“We never had an advanced economy actually asking for that kind of thing, delayed payment” said International Monetary Fund's managing director Christine Lagarde on Thursday in reference to Greece's obligations. She added, “And I very much hope that this is not the case with Greece. I would certainly, for myself, not support it.”
"The surge recently has been a little too fast for the regulators' comfort" said Hah Hong, Bocom International Holdings' chief China strategist on Friday, in reference to the Chinese stock market---particularly the stocks that comprise the Shanghai Composite Index.
"The underlying tone in the economy and the strengthening labor markets are giving you a little bit more core inflation" said Alliance Bernstein's director of global economic research Joe Carson about Friday's release of the March U.S. Consumer Price Index.
So there you have it, the recipe, we'll suppose, for a sizable one-day sell off in global equities (that would be last Friday).
Allow me to shed a little light on the looming darkness conjured up by each of the above threats:
Greece: It's crunch time, once again, for Greece. Crunch time is when he with the upper hand has a green light to bluff away. Why would one with the upper hand need to bluff? you ask. Good question. It's---in this particular poker game---because he desperately needs his opponent to fold, rather than call. For should his opponent throw in even his very last chip---and, thus, call---while our protagonist still wins, he fears his victory will be most Pyrrhic in nature. Meaning, if Greece doesn't surrender to its keepers' demands and, thus, defaults on its debt and leaves the Euro, suffice it to say that Friday's global market sell-off equates to a mere pittance of a pot. And, make no mistake, you don't want to be on either side of the publicly-appointed table when markets plunge and your nascent economic recovery potentially dies an early death.
While Greece may indeed leave the Euro (which is, in my view, likely the best longer-term scenario), I say the political risk remains too great on either side of the table, and odds are, therefore, that the can gets kicked---and the pot grows larger.
As for the markets' Friday slide: The Eurozone is the world's largest trading block, and Euro/U.S. dollar (EUR/USD) is the world's most actively traded currency pair. I.e., the Eurozone economy is finally beginning to lift off the runway and the U.S. market is in no mood these days for the dollar to go spiking ever higher. Although the consensus clearly has it continuing to appreciate going forward.
China: A 104% twelve-month return (the Shanghai index) can be a scary thing. Especially when the last few dozen percentage points have occurred while margin debt (borrowing against your equity positions to buy more equities) has literally exploded to the upside. So, the powers that be in China saw fit to put a halt to a particularly creative form of taking your margin debt beyond typical limits and, in addition, to widen the scope of opportunities for short-sellers (those who bet on a stock's decline) to have their way with shares they view as overpriced.
The inevitable out-sized drop that'll occur when Asian markets open for business a few hours from now will have been entirely by design. Better to let a little air out of the bubble now versus risking a huge explosion later, thinks China's policy makers.
As for the markets' Friday slide: China is the world's second largest economy, and is a monster driver of global economic growth. Need I say more?
U.S. Inflation: I spoke too soon on Friday morning's audio when I said that March's Consumer Price Index (CPI) came in relatively tame. That was the way I heard it on early morning financial radio. Upon inspection, I don't quite agree with the radio pundit's analysis. Sure, when we consider inflation with energy included, well, there ain't none. Oh but when we remove energy (which---understandably---everyone is so eager to do when energy prices are pushing the headline number higher), suddenly we see a rising inflationary trend. February's year-over-year reading was 1.7%. March's was 1.8%. Month-over-month we've seen two in a row with a .2% increase (do the math). Here's something I wrote in a February update (I'll highlight the part that's particularly pertinent to today's point):
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.
So here's the thing, energy prices are still low and wages are just now beginning to grow. And we're getting a CPI read that is a mere .2% under the Fed's target. Uh oh!
As for the markets' Friday slide: An acceleration of U.S. inflation could raise the near-term odds of a Fed rate hike exponentially. That first hike, I'm guessing, will---as market action would suggest---spell a bit of trouble for stocks.
Now, I need to dial that back just a bit and acknowledge that the CPI is not the Fed's favored inflation indicator. They prefer the PCE (Personal Consumption Expenditures) Deflator. Personal Consumption Expenditures, which, rather than measuring a fixed basket of goods and services (as does the CPI), takes into account where folks actually spend their money. For example, when New York steak jumps in price, lots of folks forego it and buy less expensive cuts instead. The CPI method would factor in the rising price of New York steak, even though lots of folks aren't feeling that pinch. I agree with the Fed, the PCE Deflator better measures the impact of inflation on the consumer---and its last read, ex-energy, was a comfortable 1.4% year-over-year.
