Why the Fed Minutes Matter

Yesterday’s release of the Fed Minutes from the April FOMC meeting did not reveal much; however, the market reacted in a slightly dovish manner as the dollar fell back from the highs and stocks rallied modestly.

The Fed Minutes showed that most FOMC members thought that it would be premature to raise interest rates in June, which according to Fed Funds Futures, the market was already expecting.

The financial media spun the Fed Minutes as “dovish” with multiple headlines stating “June is off the table.” Well, June was never “on” the table from a market expectation standpoint, so that is nothing new.

But, why June is off the table is what made these Fed Minutes matter.

Most FOMC members had June off the table because there wouldn’t be enough time for data to conclusively show that it is ok to raise interest rates. It was a time issue, and not one of concern for the economy. In fact, the FOMC seemed to agree that the reasons behind the economic weakness were transitory, and that they collectively expected a solid “bounce back” in Q2 after the Q1 weakness.

Point being, there is plenty of time and data for a September hike, even though it’s only considered a remote chance by the market. If we see two strong jobs report, maybe even a July hike—although admittedly that’s a long shot.

Bottom line: yesterday’s Fed Minutes release was largely in line with market expectations, but the reiteration of “data dependent policy making” will cause investors to continue to watch economic data very carefully going forward—notably the CPI number released Friday morning.

Also, given that yesterday’s Fed Minutes were pretty stale coming from the April meeting, Fed Chair Yellen’s speech at 1:00 p.m. Friday will be closely watched as market participants look for further clues and updated Fed commentary on the state of the economy and when the first rate hike may potentially happen.

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Natural Gas is Heating Up

Natural gas futures are heating up, and on Thursday the energy commodity rallied sharply on inventory data. The gains in nat gas helped push the benchmark commodity tracking index ETF, the PowerShares DB Commodity Tracking ETF (DBC), up 0.60% on the day. DBC now is hovering just below its recently established 2015 high.

Natural gas was, in fact, the big mover in the commodity space Thursday, rallying about 2.5% in the session to break through the $3 mark as the Energy Information Agency (EIA) reported a smaller-than-expected supply build of 111 Bcf vs. (E) 121 Bcf in the weekly nat gas inventory report.

The smaller supply build carried natural gas prices to their highest level since mid February, and futures now have officially entered bull market territory as they’ve traded just over 23% higher since the late-April lows.

natural gas

UNG is the benchmark natural gas ETF

Natural gas futures have benefited from a crowded short side of the market being forced to buy back positions as the market gained upside momentum, as well as a hotter-than-expected start to summer leading to increased natural gas power demand thanks to heightened air conditioner usage across much of the East Coast.

Bottom line: the fundamentals of natural gas are difficult to read out for much more than about two weeks, as the extended weather forecasts are driving the market from a demand standpoint. However, natural gas futures have established a well-defined uptrend that could see futures rally as high as $3.50 in coming weeks. But, keep in mind the move is largely all about weather right now, so if you are a buyer beware of the “Mother Nature” factor.

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Are Gold Futures Becoming Oversold?

Precious metals have been a very boring sub-sector of the commodity markets to watch over the past six weeks, and Monday was no exception as gold futures drifted sideways to close the day almost perfectly unchanged. But, looking past the tight range of the daily chart that has had gold futures corralled between $1,180 and $1,210ish for weeks now, there has been an underlying development in a key, concurrent indicator—the Commitment of Traders Report published by the CFTC.

When looking at the “COTs,” the Net Long Positions held by Money Managers on gold futures are a concurrent indicator that generally rise when the price of gold rises, and fall when the price of gold falls—and usually with pretty high correlation.

But, gold futures Net Longs held by Money Managers can also begin to offer gold futures traders with a contrarian signal when relatively high levels or low levels are reached, as they begin to forecast overbought or oversold market conditions.

gold futuresRight now, Net Longs on gold futures are approaching the low end of the spectrum at just 22,857 (suggesting futures may be potentially oversold). To put this in perspective, during the early 2015 gold rally that saw prices reach $1,300, Net Longs rapidly rose to 153,237, which is towards the high end of the range of recent years (suggesting the market may potentially be overbought).

