U.S. Fed Chair Janet Yellen expects that the U.S. economy will exhibit enough strength as the year unfolds to warrant an increase in the Fed funds rate. I agree. And, all else equal, the stock market---given present valuations---may not like it one bit.
For the first Fed hike not to be a market correction-inducing event, earnings will have to accelerate and/or Yellen and company will have to effectively sugarcoat it with promises that it's merely a sign that things are improving measurably and the best is yet to come---and that they stand ready to reverse course at the first sign of weakness. You and I will stick with the earnings story...
The European Central Bank promises all the QE (money printing) necessary to goose the Eurozone economy into sustainable growth mode. While I remain a cynic when it comes to the notion that prosperity can come by way of printing, there is indeed an historic correlation between such action and the price of your average share of stock. Thus, amid reasonable valuations and improving economies (yes, they're showing signs), we'll maintain our recently-increased Eurozone exposure.
The Bank of Japan, while standing pat at the last meeting, remains willing to do whatever it takes to achieve its inflation goal. I.e., they'll print, etc., till the cows come home---or until the price of cows is rising by at least 2% per year. Despite delivering impressive gains thus far this year, Japanese stocks in the aggregate present attractive relative valuations.
The People's Bank of China is in aggressive easing mode. China, while implementing reforms to move to a consumer-driven economy, is committed to delivering 7% growth in 2015---and is pulling out all the monetary policy stops to try and get there.
The U.S. Economy:
As I've been reporting each week, the American economy of late is indeed growing, but not---according to the data---at a threatening pace at this juncture. As I suggested above, the Fed sees the economy gaining momentum as the year unfolds. And while I'm making no prediction, I can't help but agree based on what I see in the data.
Yesterday I chastised a few prognosticators for their habit of, well, prognosticating. One cannot know when the next bear market will come growling. One, however, can guess, and if lucky, may parlay that guess into book royalties and public appearances. But it's been my observation that reputations built on market/economic prognostications wither rather quickly as subsequent guesses prove utterly fruitless.
So what's a chap like me, an investment advice giver, to do? Well, I study, I make charts, I update charts, I discover that what worked yesterday sometimes works today, and sometimes doesn't. I calculate valuations, I see the U.S. market through sectors and I make recommendations based on valuations, trends and cyclicality.
In terms of the economy, I maintain numerous charts on data that have historically exhibited some predictive value. I count 16 charts that I've assembled for the purpose of assessing whether or not the doomsayers some of my clients listen to are onto something. Well, if we're talking a major U.S. recession occurring in the near-future, I can't presently join their camp. Here's a sampling (click charts to enlarge):
The Index of Leading Economic Indicators is comprised of the average weekly hours worked by manufacturing workers, the average number of initial applications for unemployment insurance, the amount of manufacturers’ new orders for consumer goods and materials, the speed of delivery of new merchandise to vendors from suppliers, the amount of new orders for capital goods unrelated to defense, the amount of new building permits for residential buildings, the S&P 500 stock index, the inflation-adjusted monetary supply (M2), the spread between long and short interest rates, and consumer sentiment.
The red outlined areas represent every U.S. recession back to the early 70s:
The St. Louis Fed Financial Stress Index measures the degree of financial stress in the markets and is constructed from 18 weekly data series: seven interest rate series, six yield spreads and five other indicators. Each of these variables captures some aspect of financial stress. The average value for the index is zero (beginning in 1993), which represents normal financial market stress. A move in the index below zero denotes below-average stress, while a move above zero denotes above-average financial market stress.
The Chicago Fed National Financial Conditions Index measures over one hundred individual indicators for risk, liquidity and leverage in money markets, debt and equity markets and in the traditional and “shadow” banking systems.
Not a single post-war recession has occurred without the treasury yield curve first turning upside down (referred to as an inverted yield curve). Meaning, short term interest have risen to a point higher than long-term interest rates.
An inverted yield curve means that investors have so little confidence in the economy that they would rather buy a 10-year Treasury note, and tie up their money for ten years. Of course normally investors expect more of a return from a long-term investment. The reason an investor might go to longer-dated maturities even when they're paying lower yields is because he/she believes the economy is heading for a fall and the Fed will aggressively take short-term rates with it. I.e., if an investor bought the short-end of the curve he/she'd soon be holding cash (when that short-term bill matures) and looking to reinvest at a dramatically lower yield. He/she instead buys the longer-dated bond expecting its price (his/her principal) to rise dramatically once rates start plummeting.
