Saturday, August 1, 2015

Your Weekly Update - AND- On Commodities and China

On the rare occasion when a client takes me to task on a recommended asset allocation shift, it either has to do with his/her generally-understandable doubt about the near-term prospects for the position I'm taking, or it's about its poor recent performance. Of course the poor performance creates the doubt and the punditry provides the background narrative.

It goes something like this: "The fact that housing-related stocks have performed poorly of late speaks to the lack of confidence in the recovery, tight lending standards, and a lack of desire among millennials". While such assumptions may accurately explain why housing was where it was late last year, they offer little insight into where the sector is headed going forward.

Here's what I wrote on housing in my December 30, 2014 commentary:
Many times over the years I’ve dubbed, or (as I’m sure I heard this from someone else) redubbed, “it’s different this time” as investing’s most dangerous four-word phrase. Well, actually, it is different this time. That is, housing has definitely not led the way during this recovery, as it has—in terms of the rate of growth—during past recoveries. Which shouldn’t come as a surprise given that it was the housing bubble that burst all over the global economy in 2008. But it’s almost 2015, which means the first round of folks who had to go the distance and declare bankruptcy are reaching the point that brings them credibly back into the housing market. The employment indicators, as I’ve been reporting for months—as well as the jobs numbers themselves—are finally picking up measurably, wages are beginning to creep higher, consumer sentiment is hugely positive and the NAHB Housing Market Index has been dancing between 50 and 60 (57 recently) since July—above 50 means there are more optimists among home builders than there are pessimists.

Now we can get really deep into the weeds and talk about demographics and household formations, both of which speak positively going forward, but suffice it to say that it makes sense that, again, given the nature of the last recession, a pickup in the economy might very well unleash a good deal of pent up demand onto the housing market. Plus—and this is a huge plus—the housing-related companies that comprise the S&P Homebuilders Index are, in the aggregate, trading at 14.5 times next year’s estimated earnings against an earnings growth rate of 13.6%: That’s a PEG ratio of nearly 1, which makes it very cheap relative to other U.S.sectors. Oh, and the index is up a paltry 2.1% year-to-date (i.e. no worries about buying into a runaway sector).

So do we add a little homebuilders exposure? Yes, I think we do. But, like everything else, in moderation, and with a long-term, volatility-tolerant, perspective.

By the way, as of last Friday XHB (the ETF that tracks the S&P Homebuilder's Index) was up 10.14% on the  year, while the Dow was down 0.75%.

Now let's apply this thinking to commodities. Analysts are falling all over themselves to explain why commodities are experiencing one whale of a bear market. Global slowdown, China rolling over, too much supply, rosy weather, on and on. And, yes, I spend a noticeable amount of time each week tracking everything from inventories, to usage, to global weather patterns, to economic data the world over, and to the Commodity Futures Trading Commission's (CFTC) reports on recent positions taken by both speculators and the commercial users of the stuffs the world consumers. But more importantly than the whys and wherefores of the current environment, what we really should be focused on is what low commodity prices actually portend for the global economy going forward.

I.e., should we freak over why the prices of oil and olives are falling, or should we be thankful while it lasts? Should we fret over the possibility that low demand is the reason, or should we focus on the reality that low prices are the fix for low demand? Should we really bemoan the still-jingling pockets of folks as they exit the gas station, or should we celebrate the fact that they won't be heading straight home---as they swing by the mall, the movie theatre, the manicurist and the local Mathnasium to sign up their incoming seventh-grader.

Make no mistake folks, in places like the U.S., Japan, China and India, and the countries that occupy the Eurozone (the importers of massive quantities of commodities), low prices are stimuli for their economies. Of course, for the producing countries---such as Canada, Australia, Mexico, Brazil and Russia---they're a drag.

Bottom line: Falling commodity prices, while painful for some, can be an economic blessing for much of the world. As with the previously weak housing market, our ultimate task is to seek out the inherent opportunities such phenomena present, as opposed to belaboring what may or may not have led to the condition to begin with.

