Where we're seeing the good news is bad news saga play out most plainly, and painfully, is in the bond market. Good economic news fans the flames of those who fear that interest rates will soon be rising. And that fear turns into action, which makes it essentially prophetic, in a self-fulfilling sort of way. I.e., traders fearing higher interest rates sell bonds into a market fearing higher interest rates (or a market of buyers demanding higher yields [lower prices]).
Tuesday and Wednesday saw stocks sell off en masse as a robust ISM Services Sector Purchasing Managers Index, and above-estimate Unit Labor Costs, sent bond yields spiking. Stocks bounced a bit on Thursday as yields came in and then exploded higher on Friday as the BLS's April jobs report showed the average workweek remaining flat and wages ticking up ever-so-slightly---at a below-estimate pace. Bond yields tanked on the jobs report release, as traders rushed back in, then recovered a bit---but still finished lower on the day.
You may think it strange that service sector purchasing and supply managers' optimism, and folks receiving more pay/benefits, can be a bad thing for the market, but, understand, the Fed is maintaining the interest rate banks charge one another for the overnight borrowing of reserves within a range of zero to 0.25%. And that's a range that was once reserved for only the direst of circumstances.
So, being that the trend of the U.S. economy is, at this point, notably higher, not dire, traders smell higher rates a coming. And higher rates mean a higher cost of capital for companies, competition for stocks and huge pressure on valuations.
In terms of valuations, stocks' price to earnings ratios (P/Es) tend to contract as buyers demand greater returns (cheaper relative prices) from the market when safer alternatives begin paying higher interest rates. And P/Es can contract in one of two ways, either through falling share prices or rising earnings. And at a time when profit margins are approaching all-time highs---like now---and companies aren't seeing measurable revenue growth---like now---traders will conclude that P/Es are to come down by way of falling stock prices. So they sell, and stock prices fall.
Here's Fed Chair Janet Yellen essentially making that point in a discussion last week with the IMF's Christine Lagarde:
“I would highlight that equity-market valuations at this point generally are quite high. Not so high when you compare returns on equity to returns on safe assets like bonds, which are also very low, but there are potential dangers there.”
While I'm tempted to jump all over her ambiguity (I mean, valuations are either high or they ain't, all things considered), if the returns on "safe assets" are to improve going forward, without an increase in corporate earnings (which is the "potential danger")---all else being equal (which it never is btw)---valuations will indeed be getting "quite high".
So what's the Chairwoman up to? Why would she step out of her bounds (as some claim/complain) and opine on stock valuations? It's really quite simple. One of the intended transmission effects of easy monetary policy is to inflate asset prices and, hence, make economic actors (people) feel good and start acting. But the thing is, while the market's inflating may indeed turn on the spending switch, Ms. Yellen knows that a dramatic deflating can turn it off in a heartbeat. Therefore, by attempting to jawbone the market into deflating just a bit, in non-dramatic fashion, she's hoping she can mitigate the potential for something bigger when she and her cohorts begin manipulating the Fed funds rate to a more legitimate level.
A couple additional thoughts regarding Ms. Yellen's commentary:
1. Worry no more, if you're worried about Ms. Yellen's commentary sparking a severe market reaction. Fed chairpeople---like the rest of us (and that means everybody)---have not been what you'd call adept market prognosticators:
The market (S&P 500) doubled during the three years following Greenspan's famous December 1996 "irrational exuberance"speech (he was just a little early). And, as I type, small caps (the Russell 2000 Index), Facebook and biotech stocks (IBB) are up 7%, 16% and 40% respectively since Ms. Yellen herself complained of their "stretched" valuations nine months ago.
2. With regard to her characterization of bonds as "safe assets"---while we should forgive her for stating what is generally considered textbook reality---we can chastise her for being oblivious to the potential for your average citizen, or, worse yet, senior citizen, taking that statement to heart and perhaps loading up on arguably the most interest rate sensitive vehicle known to man at a time when interest rates are rock bottom. I.e., bonds, in general, are anything but "safe assets" these days.