So what's the verdict? Well, presenting a verdict, would be akin to predicting where the market goes in the short-run. And that I do not do! However, I will offer up what I believe to be the likeliest near-term scenarios---as long as you promise not to trade on them:
The Eurozone recovery continues and Greece gets more time. And Eurozone stocks experience lots of volatility while outperforming much of the rest of the developed world this year.
The Chinese central bank efforts mightily to stimulate its way to at least 7% annual growth, and its market does not crash and burn in 2015.
The U.S. survives a rough Q1, and growth accelerates throughout the remainder of the year. The Fed ever so gingerly bumps up its key rate sometime in the fall and markets hate it (could spark a long-overdue 10+% correction) initially. However, in the absence of a recession, no great bear market materializes as a result.
Could I be wrong in suggesting there'll be no U.S. recession in 2015? Could the next great bear market be lurking round the very next bend? Absolutely! Should it matter if you're a long-term, patient investor with a well-balanced/diversified portfolio who's never prone to panic? Absolutely not!
From here we'll jump straight to the markets, followed by the U.S. highlights from my economic journal. This week's highlights effectively cover the other U.S.-centric current themes.
The Stock Market:
Non-US markets have measurably outperformed the U.S. year-to-date. Don't be surprised if that remains the story throughout most of the year. That said, there are a number of potential international hot buttons that could easily delay the narrowing of the gap between the valuations of U.S. and non-U.S. securities. That's why we think long-term and stay diversified!
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: +0.67%
S&P 500: +1.67%
NASDAQ Comp: +4.53%
EFA (Europe, Australia and Far East): +8.43%
FEZ (Eurozone): +5.52%
VWO (Emerging Markets): +8.94%
Here’s a look at the year-to-date results for a number of sector ETFs:
IYH (HEATHCARE): +8.19%
XLY (DISCRETIONARY): +4.62%
XHB (HOMEBUILDERS): +4.48%
XLB (MATERIALS): +2.52%
XLP (CONS STAPLES): +1.79%
XLK (TECH): +0.70%
XLE (ENERGY): +4.17%
XLI (INDUSTRIALS): -0.93%
XLF (FINANCIALS): -2.07%
IYT (TRANSP): -5.37%
XLU (UTILITIES): -5.88%
Once again, the reminder on volatility I posted earlier in the year:
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:
As I type, the yield on the 10-year treasury bond sits at 1.87%. Which is down noticeably from last week's 1.95%. As you'll see below, last week was, on balance, not a great week in terms of U.S. economic indicators---hence the drop in yields. Like I said three weekends ago, I see bonds in general sporting a risk/return trade-off that makes going out on the yield curve not worth the risk---and I'm sticking firmly to that story.
Here are last week’s U.S. economic highlights:
APRIL 13, 2015
THE TREASURY BUDGET came in with a deficit of $52.9 billion in March... The 2015 deficit is, thus far, running at a higher clip than 2014. Here's Econoday's summary (note the increase in tax receipts, which is an economically bullish sign):
The government's deficit came in at $52.9 billion in March, up from $36.9 billion last March. Six months into fiscal 2015, the government's deficit is up 6.3 percent from last year to $439.5 billion. Helping the balance so far this year are receipts, up 7.3 percent year-to-date and reflecting strong tax receipts where gains reflect economic strength. The downward pull is on the spending side, which is up 7.3 percent including an outsized 9.4 percent increase in Medicare spending tied to Obamacare that offsets a 3.0 percent decline in defense spending. But the government's deficit, though large, is not a factor right now in the economic outlook.
APRIL 14, 2015
PPI FOR FINAL DEMAND shows inflation at the producer level remaining very low. Up .2% in March, meeting expectations. Year-over-year, PPI-FD ex-food and energy increased by .9%.
THE CENSUS BUREAU'S RETAIL SALES number ended three straight months of declines, with a .9% increase---slightly below the consensus estimate of 1.0%... Year-over-year, retail sales grew 1.3%... While not crazy-robust, retail sales reflect improving economic prospects and sentiment on behalf of the consumer.
THE JOHNSON REDBOOK RETAIL REPORT came in low last week, at a 1.1% year-over-year rate. Here's Econoday explaining it away based on Easter's timing this year:
In an Easter comparison distortion, year-on-year same-store sales were up only 1.1 percent in the April 11 week. The rate reflects the timing of this year's Easter which fell two weeks earlier than last year. Month-over-month, Redbook is forecasting a 0.2 percent gain which is an early hint of strength for the May retail sales report. Today's April retail sales report, released earlier this morning, shows wide strength.