Now, the way the indicator works is primarily based on the trend of the COTs, so just because Net Longs are currently low, it does not mean you should go out and buy gold. Rather, when net longs reverse direction and begin to move higher it is a signal that a new uptrend is potentially in the early stages of forming.

Bottom line: based on the internal indications that the COT report provides us with, gold futures are nearing “oversold” conditions and we will continue to watch the weekly report to stay ahead of a potential move developing in the near term.

If we see an uptick in gold futures net longs, and the technicals of the gold market agree, we will be inclined to initiate a long position in gold.

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April Jobs Report Preview

When the Fed will finally raise rates remains the No. 1 headwind on stocks medium term, so this April jobs report is once again very important with regards to answering that question.

Not to be depressing, but the outcome from this jobs report, regardless of the number, will likely be negative for stocks beyond any immediate reaction. The reason I say that is because market expectations of the Fed remain fully “dovish.” Entering the April jobs report, there is no expectation of a rate hike in June or July, only a small chance of a hike in September, while October is “consensus” although there is a growing chorus of people who don’t think we’ll get anything until 2016.

So, within this context, if the April jobs report number is “Too Hot” it puts a June/July hike in the realm of possibility, and makes September more likely. Neither of those events are priced into stocks or the dollar.

If the jobs number is “Too Cold” it means the expected Q2 economic rebound, which is currently priced into stocks, isn’t turning out as we expected, and that will exert downward pressure on stocks. Finally, if it’s “Just Right” we remain in Fed rate-hike limbo, which isn’t the positive catalyst we need for materially higher equity prices.

The official estimate is 230k jobs added, but with the ADP miss Wednesday morning the whisper number will almost certainly come down to around 200k or slightly lower. Below we have our typical “Goldilocks” jobs report preview, along with anticipated market reaction.

For reference, “hawkish” and “dovish” asset class reactions are provided below:

Hawkish Reaction: Stocks down, bonds down, commodities down, dollar up.

Dovish Reaction: Stocks sideways to down, bonds up, commodities up, dollar down.

The “Too Hot” Scenario

> 200k Job Adds. I realize that this “Too Hot” number is below the consensus of 230k, but this isn’t a typo. If we get job adds of 200k and some positive revisions to the March data, June/July will remain remote possibilities for a rate hike, but September becomes much more likely as a lift off date. That is not priced into stocks at these levels.

< 5.4% Unemployment Rate, ≤ 10.9% U-6 Unemployment Rate. In the March statement the Fed lowered “NAIRU” to 5.0% and below, but if we continue to see both unemployment rates grind steadily lower, again in the context of a “fully dovish” expectation by the market, this will elicit a hawkish reaction because it’ll make a September hike more likely.

> 2.2% yoy wage increase. YOY wage gains moderated a bit in the March report (up 2.1% yoy) but it’s still sitting near the Fed’s upside target (2.2%). If we see a move back above that 2.2% annual gain, that will be yet another sign that inflation is bottoming. Again, that will elicit a “hawkish” reaction.

The “Just Right” Scenario

170k—200k Job Adds/ 5.5% Unemployment Rate, ≤ 2.2% YOY wage increase. It’s hard to call this the “Just Right” scenario because that title implies the market won’t react, and that’s probably not the case. It will be near impossible to have a “Just Right” outcome from this jobs report because if it broadly meets expectations, it just keeps the markets in limbo with regards to the first rate increase, which as we have said repeatedly is a headwind on stocks.

The “Too Cold” Scenario

< 125k Job Adds. Another big miss will likely push out Fed lift off expectations, but don’t expect it to result in a material rally in stocks. A weakening economy in the context of perma-zero interest rates is not what stocks need to really break out, and if there is any short-term rally on a “dovish” reaction then that rally in stocks should be faded/sold by short-term traders.

Bottom Line

Almost all the risk into this jobs report number is to the downside for stocks short term, although the more “positive” scenario will be for a strong jobs report number. While it may cause some immediate selling in stocks, that is a dip we will look to buy, specifically in select, higher-rate sectors and inverse bonds positions.

