Saturday, June 20, 2015

Your Weekly Update - Or- A Fairy Tale and a Game of Chicken

Janet Yellen is truly a gifted storyteller. Last Wednesday I was taken back to my youth, memories of Mom reading me Goldilocks and the Three Bears: The story of a famished young wanderer who found herself in a cozy forest cottage taste-testing three abandoned bowls of porridge, then relaxing and falling fast asleep after she partook of the helping that was not too hot and not too cold.

Last Wednesday and Thursday the Goldilocks market relaxed (and rallied) after Grandma Yellen told her
economic tale.

While the FOMC's post-meeting statement offered the following about
the labor market,
Labor market conditions have improved further, with strong job gains and a lower unemployment rate.

(tasted hot!)

during the subsequent press conference Ms. Yellen cooled it off with,
“Wage increases are still running at a low level but there have been
some tentative signs that wage growth is picking up. We have seen an increase in the growth rate of the employment cost index and a mild uptick in the growth of average hourly earnings. I would call these tentative signs of stronger wage growth.”

"So in spite of the fact that there is some progress on that front the
committee wants to see some further progress before feeling that it will be appropriate to
raise rates.”

She toned her raising rates rhetoric perfectly; warning that delaying action would risk overheating the
economy. But raising too early could derail the recovery. Masterful!

She told an otherwise scary (to some) story in a manner that didn't provoke sleeplessness among the
children. In other words, she accomplished her goal of warning of a potential 2015 rate increase without
roiling the financial markets in the process. Or did she?

Well, she indeed didn't roil the markets, however, the question would be, is the market heeding her warning? Listening to the pundits, I'd say no. Traders, in my view, took Ms. Yellen's tone---not necessarily her words---to heart and took a September (if not a 2015 entirely) rate hike off the table. And I'm not so sure that she in any way intended to move the radar off of September.

"Data dependent", that's the key! Hence---given present market myopia---I maintain my position that
really good economic news remains, for now, not so good stock market news. Longer-term, however, a good economy and, therefore, higher corporate earnings growth, is what'll keep the bull market alive---
and, thus, the bears from coming home---beyond whatever correction may or may not occur as the Fed achieves liftoff.

Last week I suggested that Greece would not be the market's main focus while the world awaited the Fed's commentary. While that was indeed the case Wednesday and Thursday, the other days' action appeared to be driven by that great game of chicken being played by, let's say, the driver of a tiny Volkswagen Beatle (Greece)---with an outstanding loan against it (a hundred times greater than the value of the car) financed no less by the manufacturer---and the driver of a Mercedes-made semi truck (The IMF, ECB, EC, Germany). At first blush you might think a collision would amount to little more than the semi driver stopping to have a look, assessing what little damage there is to his own vehicle, then motoring on as if nothing ever happened.

Upon deeper thought you realize that, should the Volkswagen driver not survive, the semi driver would be tried for murder. Or, should the Volkswagen driver somehow make it out alive, then fully recover, others like him (let's say Portugal, Ireland, Spain and Italy)---thinking that the main road is just too treacherous these days---may believe that they can survive the detour out of the Euro themselves and, therefore, take the off ramp (potentially doing harm to the merchants assembled along the road). Or, should the semi driver pull completely out of the way and allow his opponent to continue screaming down the road in a car that's hopelessly upside down in debt, other like-drivers---no longer respecting the big truck drivers---may once again step on the gas and run wild, inspiring safer drivers (investors) to take detours of their own, thus doing great harm to the merchants assembled along the road.

Bottom line folks: Both sides are bluffing their way to what they hope will be their best possible respective outcomes. As I type, they're running out of Autobahn and both are about to flinch. The thing is, if they flinch in the same direction they crash.