THE NFIB SMALL BUSINESS OPTIMISM FOR MARCH was essentially the icing on the cake of an economically rough Q1. Falling 2.8 points from February's encouraging 98. The report's first paragraph pretty much sums it up:
The Small Business Optimism Index fell 2.8 points to 95.2, declining in sympathy with the rather weak stream of reports on the economy. Bad weather was certainly depressing, for both shoppers and the construction industry. All 10 Index components declined, contributing to the 31 point decline in net positive responses. The only good news is that the 10 Index components didn’t fall further, not much to hang on to. Consumer spending has not shown much strength and the saving rate has increased. Not a recession scenario overall for sure, but there is not much growth energy in the economy, especially with the energy boom deflating a bit.
I, personally, disagree with the sentiment of that last sentence. The "deflating" of the energy boom is actually a boon to the U.S. consumer at large, and, thus, the U.S. economy...
BUSINESS INVENTORIES didn't exceed sales growth in February, which is a good thing. However, the inventory-to-sales ratio remains at a high 1.36. Which doesn't speak optimistically about production in the near-term. While inventory growth reflects positively on GDP, it does not inspire companies to expand or hire (unless it's due to increased optimism), and I suspect it's a contributing factor to March's weak employment number.
APRIL 15, 2015
MORTGAGE PURCHASE APPS broke their three-week winning streak last week with a 2.3% decline. The weekly read is historically volatile.... when we look at year-over-year results purchase apps are up 7%... Here's Econoday:
After three straight weeks of impressive gains, the purchase index slipped back 3.0 percent in the April 10 week. Year-on-year, the index is still up a solid 7.0 percent in a reading that points to strength for the spring housing market. The refinance index fell for a second week, down 2 percent. Rates are very low with the average 30-year fixed-rate mortgage for conforming loans ($417,000 or less) at 3.87 percent, up 1 basis point in the week.
THE EMPIRE STATE MANUFACUTURING SURVEY, at first blush, shows continued weakness among NY manufacturers---which has been pretty much the state of manufacturing throughout the country of late. However, when we explore inside the report, we see some positive signals. Per the following from the report:
The April 2015 Empire State Manufacturing Survey indicates that business activity was flat for New York manufacturers. The headline general business conditions index turned slightly negative for the first time since December, falling eight points to -1.2. The new orders index, negative for a second consecutive month, dropped four points to -6.0—evidence that orders were declining. The shipments index climbed to 15.2, indicating that shipments expanded at a solid pace. Labor market indicators pointed to an increase in employment levels but a somewhat shorter workweek. Input price increases picked up, with the prices paid index rising seven points to 19.2, while the prices received index fell four points to 4.3. The future general business conditions index climbed for a second consecutive month, suggesting greater optimism among manufacturers than in February and March, and the capital spending and technology spending indexes also advanced.
INDUSTRIAL PRODUCTION fell in March, by .6%. Yet another sign of weakness in the US manufacturing sector. As the below excerpt from the report suggests, the decline in oil and gas drilling, plus lower output from the utility sector, as March begins its thaw, contributed measurably to the result:
Industrial production decreased 0.6 percent in March after increasing 0.1 percent in February. For the first quarter of 2015 as a whole, industrial production declined at an annual rate of 1.0 percent, the first quarterly decrease since the second quarter of 2009. The decline last quarter resulted from a drop in oil and gas well drilling and servicing of more than 60 percent at an annual rate and from a decrease in manufacturing production of 1.2 percent. In March, manufacturing output moved up 0.1 percent for its first monthly gain since November; however, factory output in January is now estimated to have fallen 0.6 percent, about twice the size of the previously reported decline. The index for mining decreased 0.7 percent in March. The output of utilities fell 5.9 percent to largely reverse a similarly sized increase in February, which was related to unseasonably cold temperatures. At 105.2 percent of its 2007 average, total industrial production in March was 2.0 percent above its level of a year earlier.
CAPACITY UTILIZATION declined to 78.4 from 79.0 in February... No reason here for the Fed to worry too much about inflation...
THE ATLANTA FED BUSINESS INFLATION EXPECTATIONS SURVEY shows inflation predictions unchanged at 1.7%.
THE NAHB HOUSING MARKET INDEX shows optimism remains on the rise among the nation's home builders. Which affirms my continued optimism for the sector going forward. Here's from the release:
April 15, 2015 - Builder confidence in the market for newly built, single-family homes in April rose four points to a level of 56 on the National Association of Home Builders/Wells Fargo Housing Market Index (HMI) released today.