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Commodity Prices are Up, Up, Up

Commodity prices were mixed yesterday, as oil futures recovered from morning losses to finish essentially flat. Precious metals bounced, while copper prices were flat. The benchmark commodity prices tracking ETF, DBC, was unchanged on the day.

The action Monday is a rare calm day of late for commodity prices; as they have been going up, up, up for most of the past month.

The aforementioned commodity tracking ETF, the PowerShares DB Commodity Index Tracking Fund (ETF) (NYSEARCA:DBC), is up nearly 6% in the past month, or more than double the performance of the S&P 500 Index.

Commodity prices

In Monday trade, gold was among the best performers among commodity prices, rallying 1.20% as technical traders looked to defend the lower end of the recent trading range at $1,180. Futures materially violated the level during Friday’s session, reaching a six-week low tick of $1,168.40. Friday’s drop was in essence a miniature “panic sell-off” as traders had become too long going into last week’s Fed announcement, betting on a dovish outcome.

However, with the unexpected and “slightly” hawkish outcome, the long trade quickly started to unwind, and then accelerated amid some hotter-than-expected inflation data (primarily the Employment Cost Index that came in above expectations). Yesterday we also saw some of the trade reverse as buyers started to come in on the dip to get positioned ahead of the main economic focus of the week—the April jobs report.

Gold will likely be sensitive to both the ADP employment report Wednesday, and the Weekly Jobless claims report Thursday, as traders watch the two reports closely during jobs week. Of course, the BLS report Friday morning will be the main event for the precious metals market this week.

Copper is another among the commodity prices going up, up, up. Although Monday copper took a breather from its recent, seven-session surge, the copper market continues to be a very volatile and dangerous market, as some of the recent intraday swings are the types that can clear a commodity trader’s account if he or she is trying to trade against the trend.

Copper futures continue to benefit from renewed stimulus chatter and fundamental shorts being caught off guard by the recent strength, and getting squeezed out of the market. Near term, the bulls continue to have momentum on their side but futures have stalled at a multi-year downtrend line that dates back to 2011, and that sits roughly at $2.93. Given that this is a multi-year resistance level, it would take several closes, and really a weekly close or two, to decisively break the trend.

Finally, oil futures were little changed to start the week after last week’s rally to new 2015 highs. Oil came within $2 of the next resistance level of $62, which also happens to be our initial upside target for this recent counter-trend rally. On the charts, we are looking at last week’s highs just below $60/barrel as the level to beat this week, while trend support is closing following the market, edging up to around $59.25.

The bottom line is that the medium-term trend, at least over the past month, has been bullish for commodity prices. If this trend continues, it will translate into renewed opportunities to profit in the space.

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Inflation is Back

The latest data is in, and it seems like we now can say with confidence that inflation is back.

A look at yesterday’s PCE Price Index & Employment Cost Index numbers demonstrates that indeed, inflation is back.

The Core PCE Price Index rose 1.4% year over year, which met expectations. The Employment Cost Index rose 0.7% vs. (E) 0.6%, and 2.6% year over year.

This tells us that inflation is back, and that it continues to firm domestically. The Employment Cost Index printed a bit hotter-than-expected in Q1, and the year-over-year increase of 2.6% is the highest since 2008.

So, in addition to the growing list of companies saying they are increasing wages (Walmart (WMT), Target (TGT) and others) the broad economic data does further imply that wage inflation is back, and finally, on a sustained rise.

Turning to the broader measure telling us inflation is back, a.k.a. the Core PCE Report, it was mostly in line with expectations. Interestingly, though, while the month-over-month increase was written as .01%, it was actually .0148%.

Taken out to the third decimal, this is the largest monthly increase since June—even more statistical confirmation that inflation is back.

Now, I realize that taking this number out to the third decimal is nitpicking a bit, but the point here is that it’s another sign that inflation is firm, and that inflation is back.

From a market standpoint, these numbers “punched above their weight” yesterday (sorry, I have boxing on my mind with the upcoming fight on Saturday) and caused a market decline, not because they were materially negative, but because the market outlook for the Fed is fully dovish.

