Commodities

August Jobs Report Preview

Simply put, the August jobs report is the most important in years, and it will decide whether the Fed hikes in September, or delays to October or December (or 2016). Given all of the recent stock market volatility, the bar for a hike in September is pretty high, but not unattainable.

If the August jobs report is “Too Hot,” look for that to initially weigh on stocks. However, I don’t think it’ll be a major bearish influence and it would actually make me more positive on growth sectors here in the US because the hike will imply a decent level of confidence in the economy from the Fed.

August jobs report

If the August jobs report is “Too Cold” or “Just Right,” expect an initial dovish reaction and a stock rally. That will not be a catalyst for a sustained rally in stocks, as Fed uncertainty will be with us for months to come. While that won’t cause stocks to trade lower by itself, it will be a headwind on markets going forward, and it will reduce the potential for a year-end rally.

The “Too Hot” Scenario (What it Takes to Hike in September)

> 275k Job Adds. If we see a 275k or higher jobs report, the chances of a hike in September will likely go back above 50% (although barely so) making a September rate hike basically a coin flip (which is not priced into stocks right now).

< 5.2% Unemployment Rate, ≤ 10.5% U-6 Unemployment Rate. In the March statement the Fed lowered “NAIRU” to 5.0% and below, so it’s going to take a material drop in the unemployment rate (bringing it close to 5%) to increase the chances of two Fed rate hikes.

> 2.4% yoy wage increase. Data on wage gains has wavered recently, so it’ll take an almost impossible jump in the yoy wage numbers to make the Fed consider two hikes.

The “Too Cold” Scenario (No Hike in 2015)

< 150k Job Adds, ≤ 2.1% yoy wage increase. This number will be technically “dovish” but it’s not a positive for stocks or the economy, so fade any material rally on a number this weak. The Fed wants to get at least one hike in, and if the job market starts to soften and the Fed feels the economy isn’t strong enough for one hike, that’s not going to be good for risk assets.

The “Just Right” Scenario (No Hike But Oct. or Dec. Still Likely)

160k—270k Job Adds, 5.4%-5.6% Unemployment Rate, 2.1% – 2.3% YOY wage increase. The range for this number to be “just right” or “Goldilocks” is pretty wide, and anything in this range likely means no hike in September, but still a high probability of a hike in October or (more likely) December.

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A Contrarian View on Crude Oil

Crude oil futures are in the red this morning, as they were yesterday morning, as another wave of global growth worries weighed on investor sentiment, and traders took profits following last week’s historic short-squeeze rally.

However, there was a sharp change in direction mid-morning as multiple bullish catalysts spurred another wave of short covering in crude oil, and both Brent crude oil and WTI crude oil futures finished the day with solid gains, up 6.67% and 7.34%, respectively.

The first catalyst for crude oil was a headline that OPEC “stands ready to talk to all other producers,” which led many traders to believe they may be reconsidering their stance on global production, and willing to make cuts in production.

On the domestic front, the EIA said that U.S. crude oil output has been lower than initially estimated, down from 9.4M b/d to 9.3M b/d in June. There were multiple other notable revisions to the data, all of which were bullish.

crude oil

Additionally, there was a halt in production in one of Canadian Oil Sands Ltd.’s projects that averages 207.7K b/d, which could ultimately have an effect on weekly U.S. crude oil supplies.

Bottom line, there were a lot of bullish headlines that drove oil futures higher yesterday, but the recent price action has been emotional and overdone as futures have rallied 30.7% trough to peak over the last week.

The market is now way over-extended and long overdue for a near-term correction back towards the low-to-mid $40s. Having said that, I would not feel confident shorting this market with as much momentum as there has been to the upside, and if there are still a large number of shorts in the market, the rally could potentially continue into the latter half of the week.

On a contrarian note, in doing some historical analysis on crude oil we found that the overwhelming majority of rallies as sharp and fast as the one from the past three days (more than 30% trough to peak) occur in oil bear markets, which is making us cautious of this sharp move.

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The Economic Data is Better

Last week, US and European economic data helped remind nervous markets that so far, US and European economic data growth remains decent. While the possibility still exists that Asian (primarily China) turmoil could cause a US or European slowdown, last week’s economic data is better than what the markets are reflecting.

