U.S. Stocks Trim Monthly Gain as Data Raise Concern on Economy
(Bloomberg) -- U.S. stocks declined, with equities paring their best monthly gains since February, as May economic data raised concern over the strength of the economy after a first- quarter contraction.
Bloomberg's teaser for Friday's market wrap-up tells us all we need to know about why stocks turned a bit sour last week. Right? Wrong! I don't buy it.
In my view, the headline should read: U.S. Stocks Trim Monthly Gain as Data Raise Concern over the Probability of Higher Interest Rates Ahead.
The following represent last week's good (better than expected) data (see the notes below for the detail that goes with each heading):
DURABLE GOODS ORDERS
THE FHFA HOUSE PRICE INDEX
MARKIT'S FLASH SERVICES PMI
NEW HOME SALES
THE CONFERENCE BOARD'S CONSUMER CONFIDENCE SURVEY
NEW PURCHASE MORTGAGE APPS
ICSC CHAIN STORE SALES
THE DALLAS FED'S TEXAS SERVICE SECTOR OUTLOOK SURVEY
WEEKLY JOBLESS CLAIMS
PENDING HOME SALES
UNIVERSITY OF MICHIGAN'S CONSUMER SENTIMENT INDEX
Here's the bad (below consensus estimates):
THE RICHMOND FED MANUFACTURING INDEX
THE DALLAS FED MANUFACTURING INDEX
THE JOHNSON REDBOOK RETAIL SALES REPORT
THE BLOOMBERG CONSUMER COMFORT INDEX
THE SECOND REVISION OF Q1 GDP
I can't stress enough the simple fact that the U.S. economy is a service---not a manufacturing---driven economy. Not that the manufacturing data don't matter, they indeed do. But when the service sector data continue to show signs of optimism, which are finding confirmation in the jobs data, you should feel very good about the economy's prospects going forward.
Clearly, in my view, short-term traders are becoming spooked by the GOOD data---and the recent commentary from Fed officials suggesting that a Fed funds rate increase is all but decided sometime during the remainder of 2015.
While many experts disagree, I think the traders are justified in their expectation of a stock market hiccup come tightening time. The question for the market timer isn't if the hiccup will occur, it's when, by how much, and for how long.
As for us investors, hiccups---or let's call them 10-20% corrections---aren't our concern. We look past the inevitable rough patches and maintain proper diversification with an emphasis toward sectors and regions that represent value and cyclical timeliness. We know that market-timing (jumping entirely in and out of the market to catch, or avoid, a short-term trend) is a fools game that can prove utterly disastrous, so we don't go there.
So what sectors and regions would I emphasize? Here's what I especially like going forward and why: Click charts to enlarge...
In the U.S.:
The 25 to 30 year-old---the average age of the first-time home buyer---is probably the most important demographic when it comes to housing. The 50 to 59 year-old---the average age of the vacation home buyer---ranks #2. Check out the population growth of those two groups between now and the end of 2018:
When your kid moves out he forms his own household. While he's likely a renter to begin with, he's taken his first step toward home ownership. Take a look at the recent growth in household formations (also a bullish economic sign):
Most folks need to borrow to buy a house. Notice the recent growth in mortgage purchase applications (have risen further thus far in Q2):
400 U.S. homebuilders get a call each month from their national association. When they're feeling good about their prospects their answers to the survey questions push the NAHB Housing Index above 50. Here's the history (the component that measures their 6-month outlook shot up to 64 last month):
Here's from Friday's CNBC article titled It's a Very Strong Sellers Market:
Pending sales of existing homes for April rose 3.4 percent from March, to the highest level in nine years, according to figures released Thursday by the National Association of Realtors. Pending sales are now up 14 percent from a year ago.
New home sales are also on the rise, jumping 6.8 percent in April to a seasonally adjusted annual rate of 517,000 units, the Commerce Department said Tuesday. That spike was higher than analysts had expected.
Meanwhile, the closely-watched S&P/Case-Shiller Index showed housing prices in 20 cities climbed 5 percent year-over-year in March.