“As the spring buying season gets underway, home builders are confident that current low interest rates and continued job growth will draw consumers to the market,” said NAHB Chairman Tom Woods, a home builder from Blue Springs, Mo.
“The HMI component index measuring future sales expectations rose five points in April to its highest level of the year,” said NAHB Chief Economist David Crowe. “This uptick shows builders are feeling optimistic that the housing market will continue to strengthen throughout 2015.”
All three HMI components registered gains in April. The component charting sales expectations in the next six months jumped five points to 64, the index measuring buyer traffic increased four points to 41, and the component gauging current sales conditions rose three points to 61.
THE EIA PETROLEUM STATUS REPORT shows another build, although in much smaller quantity than recent weeks, in crude inventories---up 1.3 million barrels. Which takes total inventories to a fresh 80-year high. The fact that refineries are past their maintenance and turnover season I'm sure is no small factor in the number---as they're now operating at 92.3% of capacity. The price has been rising of late against fundamentals that continue to deteriorate---at an albeit slower pace. Clearly speculators are betting the bottom's in... I like the bounce in our portfolios' energy exposure, and while there's no question a bottom, and I suspect a bounce, in price is out there, I remain somewhat skeptical that we're there just yet. Gasoline inventories dropped by 2.1 million barrels, while distillates increased by 2 million.
THE FED BEIGE BOOK reported generally moderately improving conditions overall. Service industries, in particular, saw rising activity and expect good growth going forward---across the twelve districts. Housing activity was a noted positive as well...
TREASURY INTERNATIONAL CAPITAL for February shows decent foreign demand for U.S. corporate bonds and agency bonds, modest demand for U.S. equities and net selling of treasuries (interesting). Net foreign long-term transactions inflow to the U.S. was $9.8 billion, after seeing net outflows of $27.4 billion (revised up from -$27.2b) in January.
APRIL 16, 2015
HOUSING STARTS rebounded 2% in March after plunging 15% in frigid February. However, the 926k number was below the 1.04 million estimate. And down 2.5% on a year-ago basis. PERMITS were up 2.9% versus a year ago, however, the 1.039 million was below the forecast of 1.085 million. These data do not support my recent optimism over the housing market. Although I remain bullish as, while not yet robust, we are seeing measurable improvements in the sector. Yesterday's homebuilder's optimism index agrees with my position...
WEEKLY JOBLESS CLAIMS are trending in a range that is solidly in line with past expansions... Coming in at 294k last week, with the 4-week average little changed at 282,750...
THE BLOOMBERG CONSUMER COMFORT INDEX shows consumer optimism cooling a bit last week. Coming off of an 8-year high the previous week... 46.6 vs 47.9... Here's from the release:
Consumer Comfort in U.S. Cools From Highest Level Since 2007
By Shobhana Chandra
(Bloomberg) -- Consumer confidence cooled last week from an almost eight-year high as Americans took a less favorable view of their finances and the economy amid smaller gains in hiring.
The Bloomberg Consumer Comfort Index fell to 46.6 in the period ended April 12, from the prior week’s 47.9 reading that was the strongest since May 2007. The economic expectations gauge for April declined for a second month.
The comfort measure “hit a fresh pothole on its road to recovery,” Gary Langer, president of Langer Research Associates LLC in New York, which produces the data for Bloomberg, said in a statement. Recent “economic news is mixed, with weaker-than-expected job growth and payroll increases in March, but gains that have put the stock markets back near record highs.”
Hiring advanced in March by the least since December 2013 as businesses aligned headcounts with slower growth that reflects the strong dollar’s hit to exports and manufacturing, and a pullback in energy-related capital investment due to lower oil prices. Even so, stock-market gains and strong sentiment will sustain consumer spending, the biggest part of the economy.
The comfort index’s outlook gauge for April fell to 50, a five-month low, from 51.5. The share of households saying the economy is improving held at 30 percent and equaled the fraction believing its weakening.
The Bloomberg weekly comfort gauge remains well above last year’s average of 36.7, which was the best since 2007.
Among its three components, the measure of personal finances fell to 58.4 last week from 60.5. The index of Americans’ views on the state of the economy dropped to 37.7 from 39.5. A gauge of the buying climate, showing whether this is a good time to purchase goods and services, was little changed at 43.7 compared with 43.8 the prior week.
Moods improved for Americans at the top of the wage scale and worsened for those at the bottom. The comfort gauge for workers earning $100,000 or more climbed to 71.9, its second-highest level since August 2007. For the under $50,000 category, it fell to 34.5 last week from 36.1. The 37.4-point gap is the second-biggest between the groups so far this year.