The highlight of the week in terms of economic data was the Durable Goods number, which beat estimates and enjoyed positive revisions to June. Importantly, the key sub-index, Non-Defense Capital Goods ex-Aircraft, rose 2.2% in July and the rolling three-month average, which is a good proxy for business investment, turned positive for the first time this year.

That Durable Goods number was important because it helped contradict the economic data of the underwhelming flash PMIs from two weeks ago, and Durables was anecdotal evidence that the manufacturing sector (while still plodding along) wasn’t getting materially worse, and that’s key.

The other big economic data number last week was revised Q2 GDP, which was much stronger vs. expectations at 3.7% vs. (E) 3.2%. More important than the headline were the strong details within the report. Non-Residential Fixed Investment (Business Spending), PCE (Consumer Spending) and Final Sales of Domestic Product all drove the number higher, and that implies that through Q2 2015 the consumer and businesses are spending more than we initially thought or expected.

Point being, this was a legitimately strong number and likely will be touted by the hawks later in September (although by itself it isn’t enough to make a rate hike in September a greater than 50% proposition given the stock market).

economic data

Economic data in housing also continued to beat estimates, and housing remains a very quiet but forceful tailwind on the economy. Earlier last week New Home Sales slightly beat estimates and while two separate measures of home prices (Case-Shiller and the FHA Housing Price Index) both slightly missed estimates, it was only because of positive revisions to June data.

Later last week, the economic data showed that Pending Home Sales slightly missed estimates but still rose in July (0.5% vs. (E) 1.0%) and the bottom line is that July housing data was almost universally supportive of a still-improving housing market.

When this selloff accelerated two Wednesday’s ago, we made very clear that it was totally detached from economic data reality, and the data last week confirmed that. Obviously risks remain that this turmoil begins to affect the global economy, but the bottom line last week was that the US economic data was good, and while it didn’t cause stocks to reverse, it certainly helped.

Bottom line: the economic data is not nearly as bad as the market would have you believe.

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The Fed Comments Aren’t What They Seem

Expectations for Fed policy have shifted over the past week thanks to stock market volatility and Fed comments from two prominent FOMC members, Atlanta Fed President Lockhart and Vice Chair William Dudley. The stock market volatility is obviously dovish for the Fed near term, and that was confirmed by the Fed comments from Lockhart and Dudley, as they both backed away from a September rate hike.

Yet despite this dovish Fed comments, bond yields have rallied and erased last week’s declines, and the long bond has dropped sharply over the past two days. To understand why (and why it can keep happening) it’s important to understand the full context of the Fed comments by Lockhart and Dudley.

Both men basically said the same thing this week, that the chances of a rate hike in September have diminished but the prospects for a rate hike in 2015 are still strong (so October or December).

Now, taken in the context of the yield curve, this matters to bond investors. Up until this latest bout of market turmoil we’ve seen consistent selling in the 2-year Treasury, as investors priced in a hike in September. Simultaneously, the 30-year Treasury bond rose significantly as investors priced in a “one and done” rate approach where the Fed would hike in September, but then delay future hikes more than previously expected, making longer-dated bonds more attractive.

Fed comments

That trade is now unwinding, and we are seeing 2-year Treasuries more buoyant, while the 30-year Treasury comes for sale.

This is because while the Fed comments make a September rate hike unlikely, a hike in 2015 does remain likely (for now). More importantly, it is probable now that the Fed may feel the need to play “catch up” given the delayed liftoff, and that makes the “one and done” less likely, and 30-year Treasuries less attractive.

This matters because 1) It could signal good news for Inverse Bond ETFs (which need all the good news they can get lately), and 2) It is steepening the yield curve, which will become a tailwind on bank stocks if this continues.

Fed comments

Bottom line—while Fed comments make a rate hike in September less likely, a hike in 2015 remains the general market expectation. And, in the perverse logic realm in which we now operate, waiting to hike until later this year could actually be a negative influence the long bond (assuming they actually do ever hike, which is debatable at this point).

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When Can We Hope for a Bottom in Stocks?

In yesterday’s post, I identified six events that have to happen before we can see a bottom in stocks. Equally important as “What” will result in a market bottom is “When” we will see a bottom in stocks.

Let’s go over the timeline for each of the six here, but keep in mind that for markets to stabilize, only some of these events need to happen. But, for it to be a legitimate “All Clear,” we need all of them to occur.

