Sunday, March 22, 2015

Your Weekly Update

You've heard me complain that zero interest rate policy (ZIRP) is inconsistent with today's economic reality. That maintaining policy typically reserved for the severest of crises while the economy's mode is anything but crisis can prove to be problematic in the long run. I've many times voiced my disappointment in the Fed's fear of financial markets. That doesn't mean, however, that I can't appreciate the predicament they've gotten themselves into.

You see, the Fed's mandate demands that they do all they can to goose the economy until it reaches what they view as full employment---as long as price stability (low inflation) is maintained.

The Fed's actions impact the economy through a number of what they call "transmission channels, mechanisms or effects". Such as interest rates, currency exchange rates, wealth, bank lending and capital formation.

The Fed's, as I put it, fear of financial markets has to do with the wealth effect. I'd say there's a large contingent of folks who entirely credit (erroneously in my view) the present bull market in stocks to Fed policy. And even if the Fed governors don't believe that themselves, they are keenly aware that there's a contingent who does. And that awareness is what makes for their precarious situation. When they finally abandon ZIRP, they fear the market will tumble as those Fed followers hit the exits.

If, at that time, the economy isn't firing on enough other cylinders, they fear that what might otherwise be a healthy market correction could cause folks (then feeling less wealthy) to pull in and put an end to what they view as a nascent recovery in very short order. There's more nuance to the wealth effect, such as the increased confidence to expand operations---and the heightened access to attractively priced (low interest rate) credit---a publicly-traded company enjoys when its market capitalization is high; and not so much when its share price declines. Not to mention, as described under "the U.S. dollar" below, the wealth effect impact of the exchange rate mechanism.

Make no mistake, while it appears as though they're dreaming up excuses to not raise rates, the Fed governors have to be growing impatient with ZIRP. They have to know that the longer this goes on, the harder the market may fall when they finally pull the trigger. And, sadly, some of the folks whom they least want to see suffer will, they fear, suffer mightily:

I received an email the other day from a dear client who had just left her accountant's office. She---given her portfolio's dearth of interest income---inquired as to whether we should consider adding exposure to dividend paying stocks. She's a client with a very conservative profile whose objective is to do better than the bank while maintaining relatively low volatility. I.e., we have to own equities to, over time, meet her return objectives, but we have to maintain low to moderate exposure. This, I assure you, is a phenomenon that is running rampant in today's market---folks who used to rely on insured CDs for income are abandoning the safety of the FDIC and venturing into the stock market for yield. And while investors moving out on the risk spectrum---and boosting asset prices---is the wealth transmission mechanism in action, it was not the Fed's intent to inspire everyday retirees to expose their portfolios and, therefore, their nerves/sense of wellbeing to equities to an inappropriately risky degree.

The fear of a market-overreaction hitting the economy, and the retiree, has Janet Yellen choosing her words most carefully these days. My fear is that her (and her colleagues') fear will keep the Fed too easy for too long, which may mean having to tighten more aggressively later and exacerbating the very thing they're trying to avoid, a major market correction.

In the meantime, here's the latest on the key themes of the day:

Central Banks:

See above...


Back on February 8th, I suggested that the then spike in oil prices (up to the mid-50s) could turn out to be a head fake. I can't say that I was making a prediction, it was simply that supplies continued to build unabated, offering no fundamental support for the spike. And, sure enough, a barrel of West Texas crude sells for $46.15 as I type---last week marked the 10th in a row that saw oil inventories rising (by a whopping 9.6 million barrels, according to the EIA). While there's no doubt in my mind that oil will find a bottom, present trends suggest it'll be lower than $46.15.

The Consumer:

Last week's Bloomberg Consumer Comfort Index bounced a titch, as respondents felt better about their personal finances. However, when it comes to their outlook on the economy, they were less optimistic---that component fell to a 3-month low, after hitting a 4-year high the previous week. Weekly reads are always noisy, and when it comes to consumer sentiment, my view is that there's strong correlation to the stock market. Which means, if I'm right, we could see a bounce in the coming week's number based on last week's rally in stocks.

Retail sales continue to come in  relatively soft, by historical standards. However the trend has been positive (2.7% year/year from 2.6% the prior week), particularly on a month/month basis (up 1.0% the past two weeks running). Look for this reading to improve based on employment data and warmer weather going forward.

