So apparently China is the new Greece. I.e., it seems like only yesterday, because it virtually was, that the world was all sideways over the Greek debt/political crisis. At the time, I reported to you that the size of Greece's economy placed it somewhere between Minneapolis and Miami---so don't sweat it (so much). Ah but China. China is a monster of an economy! Second only in size to the U.S.. Therefore, absolutely, we should be concerned about the state of its economy. Right?
Well, as the markets have dictated of late, of course! But to what extent? Good question! Let's noodle on that for a minute:
When China sneezes Apple seems to catch a cold. Why? Because Apple's sales to greater China account for roughly 30% of its revenue. That's big! Need I say more? Well, yeah, I need say more!
While China is a very big deal to Apple, using the same equation, is it a very big deal to the U.S. in the aggregate?
Well, not so much. The sum annual total of U.S. exports to China adds up to merely 0.7% of the U.S. economy. So let's say that China's economy slows to, say, 6%---which is 15% below its 2015 goal of 7%. And let's say that that slowdown equates to a 15% decline in U.S. exports to China. Well, then China's contribution to the U.S. economy drops to 0.6%. So, no big deal! Right?
Well, not so fast! China's economic well being is indeed consequential to the rest of the world. And the rest of the world is indeed consequential to the U.S.. But to what extent? To what extent do total U.S. exports contribute to U.S. GDP? Great question! The answer: A mere 13%. Hmm...
So am I saying that since 87% of the U.S. economy is not dependent on other nations buying U.S. stuff that we shouldn't concern ourselves if the rest of the world takes an economic nap for a few months, or years? Well, no. You see trade is a two-way street. And, as you may know, we Americans buy lots of stuff (lots of stuff!!) made on other shores; $2.3 trillion worth last year alone! So, indeed, the health of other nations, their ability to grow, to educate their people, to innovate and produce certain goods more efficiently than we can here at home is in no uncertain terms very important to us. So let's noodle on that for a minute.
We need a healthy China, no doubt about it. And as it attempts to reorient its economy toward services, the manufacturing sector remains its bread and butter for now. And while the stuff the Chinese buy from us doesn't register much in terms of the size of our economy, the stuff we buy from them is indeed consequential to their economy. China's exports account for nearly a fourth of its GDP. And sales to the U.S. account for roughly 20% of the total. So then, we must ask ourselves, as we get our heads around the present, and future, state of China's economy, shouldn't we direct our attention to the economic health of its largest trading partners (the U.S. and the Eurozone [China's biggest partner BTW])? Of course we should! For, surely, the health of any organization rides on the wherewithal of the individuals and institutions it caters to.
So how are the economies of China Inc.'s largest customers doing? Well, as for the U.S., pretty darn good. While I can drown you in charts, suffice it to say that when housing starts are at an 8-year high, auto sales are near an all-time record, jobs are being created at a 2 million+ annual pace and the most recent Institute for Supply Management's Non-Manufacturing (i.e., service sector---which IS the U.S. economy) Index (a gauge of conditions derived from a survey of the source) sits at its highest level in 11 years, the U.S. economy is a-okay for the time being.
And what about Europe? While I can't say that Europe's economy is quite the success story the U.S.'s has been of late, I can tell you things are looking up. Here's a year-to-date look at the Eurozone Composite (includes manufacturing and services) Purchasing Managers' Index (above 50 denotes expansion): click chart to enlarge
And here's Citi's Eurozone Economic Surprise Index (compares results with economist's expectations) since the end of May. click chart to enlarge
So should the world be fretting to the extent it is over the prospects for the Chinese economy? Considering the above, and---to add one more---considering China's massive consumption of oil (and you know what oil prices are doing [talk about your economic stimulus!]), I don't believe the world has the story quite right---at least not for the moment.
But what about the stock market? Recent action suggests China is indeed a very big deal! Now that I can't deny.
As China struggles to reorient to a more consumer-driven economy and, consequently, its growth slows to a safer and more manageable single-digit pace, the rest of the world---having grown accustomed to years of China growing in the double-digits and, therefore, having expanded its production (of commodities) capacity to meet China's demand---is having a tough time adjusting. We're seeing that play out markedly in commodities prices and, consequently, in the economies that are driven by commodities production---and in the stock prices of commodity-producing companies, and in the stock prices of the companies that provide products and services to the commodity-producing companies, and in the stock prices of the companies that provide products and services to the companies that provide products and services to the commodity-producing companies, and so on.
Ugh! No wonder the market's getting creamed! The pain felt by commodity-producing countries and companies is rippling through to the rest of the market. Right? Well, maybe. But if bear markets are typically things of recessions, which they typically are, falling commodity prices wouldn't typically be something the long-term investor would stress over. Quite the contrary in fact---as the following chart illustrates. Notice the trend in commodity prices leading into and out of recessions. As you can see, high commodity prices typically set the recessionary stage, while low commodity prices tend to help stimulate the economy back to life.