  1. Markets need to see competence from Chinese authorities. When: Just Happened. China just announced it is cutting one-year lending rates, and more importantly dropping reserve requirements. This step alone won’t solve the developing confidence problem with Chinese authorities, but it is a positive step—and the first step to a bottom in stocks.
  1. Economic data does need to stabilize in China. When: Early September. Unfortunately, the next round of Chinese data won’t come until Sept. 8, with August Trade Balance.
  1. The Fed needs to get on one page and stop letting the market view the indecisiveness in real time. When: Saturday (Hopefully). Fed Vice Chair Stanley Fischer will speak Saturday at the Jackson Hole Central Bank conference, and he needs to project confidence and certainty in the Fed’s outlook and strategy.
  1. US economic data needs to stay decent. When: This week for starters, but really the next big number is Sept. 3 (the August jobs report).
  1. Oil needs to bottom. When: There are signs of fundamentals turning, but it’s not likely imminent. Until oil settles, a bottom in stocks isn’t likely.
  1. People need to get back to work (i.e. trading desks need to get back to full staff and add human liquidity). When: After Labor Day (Tuesday Sept. 8).

Enough can happen near term so that stocks stabilize this week if what Chinese authorities just did instills some confidence, and if the Fed gets on message.

Given everything else, we likely won’t be able to declare a real bottom in stocks until September at the earliest—and not until we’ve got the August jobs report; know what the Fed’s going to do; have a chance for oil to stabilize, and have seen the latest data from China.

That doesn’t mean stocks will continue to free fall from now until then, but be wary of anyone declaring a real bottom between now and the second or third week of September.

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What Will Make This Selling Stop?

The brutal selling of last week has extended into the pre-open on Monday, with the Dow signaling it will open some 600 points to the downside. We know that this selling was due to global slowdown fears coming out of China, the commodities collapse and Fed uncertainty. Now we need to figure out what will make this selling stop.

The way we see it, five key things must happen to make this selling stop.

First, markets need to see competence from Chinese authorities. More so than the actual data, it’s the loss of the perception that Chinese authorities know what they are doing that’s fueled this spread of China-related angst. Part of the reason the rout is continuing this morning is because we heard nothing from Chinese authorities over the weekend, which, rightly or not, reinforces the idea they don’t know what they are doing—and that’s not going to make the selling stop.

Second, economic data does need to stabilize in China, but near term the former is more important than the latter (the next round of China data comes in September).

Third, the Fed needs to get on one page and stop letting the market view the indecisiveness in real time. As we said last week, even if they don’t know what they are going to do, just PRETEND. Confidence in policymakers is a key ingredient for if we want to see this selling stop.

selling stop

Fourth, US economic data needs to stay decent and refute this growing perception that China is outsourcing the next great financial crisis (which there is very little evidence it is actually doing, so far).

Fifth, oil needs to bottom. Oil forecasted this decline, and it needs to bottom before stocks can stabilize, and before we can see this selling stop.

Finally, people need to get back to work. Trading desks are empty and there is very light volume, and that is exacerbating these declines. The outlook for the US economy and US based companies is not 8% worse than it was a week ago, and much of these waterfall declines are thanks to algos crushing futures and ETFs, which is dragging the entire market down. We need people back on desks to make this selling stop.

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Is it Time to De-Risk?

The nexus of this de-risk pullback lies in global growth fears, which began back in June when commodities (and oil) went into freefall. Despite being primarily a supply driven phenomenon, the commodity decline was combined with sluggish data in China to ignite concerns about a China-driven emerging market slowdown.

Those initial growth fears, and the de-risk that followed, were isolated through June, but when combined with the Chinese authorities bungling of their crashing stock market, a lack of confidence was introduced that exacerbated the problem.

Adding to that notion was the surprise yuan devaluation. Not only did it reinforce Chinese growth concerns, that devaluation now is viewed as an export headwind to Europe and Japan, and because of that (and some slightly disappointing data) the growth outlook for those regions is under attack.

Then came the Fed Wednesday.

US growth, sluggish though it may be, was still the bright spot, and a virtual island of relative strength in a global sea of stagnant growth.

Then the FOMC Minutes revealed a “wishy-washy” Fed, which the markets have interpreted to mean that US growth may not be so good after all. The Minutes removed the one thing that can help stocks near term: Certainty over a rate hike.