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: +2.93%
S&P 500: +3.51%
NASDAQ Comp: +6.17%
EFA (Europe, Australia and Far East): +11.21%
FEZ (Eurozone): +9.54%
VWO (Emerging Markets): +9.99%
Here’s a look at the year-to-date results for a number of U.S. sector ETFs:
IYH (HEATHCARE): +8.21%
XLB (MATERIALS): +6.55%
XLY (DISCRETIONARY): +6.52%
XHB (HOMEBUILDERS): +5.04%
XLK (TECH): +4.49%
XLE (ENERGY): +3.98%
XLP (CONS STAPLES): +2.01%
XLF (FINANCIALS): +.49%
XLI (INDUSTRIALS): +.46%
IYT (TRANSP): -3.97%
XLU (UTILITIES): -6.03%
The Bond Market:
As I type, the yield on the 10-year treasury bond sits at 2.14%. Slightly higher than last week's 2.11%.
TLT, an ETF that tracks an index of long-dated U.S. treasury bonds, saw its share price decline another 1.2% last week (off 6.57% over the past month). So much for Ms. Yellen's "safe assets like bonds" comment...
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 4, 2015
FACTORY ORDERS finally picked up in March, by 2.1%, although the increase had everything to do with transportation (a sector I'm presently bullish on). Aircraft and motor vehicle (and parts) orders were very strong. Take out transportation and orders were essentially flat. Here's Econoday's commentary:
Boosted by aircraft and also by motor vehicles, factory orders rose an as-expected 2.1 percent in March. March's gain ends what were 7 straight declines as February, which was initially at plus 0.2 percent, is revised now to minus 0.1 percent. The 7 straight declines are the most striking evidence of how hard the manufacturing sector has been hit, by the strong dollar that weakens exports and also specific trouble in the energy sector due to the downturn in oil.
But in March, the sector got a big boost from civilian aircraft, an industry where big monthly swings are normal, but also from motor vehicle & parts where orders rose 6.0 percent in what is one of the very strongest gains of the recovery. Excluding transportation, however, orders were unchanged compared to only a 0.1 percent gain in February, with the latter revised down sharply from an initial reading of plus 0.8 percent.
Energy equipment rebounded 4.8 percent in the month but following a long streak of declines including an 18.5 percent drop in February. Industrial machinery was also down on the month. Other industries on the plus side include computers and defense capital goods.
Orders for capital goods in general were mixed, up only 0.1 percent on the core, which excludes aircraft, and extending their downward slope.
Other readings include a sizable 0.5 percent rise in shipments. Another plus is a small rise in unfilled orders which have been especially weak. Inventories held steady relative to sales, with the inventory-to-sales rate unchanged at 1.35.
The pop in March ends the first quarter on a positive note but the early indications on the second quarter, despite expectations of an outsized weather boost, have all been soft.
MAY 5, 2015
THE JOHNSON REDBOOK RETAIL REPORT just reported on the last week of distortion due to how Easter fell last year vs this year. Up 1.6% year-over-year. Next week's report should be robustly better, particularly with Mother's day falling on Sunday...
THE MARKIT, JPM GLOBAL SERVICES PMI continues to show solid growth. "Strong rates of output growth" were reported for Europe, China and India, as well as the U.S.
THE MARKIT U.S. SERVICES PMI showed output growth moderating a bit in April, yet it was stronger than the average Q1 read. The overall index came in at an expansionary 57.4, down from March's 59.2.
THE MARKIT COMPOSITE U.S. PMI came in at 57.0, down from 59.2 in March... Overall, the readings are very positive for the outlook going forward. However, input costs are picking up and putting pressure on margins... That's the case for higher inflation and interest rates going forward.
THE IBD/TIPP ECONOMIC OPTIMISM INDEX fell in May to below the 50 level, to 49.7. However, the details aren't all that bad. Here's the release:
The IBD/TIPP Economic Optimism Index fell 1.6 points in early May to a reading of 49.7, back below the neutral 50 level, where it's been hovering in 2015. But Americans were more upbeat about their own financial outlooks.
Gas prices rose steadily in April. While Americans are paying far less for fuel than a year earlier, that sapped some enthusiasm in the economy. Meanwhile, oil boom states are still suffering from job losses as energy companies slash capital spending. And 23% of households have at least one person working for a full-time job, up from 20% in April.
Of the 21 demographic groups tracked, 20 showed an index decline in May and one was unchanged.
• The Six-Month Economic Outlook Index fell 3.8 points to 47.7.
• Confidence in Federal Economic Policies slid 2.6 points to 43.1. That gauge hasn't been above 50 in more than eight years.