That’s why we’ve been pointing that out that the “too dovish” expectation sets up for disappointments from data that isn’t that “hawkish,” just like we saw yesterday.

For markets, this confirmation that inflation is back means the risk from overly dovish Fed expectations isn’t over yet. It also sets us up for gains in sectors such as resources, which benefit from inflation.

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A Resources Trade Update

Since the March FOMC meeting, where the Fed was surprisingly “dovish” and effectively capped the dollar rally, we have been cautiously bullish on the resources trade. The basic thesis was that between the Fed capping the dollar, low valuations, potentially bottoming inflation and 24 global central banks easing policy, the risk/reward in a bombed out resources trade was worth some risk capital.

While we’ve been following the resources trade, and keeping you updated on the FlexShares Mstar Glbl Upstrm Nat Res ETF (GUNR), we haven’t added it to our “7 Best Ideas” yet be-cause I wanted technical confirmation before getting long the resources trade.

We still don’t truly have that confirmation, as GUNR continues to ride that downtrend line (see chart below). But, while we wait for some positive technical signals, there was another anecdotal piece of positive news for the resource sector yesterday.

Resources trade

In its earnings release yesterday, which was broadly positive and caused the stock to rally over 3%, BHP Billiton Limited (BHP) said that it would be deferring a project that would have seen an increase in production of iron ore, reflecting the fact that low prices are finally starting to crimp demand.

If that is the start of a larger trend, then that could be positive for iron ore prices going forward, as well as the general commodity complex. Again, it’s only anecdotal, but between that news; better price action form the resource names; a potential bottom in the Aussie dollar, and recent firming inflation, the anecdotal positives are starting to add up in the resource sector.

GUNR remains our favorite resources trade, but volumes have dropped off lately in that name for some reason (traded about 200k shares yesterday, and have an average volume in the mid-200k).

The reason I like GUNR is because it’s not a de-facto energy ETF disguised as a resource ETF (like IGE), and does not have a ton of chemicals exposure like the better know XLB (the Basic Materials SPDR).

I realize that for some, that volume is a bit of an issue (one of my longer-term subscribers wrote in Friday asking for alternatives), so I will continue to dig for something a bit more liquid that can benefit from this trade.

As soon as we get a technical breakout, I’ll add it to our “7 Best Ideas,” as the resources trade is something I’m starting to think can outperform into year end.

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A Big Move in Oil Prices

Commodity markets were mixed yesterday, as energy continued to rally towards resistance while the metals underperformed. The benchmark commodity ETF, DBC, rallied 0.60% thanks to the heavy weighting of energy within the portfolio and the big move in oil prices.

WTI crude futures rallied 2.41% Tuesday, as traders bid up oil prices in response to a report released by the North Dakota Industrial Commission’s Department of Mineral Resources that said production in the state declined to 1.18M barrels a day, down slightly from December’s record high of 1.23M bpd.

Today, oil prices will depend on two things—the EIA, and key technical levels. With regard to the EIA, analysts are calling for a more modest 3.6M barrel build for crude oil stockpiles, but the details of the report will have just as large an effect on oil prices today. Specifically, traders will be closely watching production metrics as they continue to speculate that falling rig counts are finally leading to a drop in production (that was supported by the North Dakota data released yesterday).

Also, Cushing, OK inventories will be in focus as a continued surge at the key storage location (which is the delivery point for WTI crude futures traded on the Nymex) has had a bearish effect on the oil prices.

Technically speaking, WTI crude futures have once again approached a “tipping point” on the charts. Supporting the bulls is a month-long uptrend in oil prices that has been tested upwards of six times, and held strong each time. That trend support in oil prices is sitting at roughly $52.30 this morning.

Meanwhile, there is resistance at the upper end of the 2015 trading range between $44 and $54, specifically the 2015 high in oil prices of $54.24. Also, the 100-day moving average is offering additional resistance as oil prices have not traded above that level since mid July of last year.