On China:

I have received a few inquiries with regard to the recent volatility in the Chinese stock market, and whether it's as big a worry as many in the media suggest. I counsel that, indeed, China's crazy market of late has created volatility in other markets (U.S.'s included). My view regarding the Chinese economy, however, does not jibe with the consensus.  A China slowdown was to be expected as the powers that be rightly move the economy to more of a consumption/services orientation. My chief concern has to do with the fact that while, in some respects, China's policymakers seem to understand that allowing market forces to dictate the price and distribution of goods and services is the best approach---and will ultimately give their currency the global reserve status they're after---they are aggressively attempting to control a falling "market!" Which not only can't work (and possibly make matters worse), it does real damage to the credibility they're attempting to gain on the global stage.

China has issues, not the least of which is mounting private debt. And while, like any economy, it'll experience fits and starts---exacerbated and aided by a regime that can't help but try and control it---I don't see a great Chinese recession occurring anytime soon ($3.8 trillion in reserves carries a lot of fire power) Although I do see continued volatility in the China stock market. In fact, this weekend's release of the HSBC China Manufacturing Purchasing Managers Index could inspire a major move---in either direction---when its market opens Sunday evening. Given recent manufacturing data we should not be optimistic.

But, again, we now need to give equal attention to China's services sector, which is looking up. Here's Altegris's Jack Rivkin in a discussion last week with Maulden Economic's John Maulden on the topic:
The second story has to do with the changing mix of the Chinese economy. I did a webinar yesterday with Henry McVey and David McNellis, who run the Global Macro Asset Allocation process for KKR. They had a more sanguine view of China’s growth than the consensus, for sure. When I questioned Henry on this view, he said that people were overlooking the amazing growth of the Chinese services sector. He agrees with the major, major slowdown in fixed asset investment; but the services sector, which in many ways relates to internal elements of the China story and the consumer, is quite robust. They have a very specific window on this as investors in several service sectors in the country. It was not a story that I had previously heard spelled out so specifically. It’s not that there won’t be some hiccups or worse, but there is a transformation occurring underneath all this turmoil. It may mean slower growth in the long run, but with China following the path of the now-developed economies from agrarian to industrial to services. I am paying attention.

Stay tuned...

The Stock Market:

Non-US developed markets—even after their recent pummeling—have outperformed the U.S. major averages (save for the NASDAQ Composite Index) year-to-date. Given many foreign markets’ cheaper valuations, early-stage recoveries and, yes, accommodative central banks, I remain constructive on non-U.S.. That said, there are a number of potential international hot buttons (as we've recently experienced) 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 price changes (according to CNBC) for the major U.S. indices---and for non-U.S. indices and U.S. sectors---using index ETFs as our non-U.S. and sector proxies:

Dow Jones Industrials:  -0.75%%

S&P 500:  +2.18%

NASDAQ Comp:  +8.26%

EFA (Europe, Australia and Far East):  +6.48%

FEZ (Eurozone):  +4.67%

VWO (Emerging Markets):  -4.27%

Sector ETFs:

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

IYH (HEATHCARE):  +13.21%




XLK (TECH):  +2.97%



XLB (MATERIALS):  -5.41%

XLU (UTILITIES):  -6.84%

IYT (TRANSP):  -8.25%

XLE (ENERGY):  -12.35%

The Bond Market:

As I type, the yield on the 10-year treasury bond sits at 2.19%. Which is 10 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 0.94%  over the past 5 trading days (down 2.69% 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.

On Volatility and Timing:

Each week I share with you the very short-term (year-to-date) results for major indexes 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). While my beginning of the year optimism over non-US (developed markets that is) and the housing sector, and my 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 thus far in 2015. Plus, while we maintained our healthcare exposure I in no way expected the gains that sector has experienced this year. Same goes for energy, materials and emerging markets, only in the other direction.