• The Personal Financial Outlook Index actually rose 1.6 points to 58.3, the highest level since October 2012.
THE ISM NON-MANUFACTURING PMI shows strong growth in the services sector. However, unlike Markit's survey, there's no serious price pressure showing in this report. This report, given that the services sector creates 80+% of U.S. jobs, is very bullish for the employment outlook. Here's Econoday's summary:
The ISM non-manufacturing index extended its strong and unusually stable trend, coming in at 57.8 for April vs a very solid 56.5 in March. Over a 10-month stretch, this index has held between 58.8 on the high side to 56.5 on the low side.
New Orders are very strong, at 59.2, as are backlog orders, at 54.5 which is unusually strong for this reading. Strong orders point to future hiring which is already very strong, at 56.7. Price data, unlike this morning's PMI services index, do not show any pressure.
Otherwise, however, there is plenty of upward pressure registered in this report, one that points to a sizable rebound for the economy during the second quarter.
Here's from the report:
"The NMI® registered 57.8 percent in April, 1.3 percentage points higher than the March reading of 56.5 percent. This represents continued growth in the non-manufacturing sector. The Non-Manufacturing Business Activity Index increased substantially to 61.6 percent, which is 4.1 percentage points higher than the March reading of 57.5 percent, reflecting growth for the 69th consecutive month at a faster rate. The New Orders Index registered 59.2 percent, 1.4 percentage points higher than the reading of 57.8 percent registered in March. The Employment Index increased 0.1 percentage point to 56.7 percent from the March reading of 56.6 percent and indicates growth for the 14th consecutive month. The Prices Index decreased 2.3 percentage points from the March reading of 52.4 percent to 50.1 percent, indicating prices increased in April for the second consecutive month, but at a slower rate. According to the NMI®, 14 non-manufacturing industries reported growth in April. The majority of respondents indicate that there has been an uptick in business activity due to the improved economic climate and prevailing stability in business conditions."
The 14 non-manufacturing industries reporting growth in April — listed in order — are: Arts, Entertainment & Recreation; Real Estate, Rental & Leasing; Management of Companies & Support Services; Transportation & Warehousing; Wholesale Trade; Finance & Insurance; Utilities; Health Care & Social Assistance; Agriculture, Forestry, Fishing & Hunting; Public Administration; Retail Trade; Accommodation & Food Services; Construction; and Educational Services. The four industries reporting contraction in April are: Mining; Other Services; Professional, Scientific & Technical Services; and Information
WHAT RESPONDENTS ARE SAYING ...
"Avian Influenza is causing concerns, but has not directly impacted our operations." (Agriculture, Forestry, Fishing & Hunting)
"Clients in oil refinery sector have reduced their capital spending due to declining oil prices." (Professional, Scientific & Technical Services)
"Definite signs of economic growth in most markets serviced. New construction and capital spending apparent." (Finance & Insurance)
"Still have backorders/shortages of IV solutions." (Health Care & Social Assistance)
"Pork prices are lower due to abatement of the PEDv virus. Chicken and beef prices are up due to higher demand and output. Corn prices and oil for gasoline have been the bright spot keeping prices from taking off higher." (Accommodation & Food Services)
"Overall we see positive trends; spending has improved." (Retail Trade)
"Low fuel prices continue to have a positive impact." (Transportation & Warehousing)
"Business remains strong for this time of year and looks good for the next 12-18 months." (Wholesale Trade)
THE TRADE DEFICIT surged to $51.4 billion in March as U.S. consumers stocked up on foreign goods and services, and U.S. exports weren't in nearly such demand from consumers abroad. The latter could be the result of the surging dollar, the former speaks to the health of the U.S. consumer, and, as well, the result of the surging dollar---not to mention the settling of the West Coast port strikes. This one will likely push Q1 GDP into negative territory.
MAY 6, 2015
MORTGAGE APPS declined 4.6% last week as mortgage rates spiked higher. However, the decline was all about refinances. New purchase apps increased 1% to their highest level since January (which validates my continued optimism over housing).
THE ADP EMPLOYMENT REPORT came in below expectations at 169k for April. Per my commentary regarding services creating the jobs in the U.S., there were 170k service sector jobs created. Which means the goods-producing sector lost 1k net (+23k from construction, - 10k from manufacturing)... From what I'm reading in the anecdotal evidence, I suspect strongly that job growth will pick up measurably in the months to come.
