Did Trump Just Kill The Reflation Trade? April 13, 2017

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Did Trump Just Kill The Reflation Trade? An excerpt from today’s Sevens Report.

Trump - YellenPresident Trump, in an interview with the WSJ yesterday, appeared to change his policy on the Fed and interest rates. Specifically, Trump said he thought the dollar was getting too strong, that he favored a low interest rate policy, and he was open to keeping Yellen as Fed Chair. It was the second two comments that caught markets attention and caused a “dovish” response in the dollar and bond yields (both of which fell).

The reason these comments were a surprise was because it was generally expected Trump wouldn’t keep Yellen and was in favor of a more hawkish Fed Chair and appointing more hawkish Fed governors (there are currently three vacancies on the Fed President Trump can fill).

So, the market was expecting Trump to be a hawkish influence over the coming years, but yesterday’s comments contradict that expectation.

Going forward, from a currency and bond standpoint (the short term reaction aside) I do not see Trump’s comments as a dovish gamechanger for the dollar or rates. Yes, near term it appears the trend for the dollar is sideways between 99.50ish and 102 while the 10-year yield has broken below support at 2.30%.

But, I don’t see Trump’s comments sending the dollar back into the mid 90’s, nor do I see them sending the 10 year yield below 2%.

I also don’t expect this dovish reaction to be a material boost for stocks, because dovish isn’t positive for stocks any more (in fact the comments are causing the stock sell off this morning—more on that in minute).

Bigger picture, the longer-term path of the dollar and bond yields will be driven by growth, inflation and still ultra-accommodative foreign central banks.

Better economic growth (either by itself or with policy help) is the key to the longer-term direction of the dollar and rates (and we think that longer-term trend remains higher).

However, in the near term, his comments sent the 10 year yield decidedly through support at 2.30%, and that is causing stocks to drop as Treasury yields continue to signal that slower growth and lower inflation are on the horizon. And, since the market has rallied since the election on the hopes of better growth and higher inflation (i.e. the reflation trade) this drop in yields is hitting stocks.

The violation of support in the 10 year yield at 2.30% is important and a potentially near term bearish catalyst for stocks. If the ten year yield doesn’t stabilize and make some effort to rally over the next few days, a test of 2300 or 2275 in the S&P 500 would not shock me.

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Dr. Copper Flashes a Warning Sign

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Copper futures, which are often looked at as a gauge of economic growth expectations or a leading indicator for a growth-speculation rallies in stocks, broke down to fresh three month lows yesterday. The technical violation is a clear warning sign for risk assets in the near term.

 

Geopolitical Update: Bearish Catalyst or Excuse?, April 12, 2017

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Syria Political MapGeopolitical risk has reared its head over the past week, but while the potential military showdowns in Syria or North Korea are the focus of the media headlines, in reality these events aren’t so much direct risks on stocks as they are a reminder of just how priced to perfection the stock market is right now.

Getting more specific, it’s not that anything really got worse yesterday in Syria or North Korea (and if anything,Tillerson heading to Russia may help calm tensions). But rising geopolitical tensions are simply piling on right now along with growth and policy anxiety.

That said, there is always the possibility of more military action in Syria and/or North Korea, so I want to cover each situation briefly and review which sectors and assets are winners and losers during periods of heightened geopolitical stress (should we see one).

Syria: All about Russia. The Syrian situation is important from a geopolitical standpoint, because it indirectly pits the US against Russia. For context, Syria is in the middle of a horrific six-year civil war. The Syrian government and rebels have fought to a standstill for the last several years, thanks to Russia’s arming of the Syrian government and (likely) the US’ arming of the Syrian rebels. Given those proxies, sensationalists out there tout the possibility of the US and Russia getting involved in a military conflict due to their opposed positions.

That is the big fear; however, it is very, very unlikely that will happen. Syria simply isn’t that important to either nation, and apart from the human tragedy (which is quickly approaching Biblical standards for those poor people) that situation is much more bluster than battle.

North Korea: All About China. While Syria gets the headlines, North Korea is considered the much bigger actual geopolitical risk. The reason is partly because its leader, Kim Jong-un, is viewed as mentally unstable, and because the country has low-grade nuclear weapons.

This week, the situation has escalated after President Trump sent a US naval carrier group to patrol the waters off the Korean peninsula, a not-so-subtle reminder that the US is watching. But what likely prevents this standoff from becoming something more serious is China.

China basically funds North Korea’s economy, and it has long been believed that the only way to get North Korea to comply with international demands is through China.

From a geopolitical standpoint, it is very unlikely North Korea would launch a preemptive strike against the US, Japan or anyone else for fear of losing Chinese economic support. So again, while there are dangers, the likelihood of actual military conflict is low.