As for the housing market, it was an interesting week, to say the least. Here's from last week's economic log:
HOUSING STARTS in February came in way below expectations, at 897k.. estimates were for 1.05 million. The regional breakdown virtually assures that weather's to blame. I believe we'll see marked acceleration in the housing data as the balance of this year unfolds.

HOUSING PERMITS countered the starts number by rising 3% in February, exceeding the consensus estimate by 34k (1.092 million vs 1.058 million).

As you know---despite the volatile weekly and monthly data---I've been bullish on housing. Last week's earnings reports for Lennar and KB Homes---both posting impressive, expectation-beating, numbers---confirmed my optimism.


Despite the uncertainty of the Russia/Ukraine situation, and Greece's woes, the Eurozone economy---while not robust by any means---continues to improve. As you'll see in the stock market section below, it's been good to be an international investor so far this year---even in U.S. dollar terms.

The U.S. Dollar:

In response to last week's midweek blog post, a client asked me via email:
How can fear over a qtr % rate hike cause a 4-500 pt change? 

I explained that the Fed is never one and done---that the first hike is typically the beginning of a series. And that the dollar's been on a tear (the exchange rate transmission effect) and that the consensus believes that a rate hike would send it yet higher. And that the Fed is concerned with the high-dollar-headwind, as exporters see lower revenues/earnings and, thus, slow down on capital expenditures (expansion)---which we're seeing big time in the energy space.

And, sure enough, the dollar tanked on Wednesday (when the Fed replaced "patient" with essentially very patient) and stocks rallied. Friday's rally also coincided with another dip in the dollar.

Read last week's update for more...

The Stock Market:

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

Dow Jones Industrials:  +2.29%

S&P 500:  +2.86%

NASDAQ Comp:  +6.47%

EFA (Europe, Australia and Far East):  +7.92%

FEZ (Eurozone):  +6.71%

VWO (Emerging Markets):  +1.75%

Sector ETFs:

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

IYH (HEATHCARE):  +10.59%



XLK (TECH):  +3.30%

XLB (MATERIALS):  +1.72%




IYT (TRANSP):  +0.17%

XLE (ENERGY):  -2.19%

XLU (UTILITIES):  -4.00%

Once again, here’s my latest reminder on volatility:
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:

The yield on the 10-year treasury bond retreated yet again last week as bond prices were buoyed by the Fed's dovishness. As I type the 10-year treasury yields 1.93%, down from 2.09% a week ago last Friday.

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

MARCH 16, 2015

THE EMPIRE STATE MANUFACTURING INDEX FOR MARCH falls in line with other softening anecdotal indicators for the sector. One glaringly contradictory component is employment. Which, like many of the other surveys, shows real strength and, thus, optimism in the manufacturing space. Here's the report's overview:
The March 2015 Empire State Manufacturing Survey indicates that business activity continued to expand at a modest pace for New York manufacturers. The headline general business conditions index, at 6.9, remained close to last month’s level. The new orders index fell four points to -2.4, pointing to a small decline in orders, and the shipments index declined six points to 7.9. Labor market indicators pointed to a solid increase in employment levels and a lengthening in the average workweek. Pricing pressures remained subdued, with the prices paid index inching down two points to 12.4, and the prices received index at 8.3. As in February, indexes for the six-month outlook conveyed less optimism than in many of the preceding months, and the capital spending and technology spending indexes declined.

INDUSTRIAL PRODUCTION barely increased by .1% in February, vs a .3% consensus estimate. Manufacturing output confirms recently soft industry reports, down .2%. Here's from the report:
Industrial production increased 0.1 percent in February after decreasing 0.3 percent in January. In February, manufacturing output moved down 0.2 percent, its third consecutive monthly decline. The rates of change for the total index in January and for manufacturing in both December and January are lower than previously reported. The index for mining fell 2.5 percent in February; drops in the indexes for coal mining and for oil and gas well drilling and servicing primarily accounted for the decrease. The output of utilities jumped 7.3 percent, as especially cold temperatures drove up demand for heating. At 105.8 percent of its 2007 average, total industrial production in February was 3.5 percent above its level of a year earlier.

CAPACITY UTILIZATION, declining to 78.9%---being a classic inflation indicator---by itself puts no pressure on the Fed to raise rates anytime soon.