NON-FARM PRODUCTIVITY declined 1.9% in the first quarter, which speaks loudly to my concerns over the source of earnings growth going forward. Output declined .2% while hours worked increase 1.7%. Overall unit labor costs increased by 5%, as hourly wages increased by 3.1%, which gets added to the productivity number (where hours worked is reflected) of 1.9% to get the 5% total increase...
THE EIA PETROLEUM STATUS REPORT broke its 15-week string of inventory builds, declining by 1.9 million barrels last week. I've been maintaining that the supply glut remains and that the recent rally in oil is likely not to be sustained... although I've also maintained that ultimately we will see a legitimate bottom in oil prices. Just not convinced that it's here just yet. That said, should inventories begin to come off substantially (if last week begins a trend), I may have to change my tune. For now, looking at global supply, plus add'l supply coming on from the Gulf of Mexico, and considering recent geo-political turmoil effecting recent pricing, I continue to expect the price of oil to take a leg down in the near future. GASOLINE INVENTORIES grew by .4 mbs and DISTILLATES grew by 1.5 mbs...
THE GALLUP U.S. JOB CREATION INDEX grew to 31 for April, from March's 29. Here's Econoday's summary:
More American workers have reported that their employers were hiring over the past year than in the six years prior, with the latest data from April representing a new high mark. Gallup's U.S. Job Creation Index reached plus 31 in April, inching past its previous high of plus 30 from September of last year. The latest reading is up two points from March, and is a break from six months of fairly static measurements.
Since hitting a low point of minus 5 on two separate occasions in 2009, the U.S. Job Creation Index has climbed fairly steadily over the past six years. The first five months of 2014 saw steady increases in monthly readings of the index, rising from plus 19 in January to plus 27 in May. Since then, the index has mostly stayed between plus 27 and plus 29, apart from the higher readings last September and this April.
For the first time since Gallup began tracking the index in 2008, index scores are plus 30 or higher in all four regions of the country. Each region has a new high index score, with the Midwest leading the other regions at plus 33 in April. The index score in the East had never reached the plus 30 mark before the latest poll.
Both government and nongovernment workers reported slightly greater hiring activity, with a two-point increase in each of their index scores for the month of April. For nongovernment workers, last month's plus 33 is a new high in their net hiring perceptions, edging past the plus 32 in September. The plus 22 score among government workers is one point below the high from last August. Perceptions of hiring among nongovernment workers have consistently been stronger than those of their government counterparts in nearly all of Gallup's readings over the years.
MAY 7, 2015
THE CHALLENGER JOB-CUT REPORT showed a surge in layoff announcements in April, a large swath of which came from the energy sector. Here's Econoday's commentary:
Price-borne weakness in the oil sector was responsible for about one-third of all layoff announcements in April which totaled 61,582, well up from 36,594 in March and from 40,298 in April last year. Layoff announcements from the energy sector totaled 19,745 in April and follow two similar very heavy totals, 16,339 and 20,193, in 2 of the 3 prior months.
Layoff announcements have been on the rise but the lag between announcements and actual dismissals can take months. Also, jobless claims are currently on the decline. Today's Challenger report isn't likely to affect expectations for tomorrow's employment report.
WEEKLY JOBLESS CLAIMS remain well below the 300k mark, at 265k last week (up 3k from the week prior). The 4-week average declined 4k to a 15-year low, at 279.5k. Continuing claims are also at 15-year lows, at 2.228 million (continuing claims are reported with a 1-week lag). Tomorrow's Employment report will be interesting to see --- the numbers have improved since the sample week for tomorrow's report---which had a 296k number.
THE GALLUP US PAYROLL TO POPULATION REPORT improved in April. Here's Econoday's commentary:
In a positive indication for the labor market, Gallup's measure of unemployment slipped to 43.9 in April from 44.1 in March. A decline in Gallup's unemployment rate, currently at 6.1 percent and down 3 tenths from March, is being accompanied by a slight rise in full-time employment. Part-time work is holding relatively steady. A special positive in the report is improvement in underemployment which, reflecting the decline in unemployment, is down to 14.9 percent from March's 15.5 percent.