Supply is still tight, and buyers are flooding into the market trying to beat mortgage rate increases, Kelman noted. Many market watchers expect the Federal Reserve to begin raising interest rates in September, which will push up mortgage rates.
"Most of the buyers we talk to are really frustrated because they're getting into bidding wars, not just with two or three other buyers but with 5, 10 ,15 buyers," he said.
"Some of our markets are saying this is crazier than we ever saw in 2007, 2006 so really we're going to see stronger price increases over the next two or three months than we saw previously," Kelman added.
Despite soaring prices, most economists are not yet convinced the housing market is in bubble territory. That's most likely because they're starting from such a low base: in the wake of the 2008 crisis, housing fell into depression territory, as prices swooned by more than 30 percent from peak to trough.
Here's why, in my view, we're a long way from bubble territory (inventories of existing and new homes, plus housing starts). I circled what a bubble looks like:
When rates creep up amid a growing economy, more borrowers come to market and banks' net interest margins (profits) expand. Plus, their stocks are relatively inexpensive these days.
Getting utterly killed lately as a major airline announced that it's about to expand capacity. The market fears that this lately-profitable sector is about to risk future margins at an inopportune time. Prior to airlines taking their hit, railroads were feeling the pinch as municipalities opted for cheap natural gas (rather than railcar loads of coal), the energy sector stopped sending equipment to new production sites and Mexicans found U.S. stuff too expensive as the dollar spiked in value. Per the below (white line is total rail traffic, green is freight carloads, yellow is intermodal [those big containers they take off of boats and stick on trains]), things are looking a bit better for rails of late:
And here's a year-to-date look at the Cass Freight Index, which includes all domestic freight modes and is derived from $26 billion in freight transactions processed by Cass annually on behalf of its client base of hundreds of large shippers. These companies represent a broad sampling of industries including consumer packaged goods, food, automotive, chemical, OEM, retail and heavy equipment.
As for the UPSs and Fedexs of the U.S., here are two snippets from recent weekly updates (from the economic notes):
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, and bullish for the package delivery business…
...e-commerce as a percentage of total retail sales continues to climb to records, up a strong 4 tenths to 7.0 percent.
While transportation has huge catching up to do, and, thus, may not turn out to be a top 2015 performer, given present valuation levels and an improving economy, I like the sector going forward.
Next week I'll highlight the prospects---good and bad---for other major sectors.
Delving into the non-U.S. environment country-by-country would be more than you'd want to take in in one sitting. Suffice it say that the rest of the developed worlds' markets have some catching up to do (to the U.S.) from a rate of return (over the past couple of years) as well as a valuation standpoint. Same for their economies---which they're aggressively attempting to boost through monetary stimulus.
As for emerging markets, there's where I strongly suspect we'll see the most robust economic growth rates in the years to come. This year's been good (until last week) thus far for that portion of our portfolios. However, it wouldn't surprise me to see a knee-jerk reaction (like last week) to higher U.S. interest rates. Back in 2013, when Ben Bernanke warned the world that QE would have to come to an end, emerging markets tanked as carry trades (traders gaming interest rate differentials and currency exchange rates) unwound and money fled emerging markets in fear of a higher dollar and higher U.S. interest rates. This go round, given the huge recent rally in the dollar and rates trending higher, I don't expect a mass currency exodus. I'm thinking the capital flow to emerging markets of late is more about real investing than it is interest rate arbitrage.
