "patient" for when the first policy rate increase will occur. While some hawks are worried about rates being raised too late, most on the FOMC remain dovish. Foreign issues remain a notable downside risk and inflation is low. Many participants see an early rate increase as damping the recovery.

Even though energy is holding down inflation currently, inflation is seen as eventually returning to goal of 2 percent. But soft wage growth is a notable concern.

The Fed is getting more technical with staff presentations on unwinding operations regarding the Fed balance sheet. There were discussions regarding interest on excess reserves and on reverse repos. These are relatively new policy rates that have only been experimentally used for practice by the Fed for future tightening.

Overall, the tenor of the minutes clearly was dovish. A first rate hike is not likely before June-and increases are likely to be very gradual.

TREASURY INTERNATIONAL CAPITAL, which tracks the flows of financial instruments into and out of the U.S., shows the U.S. receiving a net inflow of 35.4 billion dollars in December. What's interesting is that foreign accounts were big sellers of U.S. treasuries, but were net buyers of U.S. stocks. U.S. accounts were big sellers of foreign bonds, and also were net sellers of foreign equities (although not nearly to the extent they sold bonds).

API WEEKLY CRUDE STOCK grew by a whopping 14.3 million barrels!! Gasoline inventories rose 1.3 mbs and distillates declined 2.7 mbs. Tomorrow's EIA report will, I suspect, also show a substantial build. This flies smack in the face of the notion that oil prices have bottomed out.

FEBRUARY 19, 2015

WEEKLY JOBLESS CLAIMS declined last week by 21,000 to 283,000. That's a significant decline. Clearly, the weekly numbers can be extremely volatile (up 25,000 the week prior). Thus, the 4-week average is important to track, which has declined for a 4th straight week to 283,250 --- it's lowest level since early November.

Continuing claims, which lag a week, increased by 58,000, however the 4-week average dropped by 10,000 to 2.398 million. The unemployment rate for insured workers remains at 1.8%.

THE BLOOMBERG CONSUMER COMFORT INDEX rose to a 4-year high last week. Here's Bloomberg's commentary:
Consumers’ Outlooks on U.S. Economy Improve to Four-Year High

By Victoria Stilwell

(Bloomberg) -- Consumers are more upbeat about the U.S. economic outlook than at any time in the last four years, bolstered by cheap gasoline and a sustained pickup in hiring.

The Bloomberg Consumer Comfort Index’s monthly economic expectations gauge rose by 1 point to 54 in February, the highest since January 2011. The weekly index was little changed at 44.6 in the period ended Feb. 15 compared with 44.3 the previous week.

Household sentiment has climbed in recent months as fuel prices plunged and payroll gains accelerated. Now that energy costs have stabilized, it will probably take a pickup in wages for American consumers to keep feeling optimistic.

The improvement in the monthly outlook index is “a positive sign regardless of a stall in views of current economic conditions,” said Gary Langer, president of Langer Research Associates LLC in New York, which produces the data for Bloomberg.

The weekly measure of Americans’ views on the current state of the economy climbed to 38.9 from 38.1 the previous period. A gauge of the buying climate, which shows whether now is a good time to purchase goods and services, rose to 38.4 from 37.2. The personal finances index, still the strongest of the three components, fell to a four-week low of 56.6 from 57.4.

Some 26 percent of Americans surveyed this month said the economy is getting worse, the least since January 2011. Thirty-five percent said it’s getting better.

Job Growth

More employment opportunities are helping quell pessimism as payrolls in January capped their best three months of job growth in 17 years. Still, wages have been slow to rise, meaning that some consumers who have come to count on savings from low gas prices may be pinched as costs start to rebound.

The average price of a gallon of regular gasoline was $2.27 on Feb. 17, up from an almost six-year low of $2.03 on Jan. 25. That compares with an average price of $3.33 over the past five years.

Cheap gasoline is especially important to lower-income households, who tend to spend a greater share of their earnings than their wealthier counterparts.

The weekly measure of sentiment rose in five of seven income brackets. Attitudes for those making $25,000 to $40,000 were the most positive since December 2007, while those making $40,000 to $50,000 suffered the biggest decline, falling to a seven-week low.

Among regions, the Northeast saw the biggest increase in confidence, which climbed to an eight-week high, showing harsh weather hasn’t damped spirits in the region. Sentiment in the South also advanced. The West saw confidence decline and attitudes in the Midwest were little changed.

THE PHILADELPHIA FED SURVEY, as have many manufacturing surveys of late, while on net positive, suggest a waning in optimism within the space. Here's Econoday with the plusses and minuses of today's release:
Slow growth is February's signal from both the Empire State report, posted on Tuesday, and today's manufacturing report from the Philly Fed where the general conditions index held little changed at 5.2 vs January's 6.3. Something else both reports have in common is substantial cooling in optimism with the Philly Fed's 6-month outlook falling to 29.7, which is still impressive looking but not compared to December's 50.9.

The new orders index is a positive in today's, still on the plus side at 5.4 vs January's 8.5. And unfilled orders are a special positive, rising to 7.3 from January's contraction of minus 8.6. Employment also is back in positive ground, at 3.9 from minus 2.0. Price indications are flat with inputs showing only marginal monthly growth and finished goods very slight contraction for a 2nd month in a row.

The sudden falloff in outlook is a peculiar twist in this week's manufacturing reports, perhaps hinting that manufacturers are less confident in their order books this year. Otherwise, the reports point to steady, non-accelerating growth at a moderate pace.

THE INDEX OF LEADING ECONOMIC INDICATORS (LEI), while remaining positive, slowed to a .2%, versus a .5% increase in December and a consensus estimate of .3%. The report's negatives were not extreme, with stock prices (January was a down month) and ISM new orders coming in the weakest. As of this writing, the stock market has recouped all of January's decline and some, which would, if it sticks for February, bode positively for February's LEI.

THE EIA NATURAL GAS REPORT shows a decline of 111 bcf in inventories.

THE EIA PETROLIUM STATUS REPORT, much anticipated after this week's monstrous (in inventory build) reading from the API, showed crude inventories growing by 7.7 million barrels last week. Clearly, recent cuts in capacity have not stemmed the glut in any way whatsoever (therefore, we should not be bullish on the price in the very near-term). Although, it's a given (barring a global economic slowdown zapping demand) that they will.  Gasoline inventories grew by .5 million barrels and distillates declined by 3.8 million barrels.

THE FED BALANCE SHEET declined $4.8 billion last week to $4.497 trillion.

M2 MONEY SUPPLY declined by $9.8 billion last week.

FEBRUARY 20, 2015

FLASH MANUFACTURING PMI, amid softening manufacturing readings from other surveys, shows a net pickup in February. Although, on balance, its components reflect the overall moderate growth results in the other surveys.

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