What started as a China growth story has morphed into a global growth worry, thanks mainly to commodities plunging combined with a loss of confidence in leadership (Chinese authorities mainly, but the Fed is playing catch up with all this confusion).

de-risk

Adding to this de-risk environment are the charts turning more negative by the day. Dow Theory is bearish, and in the S&P 500 support at the 100-day moving average has been erased and the 200-day moving average has been broken, as have the lows from mid-July.

So, a logical question to ask is: “Do we need to get de-risk and get much more defensive?”

Given the tape and how ugly yesterday was, anyone can be forgiven for saying, “Yes.” And if I were just a technical trader, the answer would definitely be yes.

But despite the ugly trading, for now, we are not getting materially more defensive, and here’s why.

First, economic data isn’t as bad as the price action implies. US numbers were good yesterday, European numbers have been decent, and Japan is just plodding along as they have been. There has been no collapse of global growth (although you wouldn’t know that by the price action).

Second, the lack of attendance and volumes is exacerbating these declines. Total volume on the NYSE was barely above the 100-day average, and well below recent sell-offs, which is odd given it was the worst day of the year.

Third, it’s not clear the Fed won’t raise rates in September. I realize that’s become the popular notion over the past two weeks, but the fact is the data in the US remains good, and a rate hike is by no means out of the question.

Despite the near-100-point drop in the S&P 500 during the last month, the index is still flat on the year (basically). While the lack of catalysts until the August jobs report on September 3 means there is a good chance this market trades lower on weak volumes, the chance of a sharp reversal if the Fed does hike rates and signals some confidence on growth is very real.

We would rather hold on here rather than de-risk, and take some more incremental pain in order to potentially capture 100-150 or so S&P 500 points on a rebound.

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Fed Pilots Don’t Inspire Confidence

Yesterday, the FOMC Minutes were taken as incrementally “dovish” thanks mainly too a lack of enthusiasm for a rate hike, and consistent mentions of China risks and too-low inflation. The Fed pilots didn’t remove a chance of a September rate hike, but they did legitimately reduce them, which isn’t a good thing for markets, as we’re seeing this morning.

That “dovish” message, which seemingly contradicts much of the other things we’ve been hearing from the Fed pilots, contributed to greater volatility in the markets late yesterday afternoon.

Now, I’m all for transparency, and generally speaking, more information is a good thing, although there are exceptions.

Being in an airplane is one of those exceptions where transparency isn’t always a good thing. We don’t need to know every detail of the flight or every warning light that goes off. We just need to know that the pilots are confident we’re all going to get to our destination in one piece.

With that in mind, right now I feel like I’m in the back of a plane, and on the in-flight entertainment system I can hear the flight attendant talking to the pilots in the cockpit.

Flight Attendant (Market): “Is it safe to land yet?” (i.e. raise rates)

Pilots (Fed): “We don’t know. It depends on the weather.” (i.e. the economy)

Flight Attendant (Market): “Well, what’s the weather like?”

Pilots (Market): “It’s not bad right now and basically the same as it’s been, but it could get worse.”

Flight Attendant (Market): “Well, ok, what are we going to do? The passengers (investors) are getting nervous and restless and want to know what’s going. We’ve been descending for a really long time and we should have landed hours ago.”

Pilots (Fed): “We don’t know what we’re going to do yet, it depends on the weather.”

The Flight Attendant closes the door confused.

Then, the pilots turn on the PA system and all the passengers can now hear them argue about the weather:

Pilot 1 (Kocherlakota and the Doves): “We can’t land in this weather, it’ll be a disaster. We’ll never make it.”

Pilot 2 (Lacker, Bullard and the Hawks): “Yes we can, we can easily make it, now’s the time.”

And then they proceed to argue over the weather conditions and flight statistics over the PA for all to hear.

If I were on that plane, I wouldn’t be particularly confident about the outcome—and that’s the same way I feel about the Fed pilots.

Fed pilots

I am using this silly example to illustrate a point that exuding confidence is an important part of leadership. That’s a point that was best communicated to me by General “Stormin” Norman Schwarzkopf when I heard him speak while I was a student at Vanderbilt. I’ll never forget what he said during that speech: “When placed in command, take charge.”