THE NAHB HOUSING MARKET INDEX continues to show optimism among homebuilders, coming in at 53 (above 50 means net optimism). However, not as much as last month (55)... Here's NAHB's chief economist David Crowe.
“Even with this slight slip, the HMI remains in positive territory and we expect the market to improve as we enter the spring buying season.”

“The drop in builder confidence is largely attributable to supply chain issues, such as lot and labor shortages as well as tight underwriting standards. These obstacles notwithstanding, we are expecting solid gains in the housing market this year, buoyed by sustained job growth, low mortgage interest rates and pent-up demand.”

TREASURY INTERNATIONAL CAPITAL, which tracks the flows of financial instruments into and out of the U.S., shows net sales of U.S. long-term securities by foreign investors of $27.2 billion in January. Foreign accounts were net  sellers of treasuries, and net buyers of agency and corporate bonds. Equities were flat. U.S. investors were net buyers of foreign bonds ($26.1B) and net sellers of foreign equities ($-13.4b).

MARCH 17, 2015

HOUSING STARTS in February came in way below expectations, at 897k.. estimates were for 1.05 million. The regional breakdown virtually assures that weather's to blame. I believe we'll see marked acceleration in the housing data as the balance of this year unfolds.

HOUSING PERMITS countered the starts number by rising 3% in February, exceeding the consensus estimate by 34k (1.092 million vs 1.058 million).

THE JOHNSON REDBOOK RETAIL REPORT continues to surprise me with its softness, although the trend---2.7% year-over-year sales increase last week vs 2.6% the week earlier---improved a little. The report estimates a strong March based on this year's early Easter. It also anticipates a spring bounce as the weather warms up. I will say that the month/month results are improving noticeably---up 1.0% for two weeks running.

MARCH 18, 2015

MORTGAGE NEW PURCHASE APPLICATIONS declined 2% last week despite lower mortgage rates. Refis declined 5%.  The weekly numbers are always very noisy... On balance, the mortgage data of late does not confirm nor contradict my optimism on housing going forward...

THE EIA PETROLEUM STATUS REPORT shows crude inventories continuing to build at an amazing pace. Up 9.6 million barrels last week to 458.8 mbs, an 80-year high. Gasoline inventories fell 4.5 mbs and distillates rose .4 mbs.

THE FOMC wrapped up its two-day policy meeting with an announcement that didn't include "patient", but offered up, in my view, language that strongly hinted that the Fed is as dovish as ever. Barring some shocking near-term data, I'd say a June rate hike is off the table.

MARCH 19, 2015

WEEKLY JOBLESS CLAIMS rose by 1,000 to 291k from a revised prior week. The 4-week average rose by 21,750, to 304,750. Both the current number and the average---and continuing claims (down 1k to 2.418 m)---are consistent with healthy economic expansion.

THE Q4 CURRENT ACCOUNT (TRADE) DEFICIT increased sharply (to $113.5 billion), as expected given the strong dollar. The deficit (utterly meaningless in my view) is all about primary income (investment income and compensation) and goods. With regard to services, the U.S. realizes a surplus, which increased by $1 billion in Q4. With regard to primary income's contribution to the deficit, it too is in surplus, however the surplus shrank $50.6 billion in Q4 from Q3's $59.8 billion.

THE BLOOMBERG CONSUMER COMFORT INDEX rose slightly last week to 44.2, which is a one-month high---fueled by a jump in the personal finance gauge. Drilling down, however, shows sentiment weakening in the consumer's outlook on the economy. As I've posited many times, I see a strong correlation between the stock market and the mood of respondents. If that holds true, we may see an outlook improvement in next week's results, given last week's rally in stocks. Here's Bloomberg's commentary:
Consumers’ U.S. Economic Outlook Retreats From Four-Year High

By Victoria Stilwell

(Bloomberg) -- Americans’ outlooks for the U.S. economy dimmed in March from a four-year high as feeble wage gains and harsh winter weather weighed on sentiment.

The Bloomberg Consumer Comfort Index’s monthly economic expectations gauge fell to a three-month low of 51.5 from a February reading of 54 that was the strongest since January 2011. In contrast, the weekly sentiment measure improved to a one-month high of 44.2 in the period ended March 15 from 43.3.

“Despite solid employment numbers, wages are stagnant, and recent reports show retail sales, manufacturing and housing starts all struggled in February,” Gary Langer, president of Langer Research Associates LLC in New York, which produces the data for Bloomberg, said in a statement.