“Economic disparity is one of the challenges facing consumer sentiment,” Langer said in the statement.
Even as hiring cooled in March, sustained improvement in the labor market is allowing consumers to keep up their spending, which accounts for about 70 percent of the economy. While payrolls rose by a less-than-forecast 126,000 workers last month, the advance followed a 12-month streak of increases exceeding 200,000.
Household finances are also getting help from gains in share prices as some corporate earnings come in better than anticipated and investors bet the Federal Reserve will be in no rush to begin raising interest rates. The Standard & Poor’s 500 Index is hovering around a record.
THE PHILADELPHIA FED MANUFACTURING INDEX gained over March, 7.5 vs 5. Here's the report's opening paragraph:
Manufacturing activity in the region increased modestly in April, according to firms responding to this month’s Manufacturing Business Outlook Survey. Indicators for general activity and new orders were positive but remained at low readings. Firms reported overall declines in shipments this month, but employment and work hours increased at the reporting firms. Firms reported continued price reductions in April, with indicators for prices of inputs and the firms’ own products remaining negative. The survey’s indicators of future activity suggest a continuation of modest growth in the manufacturing sector over the next six months.
NAT GAS INVENTORIES grew by 63 billion cubic feet last week to 1,539 bcf.
THE FED BALANCE SHEET grew last week by $1.9 billion to $4.485 trillion. RESERVE BANK CREDIT grew by $4.4 billion...
APRIL 17, 2015
THE CONSUMER PRICE INDEX for March came in at a minus .1% year-over-year rate. A reading that, on its face, would chill the argument of those who fear the Fed, in not raising interest rates, soon risks falling behind the inflation curve. When we take out food and energy, however, the so-called "core" reading jumps to 1.8% year-over-year. Month-over-month, both headline and core CPI grew by .2%. While the ex-energy reading shouldn't provoke panic, when we consider the flow through effect of energy prices to other industries, the 1.8% looks concerning to me when we consider what begins to happen once oil find its bottom---not to mention, and very importantly, what happens as wages pick up steam...
REAL AVERAGE HOURLY EARNINGS (growth in earnings minus inflation) grew by .1% (.3% increase minus .2% CPI) from February to March. However, when we factor in a .3% decrease in the average workweek, we get an average weekly earnings decrease of .2%. Year-over-year, real average hourly, and weekly, earnings grew by 2.2%. I believe that, as the labor market continues to tighten (which I expect on a trend basis going forward), we'll see this number rise noticeably later in 2015.
THE UNIVERSITY OF MICHIGAN CONSUMER SENTIMENT INCOME FOR APRIL came in very strong, at 95.9, up from 93.0 in March. Here's from Econoday's commentary:
Consumer sentiment remains very strong, at 95.9 for the mid-month April reading vs a final March reading of 93.0 and well up from 91.2 at mid-month March. The index hit an 8-year high of 98.1 in January.
A solid gain in the current conditions component to 108.2 vs a final March reading of 105.0 hints at strength this month for consumer activity, perhaps even for retail sales. The expectations component is at 88.0, up from 85.3 and pointing to rising confidence in the jobs outlook.
THE CONFERENCE BOARD LEADING ECONOMIC INDEX shows continued growth in the U.S. economy, however, at a slowing pace. Clearly, Q1 was rough. While the CB economist quoted below suggests that the slowing growth rate of the past few months suggests weaker growth ahead, I see the Q1 headwinds of weather, port strikes and maybe the impact of a rapidly rising dollar all abating. I'm expecting to see U.S. growth ramp back up as we move ahead. Here's from the press release:
The Conference Board Leading Economic Index® (LEI) for the U.S. increased 0.2 percent in March to 121.4 (2010 = 100), following a 0.1 percent increase in February, and a 0.2 percent increase in January.
“Although the leading economic index still points to a moderate expansion in economic activity, its slowing growth rate over recent months suggests weaker growth may be ahead,” said Ataman Ozyildirim, Economist at The Conference Board. “Building permits was the weakest component this month, but average working hours and manufacturing new orders have also slowed the LEI’s growth over the last six months.”
The Conference Board Coincident Economic Index® (CEI) for the U.S. increased 0.1 percent in March to 112.0 (2010 = 100), following a 0.2 percent increase in February, and a 0.2 percent increase in January.
The Conference Board Lagging Economic Index®(LAG) for the U.S. increased 0.4 percent in March to 116.2 (2010 = 100), following a 0.3 percent increase in February, and a 0.3 percent increase in January.