The Stock Market:
Non-US markets have measurably outperformed the U.S. (save for the NASDAQ Composite Index) 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: +2.14%
S&P 500: +3.24%
NASDAQ Comp: +7.68%
EFA (Europe, Australia and Far East): +9.53%
FEZ (Eurozone): +6.01%
VWO (Emerging Markets): +5.98%
Here’s a look at the year-to-date results for a number of U.S. sector ETFs:
IYH (HEATHCARE): +10.69%
XLY (DISCRETIONARY): +6.10%
XHB (HOMEBUILDERS): +5.45%
XLK (TECH): +5.31%
XLB (MATERIALS): +4.57%
XLP (CONS STAPLES): +1.23%
XLF (FINANCIALS): -0.16%
XLE (ENERGY): -0.31%
XLI (INDUSTRIALS): -0.91%
XLU (UTILITIES): -5.03%
IYT (TRANSP): -8.83%
The Bond Market:
As I type, the yield on the 10-year treasury bond sits at 2.12%. Which is 9 basis points lower 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 rise (as yields fell) 1.92% last week (down 2.57% over the past month). Last week's rally flies in the face of my opinion that stocks are spooked by the threat of higher interest rates---you'd think that bonds would sell off at least as hard, were that the case. My best guess is that last week's divergence between bonds and stocks had something to do with---among other potentialities---the proverbial flight to quality (treasuries) as the Greek talks failed to deliver (as of yet)...
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 26, 2015
DURABLE GOODS ORDERS: Ex-transportation, i.e., the core reading, exceeded expectations, up .5%, following .6% in March. Nondefense capital goods showed strength in business investment which is a very good economic sign going forward. Rising shipments will read well in Q2 GDP... Motor vehicle orders are also showing strength---another positive economic sign.
THE FHFA HOUSE PRICE INDEX: rose .3% in March, which was below expectations. While not as robust as Case Shiller's reading, the index is yet another sign that the housing market is alive and well in the U.S.
MARKIT'S FLASH SERVICES PMI continues to show real optimism in the services sector, 56.4 for May. However the reading is a bit off last month's 57.8. Growth in orders slowed, and did the backlog build. The employment component continues to show strength, up for the 5th consecutive month---denoting strong confidence in the future. The year ahead outlook component showed its best reading since last November. Note that while output prices were tame, input costs were up sharply.
NEW HOME SALES: came in strong in April, up 6.8% to an annual rate of 517,000. Inventories ticked up slightly to 205,000, but supply relative to sales fell to 4.8 months... Low supply and rising prices should fix the low inventory problem in the coming months.
THE CONFERENCE BOARD'S CONSUMER CONFIDENCE SURVEY: offers a stable reading in May, at 95.4 vs 95.2 in April. Income expectations are up slightly and buying plans for autos, homes and appliances were all higher. This is good news for the economy going forward...
THE RICHMOND FED MANUFACTURING INDEX confirms all the soft reads coming from virtually every manufacturing survey... Come in at 1 for May, off of April's -3. Weak exports (higher dollar) and contraction in the energy sector are clearing doing a number on manufacturing...
THE STATE STREET INVESTOR CONFIDENCE INDEX shows confidence growth among institutional investors, at 120.8 vs April's 113.8.
THE DALLAS FED MANUFACTURING INDEX reflects real weakness in that state's energy complex. Coming in a -20.8 vs April's -16.0...
MAY 27, 2015
NEW PURCHASE MORTGAGE APPS rose by a modest 1% last week. Year-over-year they're up an impressive 14%. Higher rates are suppressing demand for refis, down 4% last week. Average 30 yr rate is 4.07%.
THE JOHNSON REDBOOK RETAIL REPORT continues to show weak week-over-week readings, up 1.6% year-over-year last week.
ICSC CHAIN STORE SALES shows better results than Redbook's, up 3% year-over-year last week.
THE DALLAS FED'S TEXAS SERVICE SECTOR OUTLOOK SURVEY shows continued optimism, despite a deceleration in some components. Here's the release:
Texas service sector activity continued to reflect expansion in May but at a slower pace than in April, according to business executives responding to the Texas Service Sector Outlook Survey. The revenue index, a key measure of state service sector conditions, dropped from 14.6 to 3.8, its lowest reading in almost three years.
Labor market indicators reflected faster employment growth and slightly longer workweeks. The employment index ticked up a point to 8.9 in May. The hours worked index remained positive but fell slightly from 4.7 to 1.9 this month.