What It Means for Stocks

As we learned in 2016 with Brexit and Trump, just because something is viewed as being low probability doesn’t mean it won’t happen! With that in mind, there will be specific sector winners and losers if we see further elevated geopolitical tensions.

Sector Winners of Increased Tensions. Withheld for subscribers. Unlock with a free trial of the Sevens Report.

Sector Losers of Increased Geopolitical Risks. Withheld for subscribers. Unlock with a free trial of the Sevens Report.

Going forward, we don’t think geopolitics will be a major influence over stocks (and don’t think yesterday’s sell-off was caused by geopolitics). But as we said Monday, even a small uptick in geopolitical risks with valuations stretched and markets this optimistic could exacerbate any earnings, economic or policy-related pullbacks in stocks.

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Fed Balance Sheet Primer, April 11, 2016

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Fed Balance Sheet Primer

An excerpt below from today’s subscriber edition of Sevens Report.

Fed Balance Sheet Primer

Markets remain consumed by politics and geopolitics, but really the biggest macro surprise so far for 2017 came from the Fed last week, with the realization that they could begin to shrink their balance sheet in 2017. That event has potentially hawkish implications for bonds (bonds lower, yields higher), the dollar (higher) and stocks (increased headwind).

We initially warned about this possibility back in mid-March in our FOMC Preview. And, as we said back then, you’re going to be reading a lot more about this in the coming weeks, so I want to cover this topic more fully so that everyone has proper context.

Why Is The Fed Balance Sheet Important? The Fed balance sheet has ballooned over the past eight years given all the bonds it has purchased through the various QE programs. Unwinding that balance sheet without up-setting asset markets is quickly becoming the Fed’s highest priority.

To get specific, right now the Fed reinvests all the proceeds from a matured bond on its balance sheet—but that’s going to change. If the Fed gets $100 million in short-term Treasuries redeemed, right now it simply buys $100 million worth of new Treasuries. But when the Fed stops that reinvestment, that $100 million wouldn’t go back into the bond market, removing a source of demand.

The point is that when the Fed stops reinvesting principal, that will be potentially bond negative/yield positive, and that process needs to be managed very carefully considering the size of the balance sheet ($2.4 trillion in Treasuries, $1.7 trillion in mortgage backed securities).

When Will the Fed Stop Reinvesting All Bond Proceeds? Until last Wednesday, the unanimous answer would have been “2018.” But, following the Minutes, it’s looking more likely that the Fed could begin to end reinvestment of proceeds in December 2017.

Very Hawkish If:… Hawkish If:… Neutral If:… Dovish If:…

The above section is withheld for subscribers—sign up for a free trial to unlock.

What Will the Fed Stop Buying? Right now, the Fed rein-vests proceeds from both Treasuries and Mortgage-Backed Securities (MBS), so the question facing markets is whether the Fed will stop reinvestments in just one of these two securities, or whether it will stop reinvestments in both. Until the Minutes, it was assumed the Fed would only begin halting reinvestments in MBS (that way they could further support Treasuries, the more critically important market).

Hawkish If: … Neutral If: …

The above section is withheld for subscribers—sign up for a free trial to unlock.

How Will the Fed Stop Reinvesting Proceeds? The major question here is whether the Fed will slowly reduce the amount of reinvestment gradually, or whether it will just halt reinvestments all together. To illustrate the point, if one week the Fed has $100 million in bonds paying off, will they reinvest $50 of the $100 and reduce that number gradually over time, or will they just not reinvest any of the $100?

Given Fed history, a gradual reduction is what everyone expects; however, in the Minutes they talked about zero reinvestment, and it seems like the Fed is getting a bit antsy to get policy closer to normal.

Hawkish If:… Neutral If:…

The above section is withheld for subscribers—sign up for a free trial to unlock.

Bottom Line

This topic isn’t exactly exciting, and it won’t grab the headlines, but it is shaping up to be one of the bigger market influences in 2017. The reason why is simple: No one knows what’s going to happen to the bond market once the Fed begins to remove itself. On a percentage basis, it’s not like the Fed dominates the daily trading in Treasury markets. Yet sentiment is a funny thing, and the Fed needs to manage the unwind of a $4.1 trillion balance sheet successfully, because the potential for some sort of a market dislocation (especially in the age of algorithms and HFTs) isn’t insignificant. So, please keep this primer as a reference point, because I would be shocked if the Fed balance sheet doesn’t cause some sort of volatility in 2017 (beyond just the Wednesday reversal the news caused last week).