My optimism or concern over a given sector or region is based on factors such as valuations, trends, supply and demand, monetary policy and cyclicality. 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:

JULY 27, 2015

DURABLE GOODS ORDERS for June came in decent... Here's Econoday:
June was a strong month for durable goods orders which rose a slightly higher-than-expected 3.4 percent. Excluding transportation, which is where aircraft orders are tracked, new orders rose 0.8 percent which is near top-end expectations. Core capital goods orders, which also exclude aircraft, rose a very solid 0.9 percent. These readings are some of the highest of the last year and offer welcome evidence of a long awaited pop higher for what is, however, a still depressed factory sector.

Turning briefly to civilian aircraft, orders surged 103 percent after falling 46 percent in May. Swings in aircraft are common in this report and reflect monthly swings in Boeing orders. Other industries include a small gain for motor vehicles and for computers & electronics as well as large gains for machinery and fabricated metals. In a hint of strength for the construction sector, electrical equipment jumped an especially sharp 2.8 percent in the month.

Turning back to totals, shipments inched 0.1 percent higher with shipments of core capital goods edging 0.1 percent lower and including downward revisions to both May and April. The shipment readings for capital goods will not be lifting second-quarter GDP estimates for business investment. Unfilled orders ended two months of contraction with a 0.1 percent gain while inventories rose 0.4 percent, a modest build that keeps the stock-to-sales ratio unchanged at 1.68.

This is only the third monthly gain for durable goods orders going all the way back to July, which was before of course the drop in oil prices and rise in the value of the dollar, the former having torpedoed the energy sector and the second having flattened the nation's exports. Today's report will confirm for many expectations that the negative effects of the strong dollar on exports are beginning to ease.

DALLAS FED MANUFACTURING SURVEY for July shows a continued contraction in the Texas manufacturing sector, although the pace of decline has slowed. Clearly, weakness in the energy sector has been a major contributor. One major brightspot is the first time this year increase in new orders. Another is the company outlook, which also broke into the positive for the first time this year. In a nutshell, it was an overall negative report with perhaps a couple of green shoots emerging.

JULY 28, 2015

THE JOHNSON REDBOOK RETAIL REPORT has been consistently the weakest retail indicator I track of late. Up only 1.0% last week. The report cites the heat of late July as being the cause for an often slow period of sales.... It expects a pick up in mid-August (back to school season)...

THE ICSC RETAIL REPORT has been a more optimistic read on the the sector, up 2.2% last week.

With regard to retail, I should note that Amazon posted huge revenue and earnings beats for Q2. Clearly, online is taking a bite out of brick and mortar.

THE CASE-SHILLER HOME PRICE INDEX, surprisingly, came in at -.2% in May. Year-over-year prices rose 4.9%. Price concessions could be a factor.

MARKIT'S FLASH SERVICES PMI came in at a solid 55.2 for July. Here's Econoday:
Service sector growth is strengthening slightly this month based on Markit's July flash index which is up 4 tenths to a very solid 55.2. New orders are at a 3-month high and are getting a boost from both consumer spending and from business customers, the latter a welcome signal of strength for business investment. Backlogs are up and so is hiring. But optimism in the 12-month outlook, perhaps shaken by the outlook for the global economy, is the softest it's been in three years. Input prices continue to rise but final prices are flat. This report is mostly upbeat and, despite the easing in the outlook, points to solid contribution from the service sector.

THE CONFERENCE BOARD'S CONSUMER CONFIDENCE INDEX FOR JULY comfirms the findings in other reports that the consumer's confidence is waning. Weakness in this report showed up in the expectations component. The present situation component wasn't awful , however, a drop in buying plans for autos is not a good sign. The overall index came in at 90.9, vs 101.4 in June and a consensus estimate of 99.6. I suspect the highly publicized fear over China's economy and the Greece mess had something to do with the souring sentiment. I look for a bounce in next month's report.