THE BLOOMBERG CONSUMER COMFORT INDEX continues to tell a story of waning optimism among consumers. While not all such surveys are reflecting this trend, I suspect the consumer is indeed feeling somewhat less optimistic following the weak Q1, a shaky stock market, and the impact of higher gas prices (although still lower than a year ago), particularly on lower-income folks. As the labor market continues to tighten, and wages rise, I suspect we'll see this metric pick up in the coming months... Although I'm guessing the stock market---which, in my view, has a huge impact on sentiment---will be turbulent throughout the entirety of 2015... Here's from the report (note the comparison to last year's level):
Consumer Comfort in U.S. Declines to Lowest Level in Eight Weeks
By Michelle Jamrisko
(Bloomberg) -- Consumer confidence declined to an eight-week low as attitudes about the economy dimmed, particularly among those at the bottom of the income ladder.
The Bloomberg Consumer Comfort Index decreased to 43.7 in the week ended May 3, the fourth straight decline, from 44.7 the prior period. Sentiment among those making less than $15,000 a year slumped by the most since January 2011. For those earning more than $100,000, it held above 70 for a fifth week, the longest such streak in eight years.
“Income differences remain striking,” Gary Langer, president of Langer Research Associates LLC in New York, which produces the data for Bloomberg, said in a statement. “The CCI’s turbulent 2015 reflects the economy’s mixed performance.”
Optimism toward the economy deteriorated to an almost three-month low, indicating Americans remain guarded about the expansion’s prospects following the weakest quarter in a year. Bigger wage gains would ease the burden on lower-income households facing the highest gasoline prices since early December.
While the string of declines in sentiment is the longest in a year, the measure remains above last year’s average of 36.7 that was the best since 2007.
Two of three components in the index retreated last week. Americans’ views of the economy fell to 35.8 from 37.3 in the prior period.
The buying-climate index, showing whether this is a good time to purchase goods and services, declined to a six-week low of 39.8 from 41.2. The measure on personal finances held at 55.6, the lowest since the week ended March 8.
The gauge among Americans earning less than $15,000 a year plunged by 6.3 points to 21.4, its lowest level since early December. Confidence of those making at least $100,000 cooled to 71.9 from 73.7 in the prior period. Five straight weeks of readings exceeding 70 is the longest stretch since April 2007.
The difference in sentiment between those at opposite ends of the income scale is 50.5 points, the second-biggest gap since November 2007.
The report also showed optimism among men declined for a fourth week, to 44 from 46.7, while sentiment among women increased.
Three of four U.S. regions showed a drop in sentiment last week, led by the South, where it declined to its lowest this year.
NATURAL GAS INVENTORIES rose 76 billion cubic feet last week, after rising 81 bcf the week prior. Total inventory sits at 1,786 bcf.
CONSUMER CREDIT tells a different story than does the Bloomberg Comfort Index... As it rose in March by the largest amount since last July, by $20.5 billion. Revolving credit, a reflection of consumer sentiment, accounted for a respectable 20% of the increase. The $16 billion increase in non-revolving credit speaks optimistically about automobile demand.
THE FED BALANCE SHEET rose $1.2 billion last week, after decreasing by $18.2 billion the week prior, to a $4.473 trillion total. RESERVE BANK CREDIT decreased $11.3 billion...
M2 MONEY SUPPLY declined by $27.4 billion last week, after decreasing $1.9 billion the week prior...
MAY 8, 2015
THE BLS APRIL JOBS REPORT (OFFICIALLY THE "EMPLOYMENT SITUATION REPORT") bounced back markedly from March's revised 85k, to 213k. The services sector accounted for 182k, the goods producing sector 31k and government 10k. The breakdown for goods producing jobs saw gains of 45k construction (supporting my optimism over housing) and 1k manufacturing. Mining lost 15k.
The average workweek remained flat and wage growth was tepid (missing expectations), up .1%. This, in my view, is what sparked today's rally in stocks. As it counters recent robust labor cost data and calms traders fears over a looming Fed rate hike.
The labor force participation rate remained essentially flat at 62.8%, from 62.7% in March.
WHOLESALE INVENTORIES grew by .1% in March after rising .3% in February. Sales fell .2%, marking their 8th straight month of declines. THE INVENTORY TO SALES RATIO remains elevated compared to last fall/winter at 1.30.