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Tom Essaye on “The Bell” Podcast with Dan Wiener and Adam Johnson

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I was a guest on Adam Johnson’s podcast “The Bell” last week. We talk auto sales, free tuition, and a lot more.

We were also joined by Dan Wiener, editor of the The Independent Adviser for Vanguard Investors, who shares his 5 favorite funds and most “liquid” investment.

Get a free two-week trial of Tom Essaye’s Sevens Report—everything you need to know about the markets in your inbox by 7am, in 7 minutes or less.

Last Week and This Week in Economics, April 10, 2017

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Last Week in Economics – 4.3.17

Signs of a slight loss of economic momentum continued last week, and while on an absolute level growth remains “fine,” stocks need consistently better data to off-set lack of action in Washington, and that’s simply not happening right now. As a result, stocks are “stuck” at the current levels and downside pressures are building.

Looking at the notable data releases last week, the jobs report was the headliner and it was “Too Cold” according to our preview. March job adds were 98k vs. (E) 175k while wages grew just 0.2% vs. (E) 0.3%. But, the unemployment rate dropped to 4.5%, which tempered the negative fallout and helped stocks shrug off the soft data.

The other two important numbers from last week were mixed. March ISM Manufacturing PMI slightly beat estimates at 57.2 vs. (E) 57.1. However, it declined from the February 57.7. Additionally, new orders, the leading indicator in the report, dipped to 64.5 vs. (E) 65.1.

March Non-Manufacturing PMI missed estimates at 55.2 vs. (E) 57.0, surprisingly hitting a five-month low. New Orders also dropped to 58.9 from 61.2 and employment plunged to a seven-month low at 51.6.

Looking at these PMIs, they’re a great reflection of the current economic data/market dynamic. On an absolute level, the data is strong (remember any-thing above 50 is expansion). But, incrementally we are not seeing improvement, and as such these data points are not helping power stocks higher like they were in Jan/Feb.

Finally, the most disappointing economic data point from last week was March auto sales, which dropped to 16.6M (seasonally adjusted annual rate, or saar) vs. (E) 17.4M saar. That number weighed on stocks last Monday, as worries about the car market and industry continue to quietly grow.

Turning to the Fed, there was a hawkish surprise in the FOMC Minutes last week, as they revealed the Fed may begin to decrease its balance sheet (i.e. buy less mortgage-back securities and Treasuries) later in 2017. Markets reacted hawkishly when this news hit on Wednesday (dollar up, bond yields up, stocks down) as this was a legitimate surprise (no one expected the balance sheet to start to shrink until 2018).

This is a potentially significant event, and it’s something we’re going to be detailing more this week, as any balance sheet reduction will increase upward pressure on bond yields. As we said last week, this was the first true surprise of 2017.

This Week in Economics – 4.10.17

As is usually the case following a jobs report week, the economic calendar is pretty sparse, with the three key reports all coming Friday (which is Good Friday, and markets will be closed).

March retail sales and March CPI will be released Friday morning. Retail sales is important because it’s the first opportunity for “hard” March data to move higher and meet surging sentiment indicators. A beat by retail sales would be a positive for the market and imply actual economic activity is starting to close the gap on sentiment surveys.

CPI is important because of the reflation trade. The market is pricing in rising inflation and better growth, so this CPI number needs to be Goldilocks. It has to be strong enough to show that inflation is consistent, but at the same time it can’t surge so much that it makes the Fed hawkish (an unlikely scenario).

Bottom line, if Retail Sales and CPI can show 1) Better growth and 2) Steady but not accelerating inflation, it’ll help offset the recent mild data disappointments and be a net positive for stocks.

Jobs Report Preview, April 6, 2017

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For the second month in a row the major issue for tomorrow’s jobs report is simple: Will it cause the Fed to consider more than three rate hikes in 2017? If the answer is “yes,” then that’s a headwind on stocks. If the answer is “no,” then stocks should comfortably maintain the current 2300-2400 trading range.

So, tomorrow’s jobs report is once again potentially the most important jobs number in years, as it has the ability to fundamentally alter the market’s perception of just how “gradual” the Fed will be in hiking rates.

“Too Hot” Scenario (Potential for More than Three Rate Hikes in 2017)

  • >250k Job Adds, < 4.6% Unemployment, > 2.9% YOY wage increase. A number this hot would likely ignite the debate about whether the Fed will hike more than three times this year (or more than 75 basis points if the Fed hikes 50 in one meeting). Likely Market Reaction: Withheld for subscribers. Unlock by signing up for your free trial: 7sReport.com.