Limited pay gains, higher heating bills and gasoline prices above their January lows combined to leave households less upbeat this month. At the same time, the setback in March sentiment may prove short-lived as employers keep taking on more workers and inflation remains low.

The weekly personal finances gauge climbed to 57.1, the highest since early February, from 54.8 in the previous week. The weekly measure of Americans’ views on the current state of the economy was little changed at 37.2 after 37.1. A gauge of the buying climate, which indicates whether consumers think now is a good time to purchase goods and services, was 38.3 last week after 38.2.

Economy Outlook

Some 30 percent of respondents this month said the economy is getting better, the smallest share since November. Forty-three percent said it’s staying the same, up from 38 percent a month earlier.

Even with the March decline, the monthly economic expectations gauge has averaged 52.8 this year, the strongest for a comparable period since March-May 2002.

Solid job growth has helped sustain confidence, with payrolls climbing by 295,000 in February following a gain of 239,000 the previous month. At 5.5 percent, the unemployment rate is the lowest in almost seven years, according to the Labor Department.

Those gains may be giving hope to job seekers. Confidence among the unemployed climbed to the highest level since August 2007. Those 35 to 44 years old, who are in their prime earning years, were more confident than at any time since October 2007.

Wage Growth

Even with the progress in the labor market, faster wage growth has failed to materialize. Average hourly earnings climbed 2 percent in February from the year before, matching the mean pace of the expansion.

The weekly measure of sentiment rose in five of seven income brackets. Confidence for those making $40,000 to $50,000 was the highest since December 2007, while optimism among $75,000-to-$100,000 earners was the weakest in three months.

In the Northeast, where higher heating bills are coming due after temperatures plunged a month earlier, sentiment fell to the lowest level since early November. Confidence rose in the Midwest, West and South, where it climbed to the highest level since September 2007.

THE PHILLY FED SURVEY fell in line with this week's Empire State survey, and is consistent with the overall softer reads on manufacturing of late. Here's Econoday's commentary:
Slow growth with weakness in orders is the common thread for both the Empire State report, released earlier this week, and now the Philly Fed where the general conditions index held little changed at 5.0 in March vs 5.2 in February. New orders, at 3.9, are not much above zero while unfilled orders are suddenly well below zero, at minus 13.8 in a sharp decline from February's plus 7.3.

Weakness in orders points to softness in shipments, which are already below zero at minus 7.8, as well as softness in employment which is struggling to stay above zero at 3.5. Price data show contraction for both inputs, at minus 3.0, and finished goods, at minus 6.4.

The early indications on March are not that positive in what would extend a series of weak months for the manufacturing sector, a sector that the FOMC noted yesterday is being hurt by weak exports tied to weak foreign demand and complicated by the strong dollar.

THE INDEX OF LEADING ECONOMIC INDICATORS held steady in February. Econoday sums it up nicely:
Growth in the index of leading economic indicators held steady at 0.2 percent in February, pointing to moderate growth for the economy over the next 6 months. Once again the yield spread is the biggest positive for the index reflecting the Fed's near zero rate policy. The stock market is the next biggest positive followed by the report's credit index, an index that has however consistently been pointing to healthier borrowing conditions than government reports. Consumer expectations are also a positive in February but are very likely to reverse in March given the mid-month plunge in the consumer sentiment index.

Other readings include a 0.2 percent rise in the coincident index, which points to moderate ongoing growth, and a 0.3 percent rise in the lagging index, which points to moderate past growth. Growth may be slow but it is sustainable, reducing the risk of overheating and keeping the Fed's rate hike at bay.

NAT GAS INVENTORIES dropped by 45 billion cubic feet last week, to 1,467.

THE FED BALANCE SHEET grew by $6.6 billion. Given that QE has ended and the Fed continues to reinvest the proceeds from maturing securities, the weekly changes in the Fed balance sheet are market related. I.e., when yields drop, as they did last week, and bond/mortgage backed securities prices increase, the balance sheet grows. And vice versa. Total assets currently  stand at $4.496 trillion.

M2 MONEY SUPPLY declined last week by $21.8 billion.

MARCH 20, 2015


1 comment:

  1. […] And why wouldn’t falling stock prices deter the Fed, particularly when—as I suggested last week—the Fed is fixated on the wealth effect of monetary policy? Because Q1′s economic […]