(recessions are in red, the white line represents the JOC-ECRI Industrial Price Index and the yellow is crude oil) click chart to enlarge
Here's Josh Brown having fun with the fear over low oil prices (read the complete article as he does the same on corporate cash, housing, etc.). HT Jeff Miller:
I bring you terrible news.
Oil prices have plunged to the point where it hasn’t been this cheap to fill up your gas tank in over a decade. Businesses that count energy as an input cost will be forced to figure out what to do with the excess capital they’re not spending on fuel.
And, lastly, on China, I don't want to come off overly sanguine. Truly, China has its issues. Not the least of which being the last few years of mounting private sector debt and a much-advertised property bubble. That said, the knockout punch is virtually never the one the fighter sees coming. I.e., the Chinese government acknowledges these issues, and with its massive store of foreign reserves and its willingness to absorb the shocks that might bring other economies to their knees, I don't suspect that China's economic day of reckoning is yet at hand.
Moving on:
I received an email amid last week's selloff from a client asking if I feel the stock market will see a near-term bounce. Here's my reply:
Yes I do, actually.... The most likely very near-term catalyst would be a Bank of China interest rate cut, reserve req cut, etc... Plus, the technicals suggest the market's way oversold... typically a short-term bounce would be in the cards...
The dollar took a hit today against most major currencies. That, to me, is a sign that currency traders think all the current angst will take a 2015 Fed hike off the table. If the equities markets get a whiff of that, I expect a bounce. Personally, I'd rather feel more pain for now and get the Fed off of zero sooner than later (thinking longer-term)...
Bottom line: This is the market finally exhibiting a little normalcy. It's been four years since we've had a 10-20% correction (we're there in the Dow [10%], not quite in the S&P)... Barring a recession (not in the indicators presently for the U.S.), history strongly suggests we don't have a great bear market looming...
Of course "near-term" is subjective. To my friend it may mean Monday, to me it may mean sometime in November.
As I suggested in my reply, and reported to you last Thursday and Friday, the history of experiences like last week's points to the high probability of a near-term bounce. But please make note of my view that more pain now would make for a more favorable longer-term experience.
Man, we need rain!!
I, and the majority of my readers, reside in California's Central San Joaquin Valley. We have "enjoyed" an unusually long stretch of warm weather and sunshine. So much so that we now have a liquidity problem. I.e., we haven't had nearly enough rain/snowfall the past few years and, therefore, our wells are drying up, our farming industry is in jeopardy and our skies to the east are thick with the smoke of out of control wildfires. While inclement weather will force my neighbors and I off of the golf courses, the outdoor basketball courts and our favorite fishing holes, we know we need it in the worst way.
U.S. equity investors have experienced an unusual period of warmth and sunshine. And while the parched ground under a correctionless stock market is far less noticeable than that of a waterless Fresno County farm, understand that it's there nonetheless. Yes, I equate stock market corrections to real world rainstorms. They are absolutely essential to the overall health of the market and the economy. Without them, stock prices would extend toward the sky, unsuspecting individual investors would throw caution to the wind and plant every penny to their names into the market---sucking every drop of liquidity (ready cash to buy the dips) out of the ground until it cracks and gives way to a great bear market that would swallow their life savings. Leaving them stricken with panic and eventually selling the remnants of their portfolios to the Warren Buffets of the world, who will hold patiently while the soil---then fertilized by the rotted froth that accumulated during the overdone expansion---soaks up the rain and ultimately bursts forward the next great expansion/bull market.
Folks, I know last week made you nervous. But understand that intermittent corrections are blessings to bull markets---and we're way overdue! As I've been reporting, the ground under today's stock market (the economy) tests pretty good for now. So, at this juncture, the worst case scenario is likely the long-overdue 10-20% correction (i.e., it could get worse before it gets better). Although, and of course, I make no guarantees---in one direction or the other...
The Stock Market:
Non-US developed markets (EFA and FEZ below)—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 (particularly emerging markets [VWO below]). 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: -7.65%
S&P 500: -4.27%
NASDAQ Comp: -0.63%
EFA (Europe, Australia and Far East): -1.51%
FEZ (Eurozone): -3.62%
VWO (Emerging Markets): -15.39%
Sector ETFs:
Here’s a look at the year-to-date results for a number of U.S. sector ETFs:
XHB (HOMEBUILDERS): +9.20%
IYH (HEATHCARE): +5.99%
XLY (DISCRETIONARY): +3.06%
XLP (CONS STAPLES): -1.61%
XLK (TECH): -4.33%
XLF (FINANCIALS): -4.41%
XLU (UTILITIES): -4.60%
XLI (INDUSTRIALS): -9.05%
XLB (MATERIALS): -11.10%
IYT (TRANSP): -13.74%
XLE (ENERGY): -19.78%
The Bond Market:
As I type, the yield on the 10-year treasury bond sits at 2.05%. Which is 15 basis points lower than where it was when I penned last week's update. I.e., bond prices rallied hard last week as stocks tanked.