The white arrows point to past inversions. As you can see, the yield curve is presently nowhere near inversion territory:
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---given many foreign markets' cheaper valuations, early-stage recoveries and, yes, accommodative central banks. 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 (according to Bloomberg) for the major U.S. indices, non-U.S. indices and U.S. sectors---using index ETFs as our non-U.S. and sector proxies:
Dow Jones Industrials: +3.33%
S&P 500: +4.10%
NASDAQ Comp: +8.07%
EFA (Europe, Australia and Far East): +11.74%
FEZ (Eurozone): +9.37%
VWO (Emerging Markets): +10.04%
IYH (HEATHCARE): +10.57%
XLY (DISCRETIONARY): +6.99%
XHB (HOMEBUILDERS): +6.22%
XLK (TECH): +5.87%
XLB (MATERIALS): +5.62%
XLP (CONS STAPLES): +2.18%
XLE (ENERGY): +1.99%
XLI (INDUSTRIALS): +1.02%
XLF (FINANCIALS): +.89%
XLU (UTILITIES): -4.88%
IYT (TRANSP): -6.96%
The Bond Market:
As I type, the yield on the 10-year treasury bond sits at 2.21%. Which is another 7 basis points higher than where it was when I penned last week's update.
TLT, an ETF that tracks an index of long-dated U.S. treasury bonds, saw its share price decline 0.98% last week (off 6.14% over the past month). As I keep repeating, I see bonds in general sporting a risk/return trade-off that makes going out on the yield curve not worth the risk.
Once again, here's 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.
Here are last week’s U.S. economic highlights:
MAY 18, 2005
THE NAHB HOUSING MARKET INDEX showing slowing momentum at 54 in April, down from March's 56. However, above 50 denotes optimism among homebuilders. The most positive note in the report was the component measuring future demand, which rose 1 point to 64, the highest read this year. I remain bullish on the sector going forward for a number of reasons. One of the deepest would be that the two age categories that matter most for housing are on a steep growth trajectory (in number of individuals) over the next 3 years; the 25-30 year-old first-time homebuyer group (which currently account for about half of their normal share of new purchases. I.e., much room for growth going forward), and the second/vacation-home buying 50-59 year-olds...
MAY 19, 2015
HOUSING STARTS absolutely soared in April... up 20.2% to 1.135 million, and permits were up 10.1% to 1.143 million. These results are substantially better than what economists expected and speaks strongly to my present optimism on the housing market. Here's Econoday's commentary (note that multi-family activity remains big):
There were hardly any indications before today, but the spring housing surge is here. Today's housing starts & permits report is one of the very strongest on record and with starts soaring 20.2 percent in April to a much higher-than-expected annual rate of 1.135 million and with permits up 10.1 percent to a much higher-than-expected 1.143 million. Both readings easily top the Econoday high-end forecast of 1.120 million for each. The gain for starts is the best in 7-1/2 years with the gain in permits the best in 7 years.
Strength in starts is split between single-family, up 16.7 percent to 0.733 million, and multi-family, up 27.2 percent to 0.402 million. Single-family starts are up a very convincing 14.7 percent year-on-year with multi-family up only 0.5 percent.
Strength in permits is centered in multi-family units, up 20.5 percent to a 0.477 million rate and underscoring the importance of renters in the housing sector. Permits for single-family homes rose a less spectacular but still very solid 3.7 percent to 0.666 million. Year-on-year, single-family permits still lead at plus 7.1 percent vs plus 5.5 percent for multi-family permits.
Regional data show special strength for starts and permits in the Northeast followed by the West. Readings on the Midwest and South, though a bit mixed, are also strong.
Today's report is an eye-opener and will re-establish expectations for building strength in housing, a sector held down badly in the first quarter by severe weather. Note that today's report includes annual revisions including a net 10,000 upward revision to March and February (now 0.944 million and 0.900 million).
THE JOHNSON REDBOOK RETAIL REPORT continues to show lackluster results. Up 1.8% year-on-year last week. Your typical expansion range for retail sales is 3% to 3.5% annually. I should note, per last week's e-commerce report, that online retail activity has been strong of late
MAY 20, 2015
NEW PURCHASE MORTGAGE APPS declined last week by 4% from the prior week. To reverse the recent trend, refinances increased by .3%. On a year-over-year basis, however, purchase activity is strong, up 11%... The average 30-year mortgage rate increased to 4.04%. That's a measureable increase versus where we were just a few weeks ago. I expect higher rates to weigh more on refis going forward than it does new purchases. I can present a case where, with the ever-tightening rental market, that fear over increasing mortgage rates may bring buyers to market sooner than they otherwise may have shown up... time will tell...