Perceptions of broader economic conditions improved in May. The general business activity index turned positive and came in at 1.1 after two consecutive months in negative territory. The company outlook index edged up from 4.5 to 6.9 this month. About 19 percent of respondents reported that their outlook improved from last month while 12 percent noted that it worsened.
Price and wage pressures were unchanged this month. The selling prices index was similar to last month at 3.6, indicating prices increased at the same pace as in April. The wages and benefits index held steady at 16.1, although the great majority of firms continued to note no change in compensation costs.
Respondents’ expectations regarding future business conditions reflected more optimism in May. The index of futuregeneral business activity rose from 6.2 to 10.6. The index of future company outlook moved up from 10.2 to 15. Indexes of future service sector activity, such as future revenue and employment, also reflected more optimism.
MAY 28, 2015
WEEKLY JOBLESS CLAIMS, while above expectations last week, continue to come in very favorably below 300k. 282k last week. Continuing claims were up 11k at a still very low 2.22 million. The 4-week average fell 9k to 2.221k. The unemployment rate for insured workers rose 1/10th to 1.7 percent, up from the long-term low 1.6%.
THE BLOOMBERG CONSUMER COMFORT INDEX conflicts with Tuesday's Consumer Confidence Survey from the Conference Board. While CB's survey says the consumer is feeling good about the present buying climate, the Bloomberg survey suggests otherwise. Here's the release:
Consumer Comfort in U.S. Slumps on Views of Buying Climate
By Nina Glinski
(Bloomberg) -- Consumer confidence in the U.S. fell for a seventh consecutive week and attitudes about whether it was a good time to spend slumped by the most since 2011.
The Bloomberg Consumer Comfort Index decreased to 40.9 in the period ended May 24, the lowest level since late November, from 42.4 the prior week. The decline in Americans’ assessments of the buying climate was accompanied by the biggest drop in sentiment among women in more than seven years.
“A stellar Q4 last year has turned into a mixed 2015 for consumer sentiment, with highs in late January and early April followed by sharp corrections,” Gary Langer, president of Langer Research Associates LLC in New York, which produces the data for Bloomberg, said in a statement. “The latest drop has taken back about half of the CCI’s late-September to mid-January gain.”
The series of declines from an almost eight-year high in April is the longest since May 2008, and puts the index below the 41.7 long-term average that dates back to December 1985. It’s still above last year’s 36.7 average, which was the best since 2007.
The measure of the buying climate dropped to 35.5 last week, the lowest since the end of November, from 38.1 in the prior period. The 2.6 point decrease was the biggest since December 2011.
Other components of the Consumer Comfort Index also declined. Sentiment about personal finances decreased to 54.9, the lowest since early March, from 56.3. The measure of views on the economy cooled to to 32.3, the weakest since the first week of December, from 32.8.
Thursday’s report stands in contrast to the Conference Board’s May index, which suggested that American households are growing more sanguine about the economy and planning to make major purchases. That confidence gauge advanced to 95.4 from an April reading of 94.3, the New York-based private research group said Tuesday.
Women’s attitudes as measured by the Bloomberg index plunged for a second consecutive week. The 3.8 point decrease was the biggest since November 2007 and followed a 3.2 point drop the week before. Combined, it marked the largest two-week slump since records began in 1990. Sentiment among men increased.
Among income groups, those earning more than $100,000 saw optimism sag to 59 last week, an almost six-month low, from 61.4 in the prior period. Sentiment also fell to the lowest since November among homeowners, married adults and the unemployed.
Regionally, confidence in the U.S. South was the lowest since mid-October, while Midwestern households were alone in reporting a pickup.
The Bloomberg Comfort Index, presented on a scale of zero to 100, is a four-week rolling average and based on a national sample of 1,000 adults. The report’s gauges have a margin of error of plus or minus 3.5 points.
PENDING HOME SALES are sending strong positive signals for the housing sector. April's pending home sales index grew for the 4th consecutive month, jumping 3.4%. Year-over-year pending home sales are up an impressive 14%. This speaks markedly to the optimism for housing I've expressed all year...