TLT, an ETF that tracks an index of long-dated U.S. treasury bonds, saw its share price rise by 1.97% over the past 5 trading days (up 0.38% 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 and materials, only in the other direction.
My optimism or concerns over a given sector or region are based on factors such as valuations, trends, supply and demand, 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.
Last week's U.S. economic highlights:
AUGUST 17, 2015
THE EMPIRE STATE MFG SURVEY surprisingly plunged in August, -14.92 vs 4.75 consensus estimate. Despite all the negative current numbers, the six-month outlook was optimistic. Here's from the release:
The August 2015 Empire State Manufacturing Survey indicates that business activity declined for New York manufacturers. The headline general business conditions index tumbled nineteen points to -14.9, its lowest level since 2009. The new orders and shipments indexes also fell sharply, to -15.7 and -13.8 respectively, pointing to a marked decline in both orders and shipments. The inventories index dropped to -17.3, signaling that inventory levels were lower. Price indexes showed that input prices were slightly higher, while selling prices were flat. Labor market indicators suggested that employment levels and hours worked were little changed. Indexes for the six-month outlook registered somewhat greater optimism than in July, with the future general business conditions index rising seven points to 33.6.
THE NAHB HOUSING MARKET INDEX FOR AUGUST confirms my year-long optimism over housing in the U.S. Coming in at 61... Above 50 denotes optimism.
E-COMMERCE RETAIL SALES FOR Q2 came in at a very strong 4.2% gain. As I've suggested before, some of the periodic weakness in brick and mortar can be explained by the consumer's move to do more buying on line.
THE TREASURY INTERNATIONAL CAPITAL DATA FOR JUNE show foreigners buying U.S. long-term securities. Here's Econoday:
Strength in the dollar may be hurting exports but it's a definite plus for foreign investment. Foreign accounts bought a net $87.2 billion of U.S. long-term securities in June while U.S. accounts sold a net $15.9 billion of long-term foreign securities. Putting these together, inflow into the U.S. totaled a very strong $103.1 billion. This compares with a very strong inflow of $93.0 billion in May.
Foreign accounts were major buyers of U.S. Treasuries in June, at a net $69.9 billion. They were also big buyers of U.S. government agency bonds, at a net $25.6 billion, and also U.S. corporate bonds at $13.8 billion. But foreign accounts have been selling U.S. equities all year and the pace picked up in June to a net $22.0 billion.
On the U.S. side, accounts were big sellers of foreign bonds, at a net $29.3 billion, but were buyers of foreign equities, at $13.4 billion.
Country data for U.S. Treasury holders show China once again at top, unchanged at $1.27 trillion, and Japan a more distant second at $1.20 trillion vs $1.22 trillion in May. Caribbean banking centers, the favorite of hedge funds, is third at $319 billion.
AUGUST 18, 2015
HOUSING STARTS rose nicely in July, to 1.206 million vs 1.174 m in June. However, permits plunged, which signals weakness coming in the next monthly starts report. Although much of the permits plunge is explained away by the expiration of a tax incentive in the Northeast that pushed permits much higher in June. The July decline, therefore, made perfect sense. Still, we should expect somewhat of a decline in the August starts number.
THE JOHNSON REDBOOK RETAIL REPORT showed slower growth last week, vs the previous week, coming in a 1.6% year-on-year.
THE ICSC RETAIL REPORT backed off a bit as well, dropping to 2.6% vs 3.10% the previous week.
AUGUST 19, 2015
MORTGAGE PURCHASE APPS declined 1.0% last week while refis surged by 7.0%. Despite the weekly decline, purchase apps are up a huge 19% year-on-year.
JULY CPI barely budged. Here's Econoday:
Inflation wasn't brewing in July and with oil prices moving lower, inflation may not be showing much pressure in August either. The consumer price index rose only 0.1 percent in July as did the core, both under expectations. Year-on-year rates show slightly more pressure. Overall inflation is up 0.2 percent, which is very low but up from 0.1 percent in the prior month and the second positive reading of the year. The core is steady at plus 1.8 percent which is just under the Fed's 2 percent target.
Gasoline moved sharply higher in July, up 0.9 percent following outsized gains of 3.4 percent and 10.4 percent in the prior two months. But with gas prices moving steadily lower this month, the upward effects of gasoline will be turning downward in August. Another major component showing upward pressure in July is apparel which rose 0.3 percent following, however, a long string of declines. Owners equivalent rent continues to show pressure, up 0.3 percent on top of June's outsized gain of 0.4 percent.