While the stock and bond markets appear to be mildly worried that a collision will occur, the currency markets of late seem to be pricing in virtually no worries. My guess is that the currency markets have it right---that neither driver has the political will to risk a crash---and, therefore, there'll be an 11th-hour compromise. Not, mind you, that that would be the best longer-term outcome. I think a better plan---immediate panic/pain notwithstanding---might be for Greece to default on its debt, leave the Euro, go back to the drachma (its old currency) and suffer through the tough reforms it would take to get its economy on sustainable footing (while shrewd global capitalists swoop in and buy up the pieces). I'll keep you posted...

The Stock Markets:

Non-US markets---Europe (due primarily to Greece) and Emerging Markets (due largely to fear over higher U.S. interest rates) in particular---have given back a noticeable portion of their earlier gains. Although the broad EAFE (Europe, Australia and the Far East) continues to measurably outperform the Dow and the S&P. The NASDAQ, fueled largely of late by biotechs, continues to show an impressive year-to-date gain.

Given many foreign markets’ cheaper valuations, early-stage recoveries and, yes, accommodative central banks, I see more attractive opportunities outside the U.S. in the intermediate term---despite recent weakness. 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 Morningstar) for the major U.S. indices. And (according to the results for non-U.S. indices and U.S. sectors—using index ETFs as our non-U.S. and sector proxies:

Dow Jones Industrials:  +2.27 %

S&P 500:  +3.48 %

NASDAQ Comp:  +8.63 %

EFA (Europe, Australia and Far East):  +8.58 %

FEZ (Eurozone):  +3.67%

VWO (Emerging Markets):  +3.80 %

Sector ETFs:

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

IYH (HEATHCARE):  +12.35%



XLB (MATERIALS):  +3.74%

XLK (TECH):  +3.29%




XLE (ENERGY):  -3.46%

IYT (TRANSP):  -7.62%

XLU (UTILITIES):  -8.67%

The Bond Market:

As I type, the yield on the 10-year treasury bond sits at 2.26%. Which is 13 basis points lower than where it was when I penned last week’s update. We can chalk up last week's rally in bond prices (prices and yields move inversely to one another) primarily to concerns over Greece.

TLT, an ETF that tracks an index of long-dated U.S. treasury bonds, saw its share price rise 0.96%  last week (down 4.46% year-to-date).  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:

JUNE 15, 2015

THE EMPIRE STATE MANUFACTURING SURVEY shows New York manufacturers feeling relatively glum about their go-forward prospects. Shipments were good, but their dismal outlook suggests they won't stay good for long. Employment remains a positive, which begs the comment that employers generally don't hire when they're decidedly glum about the future... I.e., the positive employment outlook suggests that the outlook isn't as soft as the other components portend...

INDUSTRIAL PRODUCTION FOR MAY came in surprisingly weak (-.2%), except for two key areas---autos (+1.7%) and capital goods (+.2%). This report jibes with the Empire State Survey's weak reading... Manufacturing, in the aggregate, doesn't appear to be picking up much steam of late...

THE NAHB HOUSING MARKET INDEX sprung higher to 59, which was well above the consensus estimate. This speaks to my optimism over housing going forward. The future sales component scored a high 69, with present sales scoring an also high 65. Traffic lags, at 44, but that's up 5 points for the month.

TREASURY INTERNATIONAL CAPITAL FOR APRIL showed foreigners buying a net $1.2 billion of US long-term securities while Americans were net sellers of $12.8 billion of foreign long-term securities. That brings net long-term inflow to a $53.9 billion. March saw $25.6 billion net inflow. Thank the strong U.S. dollar!

Breaking it down: Foreign investors bought lots of agency and treasury bonds, but barely any U.S. stocks. Americans were heavy buyers of foreign equities and net sellers of foreign bonds...

JUNE 16, 2015

HOUSING STARTS IN MAY declined 11% from April's reading. However, April was one of highest readings on record. The 1.036 million starts in May is a good number. Permits in May absolutely surged! Up 11.8% to 1.275 million. Permits are a leading indicator and point to strong growth going forward.