CRUDE OIL INVENTORIES declined for the 3rd straight week, by 2.7 million barrels to 482.2 million (which remains near an 80-year record)... GASOLINE INVENTORIES declined 2.8 mbs and DISTILLATES declined .5 million mbs.
FOMC APRIL MEETING MINUTES showed that the majority of members remain near-term hesitant to raise interest rates. That said, I'm positive they're at this point anxious to get that first hike done. I also believe they'll sugarcoat it big time in an attempt to calm markets in the process... I'm betting the first one comes in September, based on my general optimism over the U.S. economy going forward...
JUST LISTENED TO AN INTERVIEW WITH THE CEO OF INTERNATIONAL PAPER..... who reported that their paper box business did much better in Q1 than anticipated. And, based on what they're currently seeing, expects the balance of the year to be even better. This is a legitimate indicator of growing economic activity...
MAY 21, 2015
WEEKLY JOBLESS CLAIMS continue to paint a very optimistic portrait of the present state of the U.S. economy, 274k last week. Claims are currently, on a trend basis, the lowest they've been since the year 2000. The 4-week average is down for the 4th straight week to 266.5k. Continuing claims were down 12k to 2.211 million. Continuing claims' 4-week average are down 20k to 2.23 million. The unemployment rate for insured workers notched lower to 1.6%.
THE CHICAGO FED NATIONAL ACTIVITY INDEX paints a pessimistic portrait of the present state of the U.S. economy. Here's Econoday's commentary:
April was not the month that anybody hoped for, failing to show much bounce at all from a very weak March. The national activity index is in the negative column for the month, at minus 0.15 to indicate sub-par economic growth. This is below the Econoday consensus for plus 0.10 and comes despite an easy comparison with a revised minus 0.36 for March.
Recent History Of This Indicator
MARKIT'S FLASH MANUFACTURING PMI remains in expansion territory, at 53.8, however it lost a little momentum in May (off from April's 54.2). Reduced spending from the energy sector and the stronger dollar get the blame. Employment, however, showed strength in the report...
THE BLOOMBERG CONSUMER COMFORT INDEX has been showing confidence on the retreat of late. It'll be interesting to see how the improved employment (and housing) picture translates to this, and other, sentiment surveys going forward. Here's Bloomberg's release:
Consumers’ Expectations for U.S. Economy Drop Most Since 2013
By Michelle Jamrisko
(Bloomberg) -- Americans’ expectations for the economy slumped in May by the most since October 2013, casting doubt on consumers’ ability to revive growth.
A measure tracking the economic outlook fell by 6 points to 44 this month, data from the Bloomberg Consumer
Comfort Index showed Thursday. Thirty-nine percent said the U.S. economy is getting worse, the largest share since the federal government shutdown 19 months ago.
“The increase in negative expectations occurred among a disparate collection of groups, indicating a generalized retrenchment,” Gary Langer, president of Langer Research Associates LLC in New York, which produces the data for Bloomberg, said in a statement.
The weekly sentiment index dropped to 42.4 in the period ended May 17, the lowest since mid-December, from 43.5 as fewer consumers said now was a good time to spend. Such angst, particularly among lower-income households, probably has its roots in steadily climbing prices at the gas pump and limited wage gains.
“Despite positive employment and housing reports, consumer concerns may reflect still-stagnant wages as well as sharp divisions between higher- and lower-income groups in economic views,” Langer said. “The latest stumble makes clear that economic travails continue for many Americans.”
The U.S. economy has largely disappointed this year, with weaker-than-expected retail sales data last week capping a recent run of reports showing scant momentum. Consumer spending, which accounts for almost 70 percent of gross domestic product, climbed at a 1.9 percent annualized rate in the first quarter, the slowest in a year and less than half the 4.4 percent advance in the final three months of 2014.
Two of three components in Bloomberg’s weekly comfort index deteriorated last week. Americans’ current views of the economy soured to 32.8, also the lowest since mid-December, from 34.5 in the prior period
The Bloomberg Economic Surprise Index has been hovering near its lowest level of the expansion, indicating economic data have been persistently disappointing.
Retail purchases barely budged in April, defying estimates for a small increase, Commerce Department data showed last week. The figures followed a 0.2 percent drop in January through March that marked the first quarterly decline in almost three years.
Spending may be slow to pick up. The Bloomberg measure of the buying climate -- showing whether this is a good time to purchase goods and services -- declined to 38.1 from 40.4, the largest decrease in a year. The measure of personal finances increased to a five-week high of 56.3 from 55.7.