THE RICHMOND FED MANUFACTURING INDEX came in surprisingly above estimates, at 13, versus the consensus estimate of 7.5. New orders, backlog orders, shipments and capacity utilization are all up. Inventories, consequently, are down---which speaks positively about future production. Such positive reports on manufacturing have been virtually non-existent of late.

THE STATE STREET INVESTOR CONFIDENCE INDEX fell noticeably in July, to 114.6 from 127 in June. Confidence toward North America declined while Asia picked up slightly and Europe declined slightly.

JULY 29, 2015

MORTGAGE PURCHASE APPS barely budged last week, down .01%, while refis rose 2% amid a falling 30-year average rate to 4.17%. Year over year purchase apps, however, are up a whopping 18%.

PENDING HOME SALES took a surprising hit in June, down 1.8%. The consensus had them rising 1%. Weekly numbers can be extremely noisy and, at this juncture, shouldn't deter the bullishness (that I share) around housing going forward.

CRUDE OIL INVENTORIES declined 4.2 million barrels last week, after increasing 2.5 million the week prior. Refiners remain in overdrive, running at 95.1% of capacity. While the per barrell price spiked on the news, it finished the week lower. GASOLINE inentories declined by .4 mbs while DISTILLATES rose by 2.6 mbs.

THE FOMC WRAPPED UP ITS TWO-DAY POLICY MEETING with a unanimous vote to keep the fed funds rate as is. Clearly, global events have them a bit concerned as the post-meeting anouncement offered no strong evidence that a September rate hike is a given.

JULY 30, 2015

SECOND-QUARTER GDP came in at 2.4%, vs expectations of a 2.9% increase. Consumption rose nicely while capex and government spending weighed on the number. This neither bolsters nor hinders the Fed's prospects for hiking the fed funds rate in September.

WEEKLY JOBLESS CLIAMS came in very low once again, at 267k, following last week's 40-year low 255k (that was influenced by auto plant retooling timing). The 4-week average sits at 274.5k.

THE BLOOMBERG CONSUMER COMFORT INDEX continued its descent last week, coming in at 40.5, vs 42.4 the previous week. I suspect Greece, China and market volatility combined to rattle the consumer's nerves.

NATURAL GAS INVENTORIES rose yet again by 52 billion cubic feet.

FARM PRICES decined 1.9% in July.

THE FED BALANCE SHEET declined by $15 billion last week, while RESERVE BANK CREDIT declined by $4.5 billion.

M2 MONEY SUPPLY growth seems to be unstoppable of late (a positive sign for future consumption), rising last week by $18.3 billion.

JULY 31, 2015

THE EMPLOYMENT COST INDEX budged ever so slightly in Q2, up .2%. I suspect Q2's reading will prove to be a recovery outlier, as there are plenty of indicators suggesting the labor market is tightening. This report will embolden those who argue against a fed funds rate hike this year.

THE CHICAGO PMI surged to 54.7 from last month's contractionary reading of 49.4. The report shows a 6-month high for new order growth and production.

THE UNIVERSITY OF MICHIGAN CONSUMER SENTIMENT INDEX for July confirms what other such surveys suggest, that the consumer isn't feeling as good about his/her prospects as he/she was just a month ago. Again, international and market uncertainty are no doubt taking their toll.


  1. […] reserve currency). I also included IMF commentary on China’s economy that reiterates what I’ve been reporting about its move to a more services/consumer-oriented economy and the resulting slower GDP […]

  2. […] world reserve currency). I also included IMF commentary on China’s economy that reiterates what I’ve been reporting about its move to a more services/consumer-oriented economy and the resulting slower GDP […]

  3. […] world reserve currency). I also included IMF commentary on China’s economy that reiterates what I’ve been reporting about its move to a more services/consumer-oriented economy and the resulting slower GDP […]