THE JOHNSON REDBOOK RETAIL REPORT continues to show readings inconsistent with what other indicators suggest. Here's Econoday:
Retail sales have been swinging strongly to the plus side but no one would ever know based on Redbook whose year-on-year rates are deeply depressed. Redbook's year-on-year same-store sales rate, which typically trends in the 3 percent area, is at a very pathetic plus 1.1 percent in the June 13 week. The commentary focuses on Father's Day and related disappointment over men's apparel sales.

JUNE 17, 2015

MORTGAGE PURCHASE APPS declined 4% last week. This comes after a surge the prior week and may reflect last week's upward spike in mortgage rates. More sensitive refinance apps declined 7%.

CRUDE OIL INVENTORIES declined again last week, by 2.7 million barrels. Refineries remain active, at 93.1% of capacity. However, GASOLINE INVENTORIES rose by .5 mbs and DISTILLATES by .5 mbs and .1 mbs respectively.

THE JUNE FOMC MEETING ended with no move on rates and commentary confirming a likely hike this year shrouded in very dovish language nonetheless.

JUNE 18, 2015

THE CPI FOR MAY came in a tenth under April's reading (for core), at 1.7%. Month-on-month, the core reading moved a mere .1%. Add in food and energy and year-over-year didn't budge, at 0%, while the month-on-month headline reading came in up .4%. Energy prices jumped last month, which explains to high .4% headline reading. These results support the argument that the Fed can be patient with raising the Fed funds rate.

WEEKLY JOBLESS CLAIMS continue to show real strength in the labor market, coming in at 267k (readings below 300k are bullish). The 4-week average sat at 276k. Continuing claims were down 50k to 2.222 million. The 4-week average for continuing claims was 2.231 million. The unemployment rate for insured workers remained at a very low 1.7%.

THE TRADE DEFICIT for Q1 came in at $113.3 billion, which was on the low-end of expectations. Goods saw a $189 billion deficit, while services saw a $59.7 billion surplus.

THE BLOOMBERG CONSUMER COMFORT INDEX, as I suggested last week that it might, showed gains following 9 weeks of declines. The components tracking economic outlook the buying climate improved. Here's the release:
Consumer Comfort in U.S. Climbs After Falling Record Nine Weeks

By Erin Roman

(Bloomberg) -- Consumer confidence stabilized after falling a record nine straight weeks as Americans became less downbeat about the economy.

The Bloomberg Consumer Comfort Index increased to 40.9 in the period ended June 14 from 40.1 the prior week. A monthly measure tracking the economic outlook rose to 47.5 in June from 44 in May.

The recent decrease in weekly sentiment that extended back to early April coincided with rising fuel costs even as households benefited from improving labor and real estate markets. Persistent gains in gasoline prices, which have climbed this week to the highest since November, could thwart further advances in confidence.

“If that continues, this week’s pause in the index’s downward trajectory may not hold,” Gary Langer, president of Langer Research Associates LLC in New York, which produces the data for Bloomberg, said in a statement. “At the same time, other indicators may help; this week’s thaw is buttressed by strengthening reports on jobs and the housing market.”

The share of households who said the economy is getting worse fell to 33 percent in June from 39 a month earlier, the biggest improvement since October, according to the monthly expectations gauge.

Two of three components of the weekly index increased in the latest report. A measure of consumers’ views on the state of the national economy increased to 33.7 this week from 32.1.

The buying climate gauge, which measures whether now is a good time to purchase goods and services, improved to 34.2 from 33.5 the week prior. The gauge of personal finances was little changed at 54.8 from 54.7.

Gasoline Prices

Higher prices at the pump have weighed on consumers’ views of buying conditions. The cost of a gallon of regular gasoline has averaged $2.80 this week, up from a January low of $2.03, according to auto group AAA.

Thursday’s comfort data showed better job prospects are brightening moods of those looking for work. Sentiment among respondents who were unemployed rose to a five-week high. Employers added 280,000 jobs in May, the most in five months, according to the Labor Department.