CRUDE OIL INVENTORIES declined for the 4th straight week, which doesn't support my pessimism over the sustainability of the recent rally in the price per barrel. Refineries have been very busy of late, raising output of both gasoline and distillates. Oil inventories were down 2.8 mbs, GASOLINE was down 3.3 mbs and distillates rose 1.1 mbs.
NAT GAS INVENTORIES 112 bcf last week.
FARM PRICES rose 2% in May after rising 3% in April. Year-over-year prices are down 9.6%...
THE FED BALANCE SHEET fell by $16.4 billion last week after dropping $20.8 billion the week prior. To a total of $4.46 trillion. RESERVE BANK CREDIT decreased $5 billion after increasing $4 billion the prior week.
M2 MONEY SUPPLY rose last week by $27 billion after increasing the prior week by $22.8 billion...
MAY 29, 2015
THE SECOND REVISION OF Q1 GDP brought the number down to -0.7% vs a consensus estimate of -.08%. The stronger dollar, resulting in a larger trade deficit, gets the blame. Underneath the headline, however, there was some good news: residential fixed investment rose to 5%, from 1.3%, and the capex drag lessened to -2.8%, from -3.4%. Here's Econoday:
First-quarter GDP was revised down about as expected, to minus 0.7 percent vs expectations for minus 0.8 and compared with an initial reading of plus 0.2 percent. Updated source data made for a bigger negative contribution from net exports as imports spiked 5.6 percent from an initial gain of 1.8 percent. The change here is tied to the port strike and the sudden unloading of imports in March. A lower estimate for inventory growth was also a negative. Turning to demand, final sales were revised downward to minus 1.1 percent from minus 0.5 percent.
On the positive side, the contribution from residential fixed investment rose to 5.0 percent from 1.3 percent while the negative contribution from business spending improved 6 tenths to minus 2.8 percent.
The first quarter was definitely weak, showing the first contraction since first-quarter 2014 when GDP fell 2.1 percent in another winter quarter affected by unusually severe weather. The Fed itself has been noting the risk that the pattern of first quarter weakness could reflect how the numbers are crunched by government statisticians to account for seasonal variations. This process may have exaggerated the underlying weakness in the quarter.
Where is GDP currently tracking? Early estimates were in the 3.0 percent range but, due to weak consumer spending, have been slipping to the 2.0 percent range.
CHICAGO PMI shows a shocking decline in confidence. Here's Econoday:
Chicago's PMI sample reports surprising and inexplicable contraction this month, at an index of 46.2 which is far below the Econoday low estimate for 51.0 and April's reading of 52.3. The index's five components all came in under 50 including very sharp contraction for new orders, production and also employment which is at its lowest level since April 2013. No longer in contraction, however, are raw material prices where higher fuel costs are a likely suspect.
Conclusions based on this report can sometimes be uncertain given its very volatile history. But this report is a red flag of sorts, coming at a time when expectations are looking for significant economic strength, not weakness. This report tracks all sectors of the Chicago economy.
THE UNIVERSITY OF MICHIGAN'S CONSUMER SENTIMENT INDEX shows the consumer feeling relatively good about his/her prospects. Here's Econoday:
Consumer sentiment has bounced back the last two weeks, lifting the final reading to 90.7 vs the mid-month flash of 88.6. The implied reading for the last two weeks is about 93 which, though down from April's 95.9 and January's peak over 98, is still very solid.
Still, there is month-to-month weakness which doesn't point to strength for consumer spending in May. The current conditions component ends May at 100.8 vs April's 107.0 in weakness that also hints at trouble for May's jobs market. A decline in the expectations component, to 84.2 from 88.8 in April, points to less confidence in the longer-term jobs outlook.
Gas prices are on the rise, up more than 5 percent from April, and are pressuring inflation expectations. One-year expectations are up 2 tenths from April to 2.8 percent as are 5-year expectations which show the same readings.
This report, like consumer confidence earlier in the week, is pointing to stability in consumer spirits, spirits that peaked earlier in the year and are now leveling.