Someone should tell the Fed that, or perhaps in a bit more direct way:

“Even if you don’t know what you’re doing, pretend!”

The Fed pilots have put us in purgatory/limbo, and that is beginning to weigh on all markets, as volatility is spiking in currencies, bonds, stocks, commodities, etc. The markets need to know the Fed pilots have a plan, and that they are in charge—and the longer that eludes us the worse this volatility will get.

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An Inflation Report and the Commodity Collapse

The best performer among currencies yesterday was the British pound, which hit a six-week high vs. the dollar thanks to a hotter-than-expected inflation report. And, the British inflation report is actually a good report to highlight because it points out how we all need to look at an inflation report going forward in the wake of the commodity collapse.

First, we can all generally ignore the headline numbers in an inflation report. Case in point, headline British inflation was up a paltry 0.1% yoy, slightly above the 0.0% expectation. But, the surprise was in “core” inflation which excludes commodities.

Core inflation popped higher, rising from 0.8% yoy to 1.2% yoy, in July. That’s still well below a high level of 2.0%, but the gain is notable—and again is anecdotal evidence that despite the commodity plunge, actual core inflation is showing signs of accelerating not just in the US, but in other regions as well.

inflation report

Commodity currencies were mixed as Aussie dropped 0.5% mostly in sympathy with new multi-year lows in the industrial metals while the Loonie rose slightly thanks to the rebound in oil.

Importantly, though, despite continued China volatility and new lows in commodities, Aussie and Loonie continue to trade above last week’s lows of 0.7201 and 0.7566, respectively.

I realize this may seem a bit odd to be focusing on these currencies, but the truth is that they are highly correlated to commodities and the global economy more broadly, and the fact that they may be trying to bottom could be a preliminary indication that the commodity slaughter is nearing an end. That’s why I continue to follow them and bring them up.

Perhaps more importantly, the British inflation report anecdotally reinforces my point that there’s really only one direction for inflation to surprise from here, and unless you’re in the camp that’s expecting a global deflationary depression, that direction is higher.

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A Busy Week of Macro and Micro

It’s a busy week of macro and micro events, as the FOMC Minutes will be the highlight economically along with CPI and global flash manufacturing PMIs. July quarter-end retail earnings continue this week with bellwethers Home Depot (HD), The TJX Cos (TJX), Walmart (WMT) (tomorrow morning), and Lowe’s (LOW), Target (TGT) (Wednesday).

We also get some important tech earnings come this week with NetApp (NTAP) (Wed) and Hewlett-Packard (HPQ), Broadcom (BRCD), CRM salesforce.com (CRM) (Thurs). Finally, all eyes will remain on China and the yuan. If it starts to fall again, look for more macro volatility.

There is a lot of important macro and micro data this week, and it will give us the most information regarding the probability of a Fed rate hike until the August jobs report, out September 4. The data this week will cause shifts in the probability of a September hike, so it will cause more volatility.

There are three “headline” macro events this week of equal importance. August Flash Global PMIs (out Friday morning) take on added significance because of recent China turmoil; the FOMC Minutes from the July meeting are obviously important, while CPI (also Wednesday) will give us more insight into whether inflation is continuing to show signs of putting in a bottom.

Starting with the global flash PMIs, this number is all about China. The latest reason the Fed won’t hike in September is potential Chinese turmoil, and recent Chinese government policy flailing has been in reaction to weakening data. Economic indicators need to show signs of stabilization for global markets to further stabilize, and for Fed rate hike expectations to rise.

macro and micro

The FOMC Minutes are always important, but this week they are especially so given the shifting expectation for a rate hike. In particular, analysts will be focused on getting more insight into what constitutes “some” additional improvement in the labor market from July, as that improvement was sighted as the lone impediment to a rate hike back in July. Basically, the FOMC very slightly implied September in the July FOMC statement, so any further insight into the mood of the Fed will be key for rate expectations.

Finally, CPI comes Wednesday, and while it is very unlikely to be a big upward surprise, any pressure on inflation will be taken as “hawkish,” as low inflation is an asset for the doves. Looking past those three macro and micro reports the latest round of housing data (July) starts Tuesday with July Housing Starts and then Existing Home Sales (Thursday).

Bottom line—this is the biggest week for data until that August jobs report, and it will set the expectation for the Fed until that jobs report is released.

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