Wealthier Americans were also more upbeat last week, likely a reflection of the gains in stock prices this year. Comfort among those making more than $100,000 a year climbed to a five-week high.

THE PHILADEPHIA FED BUSINESS OUTLOOK SURVEY FOR JUNE flew strongly in the face of Monday's weak Empire State survey, coming in way better than the consensus expectation. Here's Econoday:
In the first notable indication of strength of any kind in the manufacturing sector, the Philly Fed index has absolutely surged in the June report, way beyond Econoday's high-end estimate to 15.2 for the strongest reading since December. The gain is confirmed by an identical 15.2 surge for new orders which is the highest reading since November.

Other readings are also positive including an increase for unfilled orders and a big increase in this month's shipments. Another positive is slowing in delivery times consistent with high levels of shipping activity. On inflation, prices paid shows a big jump likely tied to energy costs, though prices received shows only marginal pressure. Showing only a marginal gain this month is employment, yet this may increase in the coming months given the other readings in this report including a nearly 6 point jump in the 6-month outlook to a very positive 39.7 which is the best reading since January.

But is this report an outlier? It certainly isn't confirmed by Monday's Empire State report which lurched into the negative column to minus 1.98. Today's report will focus attention on other Fed manufacturing reports to come including the Richmond report on Tuesday and the Kansas City report on Thursday. Both of these reports, and especially the Dallas report, have been very weak so far this year.

THE CONFERENCE BOARD'S INDEX OF LEADING ECONOMIC INDICATORS showed continued strength in May. Confirming my optimism for the U.S. economy going forward. Here's the release:
The Conference Board Leading Economic Index® (LEI) for the U.S. increased 0.7 percent in May to 123.1 (2010 = 100), following a 0.7 percent increase in April, and a 0.4 percent increase in March.

“The U.S. LEI increased sharply again in May, confirming the outlook for more economic expansion in the second half of the year after what looks to be a much weaker first half,” said Ataman Ozyildirim, Director, Business Cycles and Growth Research, at The Conference Board. “While residential construction and consumer expectations support the more positive outlook, industrial production and new orders in manufacturing are painting a somewhat more mixed picture.”

The Conference Board Coincident Economic Index® (CEI) for the U.S. increased 0.1 percent in May to 112.1 (2010 = 100), following a 0.2 percent increase in April, and no change in March.

The Conference Board Lagging Economic Index® (LAG) for the U.S. increased 0.2 percent in May to 117.0 (2010 = 100), following a 0.2 percent increase in April, and a 0.5 percent increase in March.

About The Conference Board Leading Economic Index® (LEI) for the U.S.

The composite economic indexes are the key elements in an analytic system designed to signal peaks and troughs in the business cycle. The leading, coincident, and lagging economic indexes are essentially composite averages of several individual leading, coincident, or lagging indicators. They are constructed to summarize and reveal common turning point patterns in economic data in a clearer and more convincing manner than any individual component – primarily because they smooth out some of the volatility of individual components.

The ten components of The Conference Board Leading Economic Index® for the U.S. include:

Average weekly hours, manufacturing
Average weekly initial claims for unemployment insurance
Manufacturers’ new orders, consumer goods and materials
ISM® Index of New Orders
Manufacturers' new orders, nondefense capital goods excluding aircraft orders
Building permits, new private housing units
Stock prices, 500 common stocks
Leading Credit Index™
Interest rate spread, 10-year Treasury bonds less federal funds
Average consumer expectations for business conditions

NATURAL GAS INVENTORIES rose again last week, by 89 bcf...

THE FED BALANCE SHEET rose last week by $19.8 billion, to $4.487 trillion. RESERVE BANK CREDIT increased by $23.1 billion.

JUNE 19, 2015

ATLANTA FED BUSINESS INFLATION EXPECTATIONS IN JUNE remained at the relatively tame May reading at 1.9%.

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  1. […] last weekend’s commentary I suggested that neither side in the Greek saga had the political will to risk a crash. As of this […]