Sentiment among respondents who were unemployed decreased to the weakest level since the beginning of the year. Confidence also was the lowest since at least the start of 2015 among college graduates, homeowners, married couples, women and Southerners. Those making less than $50,000 a year were the least upbeat in five months.
While the weekly Bloomberg confidence measure has dropped six straight weeks, the longest such stretch since 2013, it’s still above last year’s average of 36.7 that was the best since 2007.
A brightening employment picture may help underpin Americans’ sentiment. Payrolls rebounded in April, with employers adding 223,000 jobs after an 85,000 gain the prior month that was the smallest since June 2012. The unemployment rate dropped to 5.4 percent, the lowest since May 2008.
The housing market also has shown signs of life after a weather-depressed first quarter. Builders broke ground on 1.14 million homes at an annualized rate last month, the most since November 2007 and up 20.2 percent from March, figures from the Commerce Department showed Tuesday. It was the single-biggest monthly surge since 1991.
THE PHILADELPHIA FED BUSINESS OUTLOOK SURVEY shows decent go-forward prospects for that region. The respondents' report on inflation is somewhat perplexing given recent developments. Here's Econoday's summary:
Activity in the Mid-Atlantic manufacturing sector is slow but stabilizing, based on the Philly Fed's general conditions index which came in at 6.7 for May, down slightly from 7.5 in April and against Econoday expectations for 8.0.
The best news in the report is a slight uptick in new orders, to 4.0 from 0.7. This isn't searing but is at least in the plus column as are shipments, at 1.0 from minus 1.8. Employment, at 6.7, is also in the plus column.
Manufacturers in the region are reporting significant price contraction, especially in costs which is a surprise given the rise underway in oil prices. Manufacturers are also reporting declining prices for finished goods as well. These inflation readings, if repeated in subsequent reports, will give the edge to the doves at the Federal Reserve.
A plus in the report is a healthy reading of 33.9 for the 6-month outlook, down only slightly from April's 35.5 and up from 32.0 in March. The manufacturing sector, hit by weak exports and trouble in the energy sector, has yet to find its footing this year but this report, which is very closely watched, points to stability that in turn hints at a rebound in the months ahead.
EXISTING HOME SALES came in soft in April. Although, year-over-year, sales are up a respectable 6.1%. Inventory rose a bit, which is a good thing given the overall low supply of late, and the median price is up 8.9% year-over-year. As I've stated recently, rising prices are the answer to low inventories...
THE CONFERENCE BOARD'S INDEX OF LEADING ECONOMIC INDICATORS FOR APRIL came in stronger than anticipated, up .7% vs consensus estimate of .3% and March's .2%. This week's report showing a surge in building permits helped the index measurably. As did the yield spread, unemployment claims and the report's credit index. I share the forward-looking optimism posed by this index, however, other recent data (particularly from the manufacturing sector) indeed would question, or quell, that optimism. The services sector data, however, has retained a positive trend, which, given the complexion of the U.S. economy, keeps me for now, and on balance, optimistic.
NAT GAS INVENTORIES rose last week by 92 billion cubic feet to 1.989 bcf.
THE KANSAS CITY FED MANUFACTURING INDEX points to real weakness in the sector for the Tenth District. Here's Econoday's commentary:
The early indications on May's manufacturing activity have been slightly positive, that is until the Kansas City Fed report where the composite index is in deeply negative ground at minus 13. This is the weakest of the recovery for this reading and follows an already weak minus 7 in April.
New orders this month are deeply negative, at minus 19, as are backlog orders at minus 21. These readings, reflecting contraction for export orders and trouble in the energy sector, point to significant trouble for the region's manufacturing activity in the months ahead.
Shipments are already in contraction, at minus 9, as is employment, at a deeply negative minus 17 that contrasts with mostly positive employment indications in other reports.
Price readings in this report remain in negative ground and, like the Philly Fed report posted earlier this morning, offer support for the doves at the Fed. Watch for the final regional Fed indication on May's manufacturing sector with next week's Richmond Fed report.
THE FED BALANCE SHEET fell last week by $20.8 billion to $4.48 trillion. RESERVE BANK CREDIT increased $4 billion.
M2 MONEY SUPPLY grew by $22.8 billion last week.
MAY 22, 2015
CPI, ex food and energy, came in hot (relative to expectations) at .3% in April. This has to get the attention of those who seem to believe inflation is nowhere in sight. Should energy find life again anytime soon, and translate to the pricing of other goods and services, the Fed may find itself needing to raise rates faster than markets are presently prepared for (assuming they're prepare for at least one hike later this year)...