Oil prices

The core fundamentals of oil prices remain bearish for now, namely due to burgeoning supply level. Longer term, oil prices are likely to stay subdued. However, looking at the near term, if the bulls can push oil prices up through the aforementioned resistance, the recent gains will very likely be extended as shorts are forced to cover positions.

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Chinese Trade Balance: Not As Bad As It Seems

The March Chinese Trade Balance numbers are in, and they badly missed expectations, at least in terms of the headline number. But oddly enough, the details of the Chinese Trade Balance report offer more anecdotal evidence that the resource space may be bottoming.

On the surface, the Chinese Trade Balance was a big disappointment: Exports dropped nearly 15% vs. expectations of an 11% gain, while imports declined 11%, largely matching street expectations.

Given the peripheral concern regarding the Chinese economy, and specifically whether it can meet the 7% GDP growth target the government has set, the bad Chinese Trade Balance was taken as an obvious negative sign.

Interestingly, Chinese stocks actually rallied more than 2% following the release. That’s because first, the Lunar New Year in February likely created a lot of m/m statistical noise; and second, “bad” economic news is seen as encouraging more Chinese government stimulus, which is good for stocks.

So for now, “bad” data such as a downbeat headline Chinese Trade Balance report is “good” for Chinese stocks, as long as that 7% GDP growth figure holds.

More specifically to commodities and resources, the key sub-indicators to watch in this report are the commodity imports, and they were actually pretty good. Iron ore imports rose 2.4% m/m (saar), copper imports rose 34.1% m/m (saar), and steel rose 3.4% m/m (saar). The only real disappointment was coal, which saw imports collapse.

Bottom line: The Chinese Trade Balance data wasn’t as bad as the headlines implied, and the details actually are another piece of anecdotal evidence that resources generally are trying to bottom. To be clear, I’m not calling a bottom in resources, but the bullish case is building and this is a space.

Chinese Trade Balance

As such, we’re watching the FlexShares Mstar Glbl Upstrm Nat Res ETF (GUNR), an ETF pegged to the natural resources segment, as a barometer of action in the space.

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Q1 Earnings Season Starts Now

Although last week was the official beginning of earnings season, this week is when Q1 earnings season really begins as we start to get some bigger names—particularly financials—reporting results. For the broad market, earnings season is critical this quarter because of the potential of a further decline in the FY 2015 S&P 500 EPS.

Consider that we started the year in the high $120s, dropped to the current $118 per share, and that’s resulted in the 18X current year earnings “ceiling” in the S&P 500 declining to about 2,100. That level has been the ceiling for stocks for months. If that S&P 500 earnings number drops materially from $118, the ceiling on stocks will move lower, and that will pressure equities.

This week, most of the important results will be financial: JPMorgan Chase & Co. (NYSE:JPM) and Wells Fargo & Co (NYSE:WFC) Tuesday, Bank of America Corp (NYSE:BAC) and PNC Financial Services Group Inc (NYSE:PNC) on Wednesday, American Express Company (NYSE:AXP), Citigroup Inc (NYSE:C), Goldman Sachs Group Inc (NYSE:GS) on Thursday.

There is a decent chance these results could beat expectations thanks to stronger trading volumes in “FICC” (Fixed Income, Commodities and Currencies) so we could get a bit of an early earnings tailwind. And, if there was one earnings trade to be long here, I would say it was the larger money center banks on the chance of a trading revenue beat.

earnings season

Earnings season could mean a financials bounce.

More important, however, are industrials and tech earnings this quarter—especially the multi-national industrials like Honeywell International Inc. (NYSE:HON) and General Electric Company (NYSE:GE). They don’t start to report until next week, and it’ll only be then that we learn whether the S&P 500 2015 EPS will be lowered.

To a point, analysts will look beyond stronger dollar headwinds, and everyone knows the energy sector results will be very bad. But if we see deteriorating “linear” results (meaning March results that are worse than January) and cautious comments beyond just the dollar, stocks will react negatively to earnings season—and then the valuation issue will come into play.

Earnings will affect the market this week, but financials won’t get to the heart of the earnings season worries. It won’t be until next week that earnings season gets real—and that’s when we’ll know more about valuation levels in this market.

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