“Just Right” Scenario (A June Rate Hike Becomes More Expected, But the Total Number of Expected Hikes Stays at Three)

  • 125k–250k Job Adds, > 4.7% Unemployment Rate, 2.5%-2.8% YOY wage increase. This is the best-case scenario for stocks, as it would imply still-stable job growth, but not materially increase the chances for more than three rate hikes in 2017. Likely Market Reaction:Withheld for subscribers. Unlock by signing up for your free trial: 7sReport.com.

“Too Cold” Scenario (A June Rate Hike Becomes in Doubt)

  • < 125k Job Adds. Given the market’s sensitive reaction to the soft auto sales report earlier this week, a soft jobs number could cause a decent sell-off in equities. As the Washington policy outlook continues to dim, economic data needs to do more heavy lifting to support stocks. So, given the market’s focus on future growth, the bottom line is bad economic data still isn’t good for stocks. Likely Market Reaction:Withheld for subscribers. Unlock by signing up for your free trial: 7sReport.com.

Skip the jargon, arcane details and drab statistics from in-house research, and get the simple analysis that will improve your performance. You can join hundreds of advisors from huge brokerage firms like Morgan Stanley, Merrill Lynch, Wells Fargo Advisors, Raymond James and more… see if The Sevens Report is right for you with a free trial.

Dr. Copper Remains Resilient

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Copper futures maintained gains in resilient trade yesterday despite the sharp reversal in stocks and general risk-off money flows. Continued strength in “Dr. Copper” could be signaling a retest of all-time-highs in stocks.

 

Bond Market Problems (That May Become Stock Market Problems), April 5, 2017

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This is an excerpt from today’s Sevens Report—everything you need to know about the markets in your inbox by 7am, in 7 minutes or less.

One of the reasons I watch all asset classes so closely is because I’ve learned that other sectors often will confirm (or not confirm) a move in the stock market. Right now we are getting a pretty notable non-confirmation from the bond market.

Bond market problemsSpecifically, when stocks rally I like to see: 1) Bond yields rising, which reflects investors expecting greater economic growth and inflation (two stock positive events). 2) A steepening yield curve, which also reflects rising inflation expectations and increased demand for money via loans (something that has been sorely missing from this recovery). 3) I like to see “riskier” parts of the bond market, specifically junk bonds, rising (or at least holding flat) as investors show confidence in corporate America by lending money to riskier companies in search of greater yield (it’s an anecdotal risk-on signal).

Throughout Q4 2016, that’s exactly what we got. First, the yield on the 10-year Treasury rose from 1.54% in late September, to 2.40% at year end. Second, the yield curve steepened as the 10’s-2’s spread rose from 0.81% on Sept. 29 to 1.25% on Dec. 30. Finally, junk bonds were broadly flat during that period (although with notable volatility).

Since the start of 2017, the opposite has occurred. The 10 year started at 2.44% but now is sitting at 2.35%. The 10’s-2’s spread has decreased from 1.23% on Jan. 1 to 1.11% on Monday (the low for the year). Finally, junk bonds rallied through March with stocks, but have since given back some of those gains. If JNK (the junk bond ETF) breaks $36.19 that will be the first “lower low” of 2017, and a negative technical signal.

Point being, the bond market is reflecting an outlook that is comprised of slower growth, less inflation, and more general concern—which is almost the exact opposite of what we’re seeing in stocks right now.

To be clear, this non-confirmation isn’t a guaranteed death sentence for a stock rally. Bond markets gave non-confirmation signals consistently in 2015 when Europe was on the verge of deflation because of the flood of European money into Treasuries, which sent bonds higher and yields lower despite a stock rally. But, that’s not happening now.

So, the “gaps” in this environment are growing in size and number. The gap between political expectations and likely reality regarding tax cuts is as wide as it’s even been. The gap between hard and soft economic data continues to widen as sentiment indicators continue to surge. Now, the gap between bond market direction and stock market direction is widening.

Bottom line, the trend in stocks remains higher, but there are cracks appearing in the proverbial ledge stocks are standing on, and we better get some positive catalysts soon, otherwise we are in danger of a real pullback.

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S&P 500 Technical Update

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The S&P 500 is currently in a consolidation pattern with key support lying at 2328 while downtrend resistance has moved down to 2367 today.

 

The S&P 500 has been consolidating the late February/early March sprint to new highs for 5 weeks now. And while the long term trend remains higher, there are a few technical levels worth watching in the near term (see chart for visual on initial levels).

  • Initial, key support lies between 2328 and 2341
  • Longer term, key support is between 2275 and 2300
  • Initial downtrend resistance is sitting at 2367
  • The next medium term, upside target, determined by a measured move is to 2473