Elsewhere, however, pressures are hard to find with electricity down 0.4 percent, used vehicles down 0.6 percent, new vehicles down 0.2 percent, and airfares down 5.6 percent. Medical, drugs, and education all rose only 0.1 percent.
There may be some upward creep in the headline year-on-year rates but, given the ongoing decline in oil, this report won't be pushing the Fed for a September rate hike.
OIL INVENTORIES grew last week by 2.6 million barrels. GASOLINE stocks fell by 2.7 million barrels while DISTILLATES grew by .6 mbs.
FOMC MINUTES for last month's meeting offered little clue as to when the Fed will hike the funds rate. However, there is a consensus building that it needs to occur sooner than later. Likely this year...
AUGUST 20, 2015
WEEKLY JOBLESS CLAIMS logged yet another sub-300k number (277k). This points strongly to continued strength in the labor market!
THE BLOOMBERG CONSUMER COMFORT INDEX broke the recent trend, registering a increase to 41.1 from the prior week's 40.7. However, given the influence the stock market seems to have on consumer sentiment readings, such surveys could get ugly in the coming weeks.
THE PHILADELPHIA FED BUSINESS OUTLOOK SURVEY effectively countered Monday's disaster of an Empire State report. Here's Econoday:
That sigh you hear is one of relief, that Monday's historic plunge in the Empire State report is probably a fluke. The Philly Fed's index, which is very closely watched, posted a gain for August and not a huge plunge. The general business conditions index came in at a stronger-than-expected 8.3 vs July's 5.7. Shipments lead the report at a very strong plus 16.7. Order data show less strength, with new orders at 5.8 in August vs 7.1 in July and with unfilled orders showing a slight month-to-month decline at minus 1.0. A positive in the report is a respectable monthly gain for employment to 5.3 vs July's contraction of minus 0.4. The 6-month outlook is also a plus, up 1.6 points to a solid 43.1. The early view on the August factory is thankfully mixed. Watch tomorrow for the manufacturing PMI flash.
EXISTING HOME SALES confirm the optimism over housing I've expressed since the start of the year. Here's from the release:
Total existing-home sales1, which are completed transactions that include single-family homes, town homes, condominiums and co-ops, increased 2.0 percent to a seasonally adjusted annual rate of 5.59 million in July from a downwardly revised 5.48 million in June. Sales in July remained at the highest pace since February 2007 (5.79 million), have now increased year-over-year for ten consecutive months and are 10.3 percent above a year ago (5.07 million).
Lawrence Yun, NAR chief economist, says the increase in sales in July solidifies what has been an impressive growth in activity during this year's peak buying season. "The creation of jobs added at a steady clip and the prospect of higher mortgage rates and home prices down the road is encouraging more households to buy now," he said. "As a result, current homeowners are using their increasing housing equity towards the down payment on their next purchase."
THE CONFERENCE BOARD'S INDEX OF LEADING ECONOMIC INDICATORS declined 0.2% in July. Apparently the sharp drop in housing permits in the Northeast (following the previous month's surge inspired by the expiration of a tax break) noticeably influenced the overall number. Here's from the release:
“The U.S. LEI fell slightly in July, after four months of strong gains. Despite a sharp drop in housing permits, the U.S. LEI is still pointing to moderate economic growth through the remainder of the year,” said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. “Current conditions, measured by the coincident economic index, have been rising moderately but steadily, driven by rising employment and income, and even industrial production has improved in recent months.”
NATURAL GAS INVENTORIES increased yet again last week, by 53 billion cubic feet.
THE FED BALANCE SHEET decreased by $2.0 billion last week after increasing by $2.9 billion the week prior. RESERVE BANK CREDIT increased by $10.5 billion.
M2 MONEY SUPPLY growth has been unstoppable for weeks. Up another $26.5 billion last week. This bodes well for the U.S. economy going forward.
AUGUST 21, 2015
FLASH MANUFACTURING PMI for August came in at an expansionary 52.9. Although that's the slowest pace recorded since October 2013. Here's Econoday:
Monthly growth in Markit's manufacturing PMI sample is at its slowest since October 2013, at a much lower-than-expected 52.9 in the flash for August. A slowing in production growth pulled the index down as did moderation in what is still described, however, as solid growth in new orders. But export sales remain subdued and capital spending in the energy sector remains weak. Growth in hiring is the weakest since July last year.
This report follows mixed signals from yesterday's Philly Fed, which was solid, and Monday's Empire State which was a disaster. Today's report is also mixed with broadly weak indications offset by the continued strength in domestic orders. Next indications on August factory conditions will be Tuesday with the Richmond Fed.
[…] began this weekend’s commentary by telling of the question a friend asked me yesterday. He simply wanted to know why the